The Weekly Summary
While developments far from Wall Street continue to dominate the headlines, investors are content to digest a successful earnings season and the lingering impact of recent interest rate cuts. No news is good news now, and with the end of the year in sight, the foundation for a true Santa Rally is in place. The S&P 500 advanced another 1% this week, bringing its YTD performance to 24%. The BMR universe led the way, rallying 1.3% to take our YTD score back above 37%.
We are pleased to see our Aggressive and High Technology portfolios reviving. They still have a lot of room left to recover before they're breaking new records, but on the whole it's hard to complain while this side of the BMR world is up a collective 4% in a single "dull" week. Naturally we want the good times to continue, but with the Treasury yield curve healing a lot of investors seem to be shaking off recession fears and capturing high-growth companies on the dip.
There’s always a bull market here at The Bull Market Report! The Big Picture leads off with a look at a few of our biggest growth recommendations and the math we use to separate bubbles from bona fide bull runs. The High Yield Investor goes to the exact opposite end of the spectrum with a look at our tax-sensitive Muni Bond favorites. The end of the year is coming so it's worth getting in position to cover your tax liabilities now.
Next year is also the peak of the election cycle, which is what Gary Jefferson has on his mind now. He's also thinking about China, where developments remain elusive but fear has largely evaporated after a year of tariff threats. Let the trade war drag on as long as necessary. Our stocks are insulated at this point. Finally, with earnings season on hold for us until after Thanksgiving, our tour of the core Stocks For Success portfolio wraps up with post-earnings updates on Berkshire Hathaway, Blackstone, CBRE and one last look at Expedia, which we removed on Friday. Then it's time to review our latest logic on Square and Twilio.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: Growth At The Right Price
We’ve talked a lot this year about how much growth BMR stocks still have on their side when the S&P 500 is having to digest quarter after quarter of earnings deterioration. However, we haven’t gotten a real opportunity to quantify that investment edge. Let’s start now with a review of the math we use to evaluate stocks.
Every company worth an investor’s time generates cash or is on the road to doing so. More money in the future means that stocks will be worth more than they are today . . . provided that Wall Street remains willing to pay as much for the cash flow as it has in the past.
That’s as simple as it gets. Growing companies support swelling market capitalization as they literally create wealth. When cash flow stagnates or goes in reverse, other factors need to kick in to justify the stock going anywhere but down in the long term. From day to day, of course, growth stocks can decline and stale stocks can climb as investors reconsider their assumptions about how dynamic a given company is and what they’re prepared to pay.
This process of constant reevaluation is what drives the market’s mood. When investors are feeling confident, they want to chase fast expansion in the hope that stocks will appreciate equally quickly. But when caution dominates, the relatively speculative growth scenarios fall from favor as those same investors look for downside protection, current income and above all else, stability. As the pendulum swings, areas of the market that once carried a steep premium become available for a relative discount. Others that were once neglected suddenly heat up.
We recognize that the fast-growing stocks we love will not always be in favor every day, which is why we also cover more defensive themes to ensure that subscribers always have a chance to benefit from the market’s swings. However, when you’re playing defense, you pay a price. While you reduce the risk that something will go wrong with the companies in your portfolio, you also lock out the prospect of an upside surprise. These stocks tend to be stable, reliable and unexciting. They rarely if ever expand at a rate the naked eye can measure.
With that in mind, the standard “price per earnings” calculation doesn’t really help us. One stock will always justify a premium because it is growing so fast that today’s earnings number will look small in a matter of months. Another will make up for its lack of sizzle by paying a rich quarterly dividend, lowering the ceiling on how far the stock can reasonably go but also raising the floor on how bad the ride will get.
For our growth-oriented stocks, we divide price per earnings by the annual expansion rate we expect over the next year. Lower numbers are better. If the P/E is lower than the growth rate, it’s a sure bet that either the stock will go up over the next 365 days or the P/E itself will relax, ultimately signaling an even stronger buying opportunity. The market never lets a true opportunity like that stay open for long. The stock will go up. All we need here is the confidence to trust growth to continue.
Of course, more extreme growth stories tend to come at an earlier stage in a company’s life so actual earnings may not even be on the table. This is largely the realm of our Aggressive portfolio as well as a few other young companies like Exact Sciences (EXAS) and Spotify (SPOT), where profitability can be a year or two away. In this world, we look solely to revenue in order to see whether a given recommendation is getting too far ahead of its fundamentals.
