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Wealth Building Opportunites for the Active Value Investor

The Mini-Skirt Forecast

Today’s featured stocks include Johnson Controls (JCI), Vertex Pharmaceuticals (VRTX); and a new addition to the Growth & Income Portfolio, TiVo (TIVO).

The Mini-Skirt Forecast—Cabot Undervalued Stocks

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The Mini-Skirt Forecast

The stock market remains somewhat quiet right now, with many stocks beginning to show improving price charts vs. a month ago. Still, I don’t expect stocks to surge upward this week.

Energy and financial stocks continue to show the strongest fundamentals. Price charts are more decisive in the energy sector than in the financial sector, with most energy stocks either sitting at somewhat reliable price support, or beginning to rebound.

Technology stocks make up a trailing third place, as measured by undervalued fundamentals. But there aren’t so many of them that I would necessarily purchase a sector ETF. When you scroll down to the Growth & Income Portfolio, you’ll see a new technology stock joining the portfolio today.

By the way, last week I wrote about General Motors (GM) for Cabot’s free publication, Wall Street’s BEST Daily. Click here to read “Don’t Listen to David Einhorn About GM Stock”.

Over the decades, it’s been easy for me to judge stock market peaks and valleys based on anecdotal investor behavior – although I certainly use other indicators to assess the direction of the market. When I constantly run into people who are discussing the stocks that they own, that’s when I know that we’re at a market top. And when I constantly run into people who are asserting that the market’s going to crash, that’s when I know we’re at a market bottom.

I am not including experienced stock investors like yourselves in that description. I’m talking about folks who don’t have long-term stock market experience. You probably remember how everybody and his brother was buying real estate in 2005 and onward. That’s how I knew the real estate market was going to crash. In the investment world, the crowd is always wrong. (Yes, I say that often, don’t I? Well it’s an important nugget of truth to absorb. It’ll help you make important financial decisions, when everybody you know is pressuring you to do the same thing.)

In the mid-1980’s, I worked as a wholesaler in the Liz Claiborne showrooms in Manhattan, while I was trying to figure out where I belonged in the working world. I remember my sales manager and co-workers getting excited about stock tips in 1986, shortly prior to the crash of 1987. It was notable behavior; both unusual and curious.

In early 1987, we were presenting our fall line of clothing to the buyers, and it featured a lot of brown colors and mini-skirts. I was disconcerted by that, because businesswomen don’t wear mini-skirts; and brown is not a wardrobe staple for most people. I had a sense of foreboding about the coming fall season. And then the stock market crashed in October. I’m sure the wardrobe and stock market problems were coincidental, but I’ll always associate them when I recall the October 1987 stock market crash.

Send your stock market stories to Crista@cabotwealth.com. I love hearing about your successes, and lessons
learned.
Portfolio Notes
Make sure to review the Special Bulletins from March 3 and 6, in which I mentioned news, rating changes and/or price action on BP plc (BP), Boise Cascade (BCC), Dollar Tree (DLTR), Exxon Mobil (XOM), GameStop (GME), Martin Marietta Materials (MLM), Royal Caribbean Cruises (RCL) and Vulcan Materials (VMC).

Buy-Rated Stocks Most Likely To Rise More Than 5% Near-Term:
BP plc (BP)

Today’s Portfolio Changes:
Johnson Controls (JCI) moves from Buy to Strong Buy.
TiVo (TIVO) joins the Growth & Income Portfolio with a Strong Buy rating.

Last Week’s Portfolio Changes:
Chipotle Mexican Grill (CMG) joined the Buy Low Opportunities Portfolio on March 30.
Vertex Pharmaceuticals (VRTX) moved from Strong Buy to Buy on March 29.

Growth Portfolio

Growth Portfolio stocks have bullish charts, strong projected earnings growth, little or no dividends, low-to-moderate P/Es (price/earnings ratios) and low-to-moderate debt levels.

Featured Stock: Johnson Controls (JCI - yield 2.4%)

JCI Chart

Johnson Controls (JCI) joined the Cabot Undervalued Stocks Advisor portfolios in October 2015. The company subsequently merged with Tyco and spun-off Adient plc (ADNT).

