Valuentum Exclusive Analysis for the Discerning Investor

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Image: Since 2010, a large cap growth ETF has outperformed the S&P 500 by nearly 150 percentage points (15,000 basis points). Since 2010, a large cap growth ETF has outperformed a small cap value ETF by over 275 percentage points, or 27,500 basis points (image not shown). We expect continued outperformance from companies within the large cap growth bucket.

By Brian Nelson, CFA

The markets have been see-sawing the past couple weeks as the global economy continues to recover and much of the world awaits the outcome of the 2020 US Presidential election. We think the equity markets have largely factored in the forecasted epidemiology curve with respect to COVID-19, including infection spikes across the world, so recent market volatility has largely been driven more by political/election risk than anything else.

To nobody’s surprise, we expect continued volatility heading into and during election week, but we’re also maintaining our above market fair value estimate on the S&P 500 of 3,530-3,920 (the S&P 500 stands at about 3,300 at the moment). Once election week passes, we expect one of the best Santa Claus rallies in years as consumer sentiment improves. As a result of COVID-19, e-commerce proliferation will be more evident during the holiday season this year than ever before.

Our newsletter portfolios remain well-positioned, and we continue to like the areas of large cap growth, big cap tech, and the NASDAQ. Our favorite names are those with strong net cash positions and solid expected future free cash flows with competitively advantaged business models that are tied to secular growth tailwinds in industries where many players can win. We’ve continued to point to Facebook (FB), Alphabet (GOOG), and PayPal (PYPL) as a few of our favorite longs in this environment.

Pinterest Quarter Positive for Facebook, Google

On October 28, Pinterest (PINS) reported third-quarter results that showed revenue soaring nearly 60% and adjusted EBITDA coming in at $93 million, more than tripling the consensus estimate of $27.6 million. Global active users advanced 37% on a year-over-year basis, to 442 million, also coming in higher than the consensus figure. Importantly, momentum at the image sharing and social media service continued into the current calendar quarter.

Pinterest’s management noted that its “current expectation is that Q4 revenue will grow around 60% year over year, a modest acceleration compared to (its) growth rate in Q320.” Management also had the following to say in its press release: “The strong momentum our business experienced in July continued throughout the rest of the third quarter. (It's) extremely pleased with the broad-based strength of (its) business, driven by recovering advertiser demand as well as positive returns from our investments in advertiser products and international expansion.”

The read-through from Pinterest’s fundamental momentum to large cap growth, big cap tech, and the NASDAQ is extremely positive, and we continue to point long-term investors to the best ideas within these areas. We maintain our view that top-weighted idea in the Best Ideas Newsletter portfolio, Facebook is one of the best long-term ideas that the market has to offer today, and we look positively on top-weighted idea in the Best Ideas Newsletter portfolio, Alphabet in light of the momentum behind Pinterest’s business.

Visa Shows eCommerce Remains Resilient

E-commerce demand is not slowing either, and for that, we continue to like payment processors, PayPal and Visa (V). The former is hovering around $200 per share, while the latter put up a very nice fiscal fourth-quarter report October 28. Payments volume, cross-border volume, and processed transactions showed growth in Visa’s fiscal fourth quarter. Here’s what Visa’s management had to say in its fiscal fourth-quarter release:

While our business drivers and financial results were impacted by COVID-19 in 2020, we’ve made significant progress in advancing our growth strategy. Visa drove the adoption of eCommerce and tap to pay to accelerate cash digitization, successfully unlocked new flows by expanding Visa Direct and B2B partnerships, and facilitated client innovation through our value added services. As the world turns increasingly to digital payments, we see tremendous opportunity for growth. We’ll remain thoughtful in our investments as we advance our strategy to enable the movement of money for everyone, everywhere.

