The equity markets have welcomed a strong earnings season thus far, but valuation risk and tail uncertainties remain, not the least of which is the possibility of failed tax reform in the US.
By Brian Nelson, CFA
Money is cheap, and investors are partying like its 1999 all over again. The latest move on the trading vehicle for the S&P 500, the SPDR S&P 500 ETF (SPY) is yet again approaching new highs. We like the ongoing momentum in the stock market, something that we outlined in our “shocking” predictions for 2017, but we continue to reiterate our cautious stance, not only with respect to underlying valuations but also as it relates to the possibility of failed tax reform in the US as the Trump administration takes initial steps toward implementation following its miscue at healthcare reform within the first 100 days of Trump being in office.
Thus far, we’ve been mighty pleased with the earnings reports from a number of newsletter portfolio holdings. Visa (V), for one, is now a $90+ stock as the heavily-weighted company continues to propel performance in the Best Ideas Newsletter portfolio. Its fiscal second-quarter earnings report, released April 20, sent shares marching even higher, as it beat on both the top and bottom lines relative to consensus estimates. We love Visa’s network effect, one of the strongest competitive advantages in all of business, and its free cash flow generating prowess, ongoing robust payments volume growth, and healthy balance sheet give us confidence to continue to include the company in the Best Ideas Newsletter portfolio. Very few companies generate annual operating margins in the mid-60s like Visa does. Incredible.
Another favorite of ours PayPal (PYPL) put together a very nice showing during its first quarter, results released after the close April 26. Revenue advanced 17% in the period, while non-GAAP earnings per share leapt 19%, to $0.44. The company added 6 million new active customer accounts during the quarter, and payment transactions and total payment volume continue to advance nicely. Concurrent with its first-quarter report, PayPal announced a brand-new $5 billion share repurchase program as it raised its 2017 guidance for both the top and bottom line. As the market continues to become more and more familiar with PayPal as a standalone entity, we like what the future holds with respect to an increasingly more optimistic backdrop on shares, which are also included in the Best Ideas Newsletter portfolio. It’s hard to be disappointed with a beat-and-raise first-quarter report.
We also continue to be excited about Hasbro (HAS), a long-time holding in the Dividend Growth Newsletter portfolio. We’ve been pounding the table on the idea time and time again, the latest, “EVERYTHING DIVIDENDS + 3 TOP IDEAS (October 2016),” one of our team’s finest podcasts. If you haven’t had a chance to listen in, three dividend growth stalwarts are highlighted in there (the podcast from October of 2016). Shares of Hasbro have now surged past $100 each, following a fantastic top and bottom-line beat in its first-quarter report, released April 24. During the period, ‘Entertainment and Licensing’ revenue advanced 24%, while that segment’s operating profit more than doubled. We like what Hasbro is doing, and we plan to continue to include shares in the Dividend Growth Newsletter portfolio until our brand/licensing thesis is challenged, or unless valuation/technicals dictate.
Best Ideas Newsletter portfolio holding Facebook’s (FB) stock price is now approaching $150 per share, a brand new high, and while the company continues to stem off negative events published on Facebook Live, we like its share-price performance a lot. Facebook, in our view, hones in on the essence of human nature, to want to share, to publish, and to be heard–and businesses are spending lots of money trying to reach the social media giant’s many, many users. Though a disappointing report after the close April 26, another strong performer of late had been Buffalo Wild Wings (BWLD), but less so for fundamental reasons, and more due to activist pressure, which we don’t think will let up anytime soon (a good thing). Buffalo Wild Wings’ recent rally will be met with selling pressure as the company reduced its fiscal 2017 bottom-line guidance after the close, April 26, but we’re anticipating positive changes at the company that are almost sure to come. Both Facebook and Buffalo Wild Wings are included in the Best Ideas Newsletter portfolio.
A couple other restaurants faring well this earnings season have been Chipotle (CMG) and McDonald’s (MCD), the former once a part of the latter’s portfolio many a year ago. Chipotle’s shares have rocketed to a 52-week high of late on the heels of a strong near-18% comparable store sales increase during its first-quarter report, released April 25. Of course, such massive comp expansion is lapping troubles of yesteryear, but it is encouraging to see customers come back to the burrito giant. Chipotle continues to open restaurants at a breakneck pace, too, with 195-210 new ones expected in 2017. Its once-former parent, McDonald’s also put up a decent first quarter report April 25, with global comparable store sales advancing 4% during the period. Clearly, and we humbly admit, McDonald’s is doing much better than we anticipated thus far into 2017. Neither Chipotle nor McDonald’s are included in either newsletter portfolio.
Three newsletter portfolio holdings that haven’t been performing as well as we would have liked include Michael Kors (KORS), Teva (TEVA), and General Electric (GE)–all three included in the Best Ideas Newsletter portfolio, but the latter is also included in the Dividend Growth Newsletter portfolio. As it relates to Michael Kors, because the weighting is one of the smallest in the Best Ideas Newsletter portfolio, we’ve been putting greater emphasis on its long-term valuation opportunity, and absorbing most of the near-term volatility on the technical side. If Michael Kors had been closer to a full weighting (5%+ or more), for example, we would have been more aggressive and probably lightened up on shares. We admit, however, that we think we could have done a better job of removing the position near its short-term peak, but we also still like that at least a small part of the Best Ideas Newsletter portfolio has been exposed to the more speculative side of retail, even though this area hasn’t been in favor as of late. M&A talks have been heating up though.
Teva has been nothing short of a nightmare for us of late, and it seems as though the bad news keeps coming, the two latest data points being expectations for additional generics pricing pressure from Cardinal Health’s (CAH) latest outlook and turnover in the executive suite (CFO Eyal Desheh plans to step down). Teva has taken on too much debt, but proceeds from its plans to shed its oncology portfolio many help. Even though its dividend is far from safe, it’s hard for us to say that shares are not incredibly cheap. As with Michael Kors, we watched this one for too long when we should have taken profits, but we can’t look back. With Teva’s free cash flow yield, it’s hard not to be patient as the company gets its financial house back in order, perhaps under a more conservative executive team. We’re not happy with its performance, perhaps needless to say.
The third idea that hasn’t quite powered higher in line with our expectations is General Electric. Of course, we still like its robust free-cash-flow generating business model, but from doubling down on energy just in time for energy prices to collapse to shedding its SIFI designation as banking stocks soar, the executive team has fallen victim to “bad timing.” Still, GE’s first-quarter report, released April 21, showed its top and bottom line ahead of expectations, with industrial segment revenues up 7% in the period, backlog up 3%, and orders up 10%. Widely-followed, GE has had a tough time getting good press, with all the critics seeking a “differentiated call” or unique perspective,” in our view, but that may let up. We’ll be watching its free cash flow generation closely as it relates to dividend strength.
Caterpillar (CAT), DuPont (DD) and 3M (MMM) had solid calendar first-quarter reports, likely the three biggest reasons why the market is marching higher during this last week of April 2017. Caterpillar’s better-than-expected first-quarter