Johnson Controls is now a multi-industry company with the following business mix: fire & security services, residential and commercial HVAC/R (heating, ventilation, air conditioning and refrigeration), automotive batteries and building equipment. In March, the company signed an agreement to sell its Scott Safety division to 3M Company (MMM) for $2 billion. Proceeds will be used to pay down debt and repurchase stock. The market continues to assess the company’s future in light of last year’s M&A activity. HSBC began coverage on JCI with a buy rating last week.

Johnson Controls operates on a September calendar year. Analysts expect the company to achieve earnings per share (EPS) of $2.64 and $3.06 in 2017 and 2018. That gives the company a 15.9% EPS growth rate in 2018, and a P/E of 13.4. The stock is still undervalued, and therefore maintains its position in the Growth Portfolio. (We can’t easily derive a 2017 EPS growth rate, simply because last year’s merger & spin-off disrupt our normal apples-to-apples comparison measures.)

JCI was the best 2016 stock performer among its electrical equipment & multi-industry peer group, and almost the slowest performer so far in 2017. I’m moving JCI from Buy to Strong Buy today, due to the stable price chart, low price, strong EPS growth rate, low P/E and attractive dividend yield.

The stock is trading between 40.50 and 45.50. For those of you who like to buy low while the stock market is
resting, JCI presents a great opportunity today. Once JCI rebounds to recent highs around 45.50, it will still be undervalued. Given a moderately strong stock market, JCI could reach the upper 40’s in 2017. Strong Buy.

Growth Portfolio

Updates on Growth Portfolio Stocks

ADBE

Adobe Systems (ADBE) is a software company with aggressive earnings growth. Consensus earnings estimates rose another fraction last week, in the wake of a strong first quarter earnings report. The stock remains relatively fairly valued, with the P/Es equal to the EPS growth rates. ADBE could continue reaching new highs this month. Hold.

AIG

American International Group (AIG – yield 2.0%) AIG is a very undervalued diversified insurance company with strong projected earnings growth. The stock is trading between 60 and 67. Strong Buy.

DLTR

Dollar Tree (DLTR) is a North American retailer of discount merchandise. In a meeting with analysts last week, Dollar Tree’s CFO said that the 2015 acquisition of Family Dollar Stores continues to meet cost savings targets. In addition, the company is increasing its new store development targets from 7,000 to 10,000 stores for Dollar Tree, and from 12,000 to 15,000 stores for Family Dollar (up from current 6,000 and 8,000 stores, respectively). The company is also planning 1,000 stores in Canada.

Dollar Tree is projected to achieve much stronger EPS growth rates than its peers. Nevertheless, the stock is overvalued based on 2019 numbers (January year-end). I plan to keep the stock for an expected share price rebound. DLTR rose to short-term price resistance at 80 last week. We could see the stock retrace November’s high near 90. Buy.

GS

Goldman Sachs Group (GS – yield 1.1%) is an undervalued investment bank; that I expect to achieve strong double-digit earnings growth in 2018 and 2019 (December year-end). Last June, Goldman passed the
Fed’s annual stress test, with plans to increase both the quarterly dividend payout and the share repurchase authorization. Importantly, Goldman has not yet followed through with either piece of its capital plan. There’s a
dividend announcement coming up in mid-April, and it’s been two years (eight quarters) since Goldman last increased its dividend. We might see a dividend increase this month. GS could trade anywhere between 210 and 255 in the short term, prior to its next upside breakout. Strong Buy.

MLM

Martin Marietta Materials (MLM – yield 0.8%) is an aggressively growing supplier of construction aggregates. Jim Cramer recommended MLM and Nucor (NUE) on March 31, in relation to national infrastructure projects. (Nucor is a great company, but EPS growth is expected to slow to 7.8% in 2018.) In addition, TheStreet published an extensive technical analysis of MLM last week, and Citi began analyst coverage of MLM with a Buy rating. The stock has been trading between 205 and 240 this year. I expect it to surpass that trading range later in 2017. Strong Buy.