Whether it’s earnings or revenue, we know how much investors have paid for any given company at a particular expansion rate. Doing the math tells us whether a stock is comfortably inside that historical framework or testing the limits . . . and when the fundamentals argue that the market is underrating the company relative to its peers, the only thing holding the stock back is investor sentiment.
Sentiment comes and goes. Fundamentals are facts. And when sentiment shifts, historical parameters that investors in a certain frame of mind once accepted can apply again. Right now, however, the S&P 500 as a whole doesn’t look appetizing from any angle here at 17.5X earnings balanced against at best zero growth until the 1Q19 numbers come in six months from now. That’s not a strong “offense” at all, and when you factor in a 1.8% yield for the index, there’s no real defense here either.
Someone who buys the index is counting on other investors to get so hungry for these stocks that they’ll be worth more six months from now . . . even though there’s no material sign of that happening. That’s an argument based solely on faith, hope and laziness. We aren’t ruling out the prospect that the S&P 500 will climb 2% to 5% between now and May in anticipation of better things ahead, but we aren’t naïve enough to bank on it.
For the index to climb 5%, stocks need to shock us with at least 5% growth in the current quarter. Right now it looks more likely that the bottom line will actually decline again, which will leave the market as a whole overextended until those 1Q19 numbers give Corporate America another chance to flip the trend. That’s a lot to ask your fellow investors to swallow in order to make your portfolio pay off in the near term.
On the other hand, our stocks come with concrete reasons for current shareholders to keep holding on and new ones to buy in. Take a company like Alphabet (GOOG), for example. It currently commands a 25X multiple, which looks high on days when the market is looking for a sure thing but is reasonable when you factor in an anticipated earnings growth rate 6% above what the S&P 500 has been achieving lately.
It’s worth a premium. And we know that when investors are greedy for growth, that premium expands. Back in April, Alphabet’s growth curve rated a 27X multiple, which implies that the stock could easily rally beyond $1,400 without straining history one inch. All it needs to do is hit its targets and confirm that the expansion will continue as planned. Any additional upside will push the bar even higher.
Amazon (AMZN) is a more extreme example at 74X earnings and an anticipated bottom-line growth rate of barely 4% over the next 12 months. In this case, investors are looking at the revenue trend, since we all know at this stage that CEO Jeff Bezos is chasing sales right now instead of margins. We’re paying above $1,700 for roughly 19X revenue growth, which is substantial for a company of this scale.
Everything else being equal, that’s the same math that took Amazon within sight of $2,000 just six months ago. The math has gotten a little cloudier for this stock over that time period but the long-term calculations haven’t really changed. Only Wall Street has cooled. By the time it heats up again, Bezos will have had plenty of time to keep working his magic and that $2,000 historical ceiling will become a new floor.
Berkshire Hathaway (BRK.B: $220, flat last week)
Berkshire is having a good year, up a reliable 12% YTD. The stock recently set a new all-time high, as Warren Buffet’s conglomerate continues to impress.
Berkshire had an excellent 3Q19, with operating earnings of $7.9 billion, rising 14%. Much of that was driven by the Insurance business, which includes industry giant Geico. Insurance’s investment income rose 20% YoY to $1.5 billion. Railroad, utilities and energy earnings were up over 6% YoY to $2.6 billion, and other businesses increased 2% to $2.5 billion.
Berkshire owns such a cross-section of the U.S. economy that when things are going well (as they currently are), the company outperforms. With the Fed lowering interest rates and the broader economy chugging along, expect continued upside from Berkshire. Plus, the China trade war is on its last legs – once that is resolved, clear sailing ahead for this stock.
BMR Take: Berkshire is a U.S. staple, which has its fingers in many industry pies across the world. The conglomerate is investing in everything from wind farms in Canada to digital payment processors in India. But it’s the old stalwarts of Insurance, Industrials and Transportation that keep Berkshire humming. Our $230 Target Price is getting closer and closer, and we expect a raise coming in early 2020.
Blackstone Group (BX: $52.50, up 2%)
Blackstone is the largest Private Equity (PE) company in the world. If you’ve been following The Bull Market Report, you know that PE is having its moment now, with institutional capital flowing out of the imploding hedge fund industry and into the more stable returns of PE.