We continue to like Visa as a top-weighted idea in the Best Ideas Newsletter portfolio. The company’s free cash flow generation is top-notch, and as we’ve reiterated time and time again, Visa benefits from one of the strongest competitive advantages out there, the network effect. As more and more consumers use its cards, more and more businesses accept them, and so on and so forth. There may be no better competitive advantage than the network effect, in our view.

Dunkin Brands Going Private

On Sunday, October 25, news hit the wires that Dunkin Brands (DNKN) may look to go private with a deal from Inspire Brands. We’re huge fans of Dunkin Brands’ franchising business model, and its coffee and donuts remain a staple in the lives of coffee and donut lovers everywhere. According to reports, Inspire is offering to take Dunkin private at $106.50 per share, which represents a modest premium to where shares are trading at October 29.

We think Inspire is paying way too much for Dunkin Brands’ shares as the high end of our fair value estimate of $85 implies 27x consensus 2021 numbers. The deal price would imply an earnings multiple of 34x on 2021 numbers. Shareholders should take the money and run, in our view. We expect to update our fair value estimate to factor in a probability of a take-out, but there continues to be uncertainty as to whether this deal gets done.

Inspire already owns Buffalo Wild Wings, Arby’s Sonic, and Jimmy John’s chains, so we view the firm as a motivated buyer. Many other analysts believe the price is a bit steep relative to the quick service peers’ average EV/EBITDA multiple, and the price is also higher than the highest priced quick service restaurant, Domino’s (DPZ), relative to its 2021 expected EBITDA. We’re keeping a watchful eye. Our favorite restaurants remain Domino’s and Chipotle (CMG).

AMD Teams Up With Xilinx

On Wednesday, October 27, Advanced Micro Devices (AMD) announced that it had entered into an agreement to acquire Xilinx (XLNX) in an all-stock transaction priced at $35 billion. If you recall, Xilinx was one of the top 10 names that we highlighted near the March 2020 bottom, names that have outperformed significantly. Since that time, on a price basis, Xilinx has now advanced nearly 70% versus the SPY’s price return of less than 40%, yet another huge outperformer.

We like Xilinx's technological edge and healthy financials, so we think it will be a great fit in the AMD portfolio. Years ago, Intel acquired Xilinx’s largest FPGA rival Altera, and we liked that move. Many are saying that the AMD-XLNX tie-up will allow AMD to better compete with Nvidia (NVDA) and Intel (INTC), and we have to agree. In light of the ever-increasing competitive landscape, particularly in data centers, we opted to remove Intel from the simulated newsletter portfolios October 28.

Year-to-date, the semiconductor space (SOXX) is up more than 20% on a price basis, while the SPY is roughly flat. But it remains a fickle industry, and fast-changing technology makes investments hard to stick with over the long run. We’ve had success with Intel and Xilinx in the past, but we’re not rushing to add any semiconductor exposure to the simulated newsletter portfolios at this time. Look at how fast AMD closed ground on Intel, for example. This could happen to any name in the semi space.

Concluding Thoughts

Our favorite areas remain large cap growth, big cap tech, and the NASDAQ. Our best capital appreciation ideas remain in the Best Ideas Newsletter portfolio, while our best dividend growth ideas remain in the Dividend Growth Newsletter portfolio. Our favorite high yield dividend paying ideas remain in the High Yield Dividend Newsletter portfolio. Investors should not expect a target of dividend growth for capital appreication ideas, no more than they should expect a target for capital appreciation for dividend growth ideas.

We continue to prefer concentrated newsletter portfolios to deviate from the average market return, and we welcome the increased firm-specific risk that comes with overweighting our high-conviction ideas. By extension, the higher we weight an idea in the newsletter portfolios, the more we like it. Much like any screener, we use the fair value estimate range and VBI ratings, among other considerations, as the starting point of our analysis. We maintain our view that a qualitative overlay is vital to any process, a truism that the many quant failures of the past decades have only reinforced.

Stay safe and be well, my friends.

Brian Nelson owns shares in SPY, SCHG, DIA, VOT, and QQQ. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.