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PulteGroup (PHM – yield 1.5%) is an undervalued homebuilder with aggressive earnings growth. Here’s a FastMoney discussion of the potential NAFTA renegotiation and various stock recommendations, including PHM at the 3:30 minute mark in the video. PHM broke past four-year upside resistance in March, and is trading between 23 and 24. I expect a sustainable run-up. Buy PHM now. Strong Buy.

PWR

Quanta Services (PWR) is a power management company. Quanta hosts its 2017 Investor Day on April 4. In response, there could be an increase in trading and new analyst reports in the coming days. Read more about PWR in this Zacks research report. PHM is trading between 35 and 39, and could easily break past 39 during the next bullish move in the broader market. Buy.

VMC

Vulcan Materials (VMC – yield 0.8%) is an aggressively growing supplier of construction aggregates, asphalt and concrete. Citi began recommending VMC last week. The stock had a big price correction this winter, and now appears ready to ratchet upwards. There’s upside price resistance at 135. Strong Buy.

XL

XL Group (XL – yield 2.2%) is a very undervalued global property & casualty insurer. Read more in this recent research report from Zacks. XL has traded between 39.50 and 41 for the last seven weeks. Strong Buy.

Growth & Income Portfolio

Growth & Income Portfolio stocks have bullish charts, good projected earnings growth, dividends of 1.5% and higher, low-to-moderate P/Es (price/earnings ratios), and low-to-moderate debt levels.

Featured Stock: TiVo (TIVO - yield 3.8%)

TIVO

TiVo is a digital entertainment company that provides technology licensing and related services, which enable people to access online and televised entertainment. The company has about 6000 existing and pending patents on intellectual property. TiVo serves 25 million homes in over 70 countries. The stock is typically compared to technology peers such as Universal Electronics (UEIC), Qualcomm (QCOM) and
Microsoft (MSFT).

Rovi purchased TiVo for $1.1 billion in September 2016, and changed the merged-company’s name to TiVo. The new Tivo is led by experienced management from Rovi, while several former TiVo board members have joined the new board of directors. TiVo sells to most major electronics manufacturers and entertainment service providers, except Comcast (CMCSA).

Management expects revenue to grow from $800 million in 2016 to $1 billion in 2018; and to achieve $100 million in cost synergies, with 65% of the savings to take place in the first 12 months.

The merged company reported $1.42 earnings per share (EPS) in 2016 (December year-end). The consensus estimate of five analysts projects $1.60 and $2.26 EPS in 2017 and 2018, representing 12.7% and 41.3% growth rates. The corresponding P/Es are 11.6 and 8.2. This stock is seriously undervalued.

In an important recent development, TiVo declared its first-ever quarterly dividend this winter. At $0.18 per share, that amounts to an annual yield of 3.8%. Frankly, it’s highly unusual for a new dividend to be so big; akin to starting up a sports car and going from zero to 100 in five seconds.

The long-term debt-to-capitalization ratio is 34%. I’m pleased with any number below 40%, especially in light of Rovi’s history of acquisitions, indicating that management is handling the balance sheet well.

TIVO is a small-cap stock. Investors should be aware that small-cap stocks tend to be volatile.

The share price rose to a recent high of 23.40 at the time of the early-September 2016 merger, and later ratcheted down near 18.00 by early February 2017. You can see on the price chart that the share price spiked upward in mid-February when the new dividend was announced, but the stock hadn’t established price support yet from its recent decline, so it promptly returned to 18.00.

I think we’ve seen the bottom of the new company’s trading range. There’s strong projected earnings growth and a big dividend yield which will attract both growth investors and dividend investors.

As the company begins reporting post-merger quarters, and the market gains confidence in the company’s direction, management and profitability, we could see TIVO retrace its recent high around 23, giving new buyers a potential 24% capital gain in 2017. Strong Buy.