Blackstone has been a major beneficiary, having just raised the largest-ever Real Estate fund of $20.5 billion. That comes on the heels of a $22 billion buyout fundraise – the firm’s eighth – as well as the largest-ever pure PE fundraise of $26 billion. That’s a lot of ‘largest-evers’ for one company. Such is the size and scale of Blackstone. Remember, as a PE company, Blackstone earns fees on its AUM, so the more assets under management, the higher the fees the company collects. In 3Q19, the company posted $555 billion in AUM, for a 21% YoY gain. That led to $18 billion of inflows, for a 27% YoY improvement.
Plus, the company made headlines recently after altering its structure form from an LP to a C-Corp. That’s no small move, as it improves liquidity for the stock by allowing ETFs and other investment vehicles who are prohibited from investing in LPs to purchase shares.
BMR Take: With all of this good news, it should come as no surprise that the stock is up 68% YTD, and keeps setting new all-time highs. Our $52 Target Price has just been breached, so we’re raising it up to $62. We’re maintaining our $40 Sell Price.
CBRE Group (CBRE: $56, up 3%)
Yet another stock that’s producing all-time highs, CBRE is up 40% YTD with no signs of slowing. 3Q19 turned out very strong, with revenue of $6 billion improving 13% YoY. EPS of $0.79 beat market estimates by a penny. The company maintained its full-year EPS guidance, but noted an EBITDA decrease of 2% on the quarter, due solely to Real Estate dispositions (a one-time event). Advisory Services and Global Workplace Solutions were both up double-digit percentages, so all is good with the underlying business.
The U.S. Commercial Real Estate market remains on solid ground, with a hefty supply of capital for investment (see the above Blackstone Real Estate fundraise for proof), high occupancy rates across the board and a slate of development activity in the pipeline. The company operates across a range of sectors, and many are experiencing increasing developments, especially Retail and Hotel/Resorts. This bodes well for the company’s long-term outlook.
BMR Take: While the Real Estate Investments business suffered from a one-time disposition event, that wasn’t enough to ding the stock, as investors focused on what matters most: the long-term health of the underlying business. The company posted strong numbers otherwise, and maintains a low debt/EBITDA profile (only 1.5, much lower than competitors Cushman & Wakefield and Newmark Group). We’re reiterating our $60 Target Price, and expect the stock to breach that target in 2020.
Expedia (EXPE: $96, down 5% . . . and remember, we have CUT this stock)
The stock took a nosedive after a rough quarter, down 30% on the earnings release. Unfortunately, that puts us in negative territory (down 4% since we added it last year). The 3Q19 missed expectations, with revenue of $3.6 billion coming in a mere $10 million short of expectations, yet EPS of $3.38 missed by $0.43. That dinged the stock severely. EBITDA was also flat YoY at $912 million.
As we mentioned in a News Flash earlier last week, worries over Alphabet’s emergence into the space are overblown. Expedia is a big advertiser on Google, and the company’s brand awareness cements it as a leading player in the space. So Google isn’t trying to squeeze Expedia out, they’re just moving in to capture some market share and diversify their overall business. Plus, Expedia is diversifying successfully into Vrbo, which is now the chief competitor to Airbnb.
That said, however, the stock did crash right through our Sell Price of $112. So we’re honoring that call and have exited Expedia. You are welcome to stick with the stock and wait around for the eventual bounce (it will happen), but we are moving on.
BMR Take: Expedia is still a fundamentally strong company that is diversifying, but if a single bad quarter can upend the stock like this, that’s enough for us to move on. We do believe Expedia will bounce back over the next year, and we may re-enter at some point, but for now we’re cutting our minor losses on the year.
Square (SQ: $65, up 4%)
Square was having a terrific year (up 43%), until the 2Q19 numbers came out, when concerns over a revenue growth rate deceleration took over, and the stock was sold off. It is still up 13% YTD, by the way, so it is not doing too badly.
After the 3Q19 numbers came out, it’s clear Square is back on track. Revenue of $600 million rose 40% YoY, and EPS of $0.25 nearly doubled last year’s third quarter EPS of $0.13. Gross payments volume increased 24% YoY, to $28 billion, and EBITDA of $131 million nearly doubled.
Digging in a little deeper, we see that Square’s Cash App is surging. Revenue of $160 million was up 115% YoY, and gross profit of $120 million was up 125% (those numbers exclude Bitcoin, which Square accepts, and fluctuates so greatly that the company offers figures excluding Bitcoin. Fine with us, to tell you the truth!)
