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There are four takeaways from this piece you must know. We’re removing Coach from the Dividend Growth Newsletter portfolio, Buffett may no longer be against paying a dividend at Berkshire, US unemployment now stands at 4.4%, and market valuations remain frothy.

By Brian Nelson, CFA

In the financial world, Berkshire Hathaway’s (BRK.A, BRK.B) annual shareholder meeting probably received the most attention the first weekend of May, and we continue to be content with including shares of the Oracle of Omaha’s brainchild in the Best Ideas Newsletter portfolio. Mr. Buffett, however, seems to be open to more and more ideas as the years go by, with him more recently stating that he’s no longer against paying a dividend. This, now after his foray into airlines, has us thinking quite a bit about his teachings of yesteryear. Is Uncle Warren now just playing to the crowd?

In any case, if Buffett does give the thumbs up for a dividend payment, Berkshire could find its way into the Dividend Growth Newsletter portfolio, too, but only at the right price. His selling of IBM (IBM) and admission that he was wrong with that idea may be the biggest news of all. Readers of Valuentum never would have been involved in Big Blue’s shares, now the poster child for poor earnings quality. IBM is in sad shape after executive incentive miscues, but as we noted time and time again, the writing was on the wall.

In other news, it’s hard to believe that the US unemployment rate was once at 10% at the height of the Financial Crisis, especially in light of news, released May 5, that the US added 211,000 new jobs in April, pushing the US unemployment rate down to 4.4%. The job recovery has been simply incredible under Barack Obama (2008-2016), and the measure is now at the lowest in roughly a decade. We hope that the Trump administration can keep things moving in the right direction.

Though there are imperfections in how unemployment is measured, the US economy remains on solid ground, in our view, even as Brexit looms and the Fed continues to tighten. We believe that, while many Americans are employed and generating an income, underemployment still remains a key issue, and debt may be the biggest issue of them all. From subprime car loans to student loans, Americans seemingly can’t get enough of “leverage,” and we think it will eventually come home to roost in ways that we may not be able to predict as of yet. We’re not sure politicians are ready to look at America’s debt problem straight in the eye. After all, the US itself has been operating under mountains of debt for decades now.

Speaking of easy money, the US market’s overall valuation remains more-than-full, in our opinion. In fact, we think it is “stuffed.” The latest reading from FactSet is that the forward 12-month P/E ratio for the S&P 500 (SPY) is now at 17.5 times, above the 5-year average of 15.2 and the 10-year average of 14. Hopes are riding high that President Trump will be able to execute upon his promise of corporate tax reform, but we have doubts. Even if “The Donald” is successful, it won’t be easy, and we doubt anything material will happen before the end of 2017, something that may be necessary for companies to hit consensus earnings estimates in 2018, which may be already embedding in some tax breaks, if not explicitly than implicitly by the analyst community. Here’s what FactSet had to say about sector valuations May 5--very few are collectively attractive on a forward PE basis:

At the sector level, the Energy (27.6) sector has the highest forward 12-month P/E ratio, while the Telecom Services (12.9) sector has the lowest forward 12-month P/E ratio. Nine sectors have forward 12-month P/E ratios that are above their 10-year averages, led by the Energy (27.6 vs. 18.2) sector. One sector (Telecom Services) has a forward 12-month P/E ratio that is below the 10-year average (12.9 vs. 14.3). Historical averages are not available for the Real Estate sector. [XLE, IYZ]

In other news, the retail REIT industry was hit by some bad news from Spirit Realty (SRC), which sold off aggressively last week, as it missed expectations on both the top and bottom line. Management noted that “a confluence of issues impacted a number of our credit watch list tenants in the first quarter resulting in an abnormally high credit loss. Furthermore, given the record number of bankruptcies in consumer and retail related companies thus far in 2017, and given that Shopko is our largest tenant, we are adjusting our outlook and approach for the balance of the year, including significantly reducing our acquisition activity.” Though we believe Spirit’s issues are more company-specific, we continue to be cautious on the retail REIT group, in general, in light of Amazon’s (AMZN) growing dominance. We’re still comfortable with a small position in one of our favorites, Realty Income (O), however, which exceeded expectations when it reported first-quarter results April 25. The “Monthly Dividend Company” expects full-year 2017 AFFO per share in the range of $3.00-$3.06, up 4.2%-6.3% from 2016.

REITs - Retail: CONE, COR, DDR, DLR, FRT, GGP, KIM, MAC, O, REG, RPAI, SKT, SLG, SPG, SRC, TCO, WPC

We’re taking the opportunity May 8 to shed Coach (COH) from the Dividend Growth Newsletter portfolio on pricing strength originating from news that it plans to purchase Kate Spade (KATE). We think the deal makes sense strategically and estimated synergies are achievable, but we don’t like the increasingly acquisitive nature of Coach’s executive team, and its balance sheet is no longer as appealing as it once was (we included Coach in the Dividend Growth Newsletter in part because of the net cash position on its books, which will be no longer). Kate Spade shareholders will receive $18.50 per share in cash for total transaction value of $2.4 billion, funded by cash and debt. The ride in Coach’s shares was volatile while it was in the Dividend Growth Newsletter portfolio, but in the end we came out ahead. Excluding the many dividend checks from the handbag maker, shares removed at $44.65 reveals a capital appreciation gain of ~20% from cost -- not bad. We have high hopes for the COH-KATE combination, but we’re moving on.

Best Ideas Newsletter portfolio holding Facebook (FB) continues to be a star performer, and while many didn’t like its first-quarter results, released May 3, we did. The company is off to a “good start” in 2017, with advertising revenue jumping more than 50%, and net income and diluted EPS advancing more than 70% each. The company’s operating margin also expanded nicely, roughly 4 percentage points on a year-over-year basis during the first quarter of 2017. Cash and marketable securities now stand at $32.3 billion on a debt-free balance sheet, while free cash flow surged to $3.79 billion from $2.35 billion in the year-ago quarter. It is logical to expect some slowing of Facebook’s revenue growth in coming periods (due to the law of large numbers) as it combats fake news and other misdeeds on its platform, but we still like shares a lot. Facebook is trading north of $150 at the time of this writing.

Just a few more tidbits before we wrap things up -- AIG (AIG) posted a better-than-expected first quarter report May 3, but we continue to opt for Berkshire as our diversified insurance exposure. We’re generally not as enthused about owning insurance entities as their books are tied to market investments, something that we spend a lot of time ourselves evaluating. We continue to hear a lot of chatter, takeover speculation, on consumer staples entities from General Mills (GIS) to Kellogg (K), and it’s difficult to make much of the rumor-driven, intraday moves on these companies, as they have been noticeable; there’s lots of money moving in and out of these consumer staples giants. The last item to note is CenturyLink’s (CTL) poor first-quarter results, released May 3. We think the company is setting up to cut its dividend again (it has a Dividend Cushion ratio of -1.9 at the time of this writing).

Don’t forget to read healthcare and biotech contributor, Alexander J. Poulos’ recent note, too: “WBA, ESRX, CVS: Earnings Update for the Pharmacy Services Industry.”