Growth and Income Portfolio

Updates on Growth & Income Portfolio Stocks

BP

BP plc (BP – yield 6.9%) is a very undervalued integrated oil company that’s based in London. Consensus earnings estimates continue to shift for BP. EPS are expected to rise 164% and 22.5% in 2017 and 2018 (December year-end); with respective P/Es of 15.5 and 12.7. BP is now rising above its February/March trading range. There’s upside resistance at 38, at which point the stock will still be quite undervalued. Buy BP now. Strong Buy.

BX

Blackstone Group LP (BX – yield varies between 3% and 6%) is an alternative asset manager. Limited partnership distributions are reported on a Schedule K-1 tax form for income tax filing purposes. The stock is undervalued and the price chart is moderately bullish. BX has traded between 28.50 and 31 all year, and could rise to price resistance between 38 and 39 this year. Strong Buy.

XOM

Exxon Mobil (XOM – yield 3.6%) is an undervalued integrated oil company, projected for aggressive earnings growth in 2017 and 2018. Last week, the company announced a new oil discovery in offshore Guyana. XOM is low within its trading range, between 81 and 92, and appears ready to rise. Buy XOM now. Strong Buy.

GME

GameStop (GME – yield 6.7%) is a retailer of games, collectibles and technology; with additional ventures in the entertainment field. Hold GME for the large dividend and a near-term rebound to 26. Hold.

HRB

H&R Block (HRB – yield 3.8%) is a nationwide tax preparation company that’s expected to achieve 5-6% annual earnings growth in 2017 and 2018 (April year-end). The stock is volatile, recently trading between 22 and 24.50. Hold.

RCL

Royal Caribbean Cruises (RCL – yield 1.9%) is a cruise vacation company. RCL is slowly rising to medium-term price resistance at 102. Hold.

WHR

Whirlpool (WHR – yield 2.3%) is a global manufacturer of home appliances. The stock is undervalued, with double-digit earnings growth. Whirlpool has been increasing its dividend annually during the third week
in April. WHR has traded between 170 and 190 since early January. Buy WHR now. Strong Buy.

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks have neutral charts, strong projected earnings growth, low-to-moderate price/earnings ratios (P/Es) and low-to-moderate debt levels. (Dividends are not a portfolio requirement, but some of the stocks will have dividends.) Investors should be willing to wait patiently for these stocks to climb.

Sometimes a stock in the Buy Low Opportunities Portfolio produces good capital gains and the share price is no longer low, yet the stock remains an attractive investment. Those stocks will then be moved into the Growth Portfolio or the Growth & Income Portfolio.

Featured Stock: Vertex Pharmaceuticals (VRTX)

VRTX

I often remind investors that a common reason a stock can be undervalued is that a company has changed in a dramatic way, but the market has not yet perceived where the company is going. Here are a few common reasons that investors might be stuck in the past:

• A company used to lose money every year, but now it’s turning a profit.

• A company had a scandal, such as tax-reporting irregularities, but new management has resolved the former problems.

• A company made a big change in its revenue model, which temporarily impacted profitability.

• A company was harmed by a big one-time problem—a fire in a chemical plant, an E. coli outbreak—and again, management is working harder to prevent such problems in the future.

Vertex Pharmaceuticals (VRTX) is such a company, having turned a profit in 2016 after a very long string of annual net losses. There’s nothing unusual about biotech companies losing money … I’m just not inclined to invest in them, because they don’t fit my stock investing strategy. But once they become profitable, I’m willing to focus 100% on their future.

As a result of Vertex’s new path to profit, I added the stock to the Buy Low Opportunities Portfolio in July 2016. Vertex is a biotech company that produces drug therapies, predominantly serving people afflicted with cystic fibrosis. Last week, Vertex reported on a successful Phase III trial of Tezacaftor/Ivacaftor, a new cystic fibrosis combination treatment, generating a huge spike upward in the share price. Vertex also has three Phase II triple combination drug therapy studies in place.

In my March 29 Special Bulletin, I mentioned that there are currently 26 analysts covering the stock and issuing earnings estimates. As a result of last week’s good news, most of these analysts will be issuing updated research reports to their retail and institutional clients, generating additional excitement and confidence in the stock. One such analyst upgrade was featured a few days ago, in this Barron’s article.

Consensus earnings estimates edged up a little last week. Wall Street expects EPS to grow 88.2% and 91.3% in 2017 and 2018 (December year-end); with corresponding P/Es of 68.3 and 35.7. Those are high P/Es, but as long as they are below the EPS growth rates, I’m very comfortable with those numbers. Analysts’ consensus estimates project Vertex’ EPS growing by 62% per year for the next four years, and for revenues to double to $4.0 billion.

Importantly, VRTX did not give back any of its share price gains after last week’s run-up. Still, a pullback would be normal; and lacking any bad corporate news, VRTX pullbacks should always be considered buying opportunities. The best-case scenario this year is that VRTX could rise all the way to its 2015 high around 140. Buy.

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Updates on Buy Low Opportunities Portfolio Stocks

ADM

Archer Daniels Midland (ADM, yield 2.8%) is a manufacturer and processor of agricultural commodities. ADM is climbing towards price resistance at 47, where I may sell because the 2018 P/E is now higher than the 2018 expected earnings growth rate. Hold.

BCC

Boise Cascade (BCC) is a very undervalued and volatile aggressive growth wood products manufacturer and building materials distributor. BCC has traded between 26 and 29 for eight weeks. There’s longer-term price resistance at 32. Buy BCC now. Buy.

CMG

Chipotle Mexican Grill (CMG) is a restaurant chain with over 2,200 locations, mostly in the U.S., and mostly serving Mexican food. Last week, when I introduced CMG into the Buy Low Opportunities Portfolio, I mentioned that the company has no long-term debt and strong EPS growth, making it a possible buyout target. CMG has one-half the market cap of Yum! Brands (YUM), one-tenth the market cap of McDonald’s (MCD), and much lower market cap than Starbucks (SBUX) and Restaurant Brands International (QSR). So if you’re wondering who could potentially surprise the market with a buyout offer, those are the main contenders among restaurant companies. And of course, non-restaurant companies and investor consortiums could additionally make an offer for CMG.

CMG appears to have begun its rebound last week. There’s upside resistance at 530, and more at 750. Strong Buy.

LM

Legg Mason (LM – yield 2.4%) is a seriously undervalued asset
management & financial services company with aggressive earnings
growth. LM has traded between 34.50 and 37.50 for eight weeks. There’s
additional upside resistance at 40. Buy.

MAT

Mattel (MAT – yield 5.9%) is a global toy manufacturer. Here’s an interview with Mattel’s COO regarding the Barbie brand. MAT is a very undervalued aggressive growth stock. MAT fell down to the mid-20’s ten weeks ago. It’s not yet ready to rebound. Anybody who buys now will lock in a big dividend yield and the potential for large capital gains this year. Buy.

SCHN

Schnitzer Steel Industries (SCHN, yield 3.6%) is a scrap metal recycling company. Schnitzer pre-announced second quarter results on March 22 (August year-end), with final results to be reported on the morning of April 6. The company expects to report EPS in the range of $0.37 to $0.40, while the analysts’ estimate is $0.33; so clearly, there will be an upside earnings surprise which is not yet reflected in the share price. SCHN is an undervalued aggressive growth stock. SCHN has traded down to price support that was established in October 2016. Strong Buy.

TSO

Tesoro (TSO – yield 2.7%) is a petroleum refining and marketing company. Tesoro intends to increase EPS through a combination of organic growth and acquisitions. TSO is an undervalued aggressive growth stock. Buy TSO now while it’s low within its trading range. Buy.

THR

Thermon Group Holdings (THR) is an electrical equipment company. The stock appears capable of surpassing upside resistance at 21 this week. There’s additional price resistance at 25. Buy THR now. Strong Buy.

TOT

Total SA (TOT – yield 5.3%) is an international oil and gas company that’s based in France. TOT is a greatly undervalued, aggressive growth stock. TOT has been trading between 48 and 52 since December. Strong Buy.

UEIC

Universal Electronics (UEIC) is a consumer electronics company. UEIC appears to have begun climbing toward upside price resistance in the upper 70’s. Hold.


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Send questions or comments to crista@cabotwealth.com.
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