All of the above is good news for Square. The stock has popped over 5% since the earnings release, and we expect further price appreciation as the year progresses.
BMR Take: Our $105 Target Price is still a ways away, but the stock was well on its way there prior to the 2Q19 earnings. 3Q19 has us back on track, and we expect 4Q19 to be equally strong. Now is a good time to buy the dip on Square if you’re not in the stock already. If you’ve already invested, ride the upward trajectory throughout the rest of 2019.
Twilio (TWLO: $99.50, up 6%)
Twilio is another stock that was soaring mid-year, on its way to a healthy double, until the stock sank after the 2Q19 and even 3Q19 earnings releases, despite the fact that they were both incredibly strong. Yet the company lowered its 4Q19 forecast a tad, and that was enough to send the stock down sharply.
3Q19 revenue of $295 million grew 75% YoY, 7% sequentially. Active customer accounts more than doubled to 170,000, and here the Sendgrid acquisition is paying massive dividends.
However, the company guided down its 4Q19 revenue to $312 million from $320 million, and that was enough to send the stock lower. Part of that has to do with WhatsApp scaling back its usage of Twilio – the company is Twilio’s largest customer, but in the whole scheme of things, quite minor now.
BMR Take: Twilio is still the dominant player in the communications-as-a-service market. Management is known for setting conservative quarterly guidance and smashing through those numbers, so don’t be surprised if 4Q19 comes out much better than expected. The company continues to expand gross margin, from 55% during 3Q18 to 58% this past quarter. As with Square, our $156 Target Price for Twilio is a long way off, but we see this stock bouncing back from the past few months which were rough, to end the year strong. It remains what just might be a our favorite aggressive stock.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
China trade negotiations still make up a large part of the headlines. Now, the Chinese are demanding assurances that there won't be any new tariff increases or new impositions during the Phase II talks in 2020, while the U.S. seeks assurances that at least one of several unfair policies will be corrected. We remain doubtful the Chinese can be counted on to make any real concession and that these negotiations could last long enough to challenge the record for the longest-running soap opera in history. We jest, of course, but it wouldn't be a surprise if the gamesmanship by the Chinese continued until the 2020 elections.
Why is this relevant to you, me and the Fed? Remember, experts have estimated the damage of the trade war to have a negative impact of 0.5% to the U.S. GDP and a more significant impact on China of almost 2% of GDP. To put it in real numbers, the trade war is reducing GDP in the U.S. by $12 billion and is reducing output in China by $300 billion at current exchange rates. China needs to blink. They just won’t do it yet.
Admittedly, all these macro numbers are hard to process, but it's important to understand that our economy is hovering around 2% growth and a hit to our annual output will be felt. That is what keeps the Fed economists up at night and may well be the reason for recent comments by Chairman Powell that the pace of further rate cuts is under review for the remainder of the year. There isn't much fat left to trim via monetary policy and most experts believe Powell wants to keep some arrows in his quiver.
As for investors, it's prudent to be patient and let the two largest economies in the world find a way out of the trade war. That basically means investors should expect slower global growth. But growth is still growth. There are plenty of solid companies out there that are improving in efficiency and adding value to the task of wealth creation. There is still huge growth potential in technology, medicine and many other areas: 5G Communications, Robotics, Augmented Reality, Artificial Intelligence, Stem Cell research and the list goes on.
As one expert recently said, "The greatest investors, men like Warren Buffett, Peter Lynch and John Templeton, didn't just have a positive outlook. They maintained an optimism about the future that simply didn't have an off switch.” This is something investors will need to keep in mind as we head into the coming election cycle. The doom and gloom rhetoric will undoubtedly be ramped up to a fever pitch. We believe investors who remain patient and optimistic will be the ones best able to keep their financial goals and objectives on track.
And these investors will have history on their side. We took a look at how stocks have responded in the 52 weeks prior to America going to the polls to choose the next occupant of the White House. Analyzing statistics going back to 1972 when Richard Nixon defeated George McGovern in a landslide, we came up with twelve different sets of readings.
The mean return for the S&P 500, exclusive of dividends, calculated to 8.69% in pre-election years compared to an average gain of 9.01% in the intervening years. If, however, the horrific -33.84% performance from 2008 during the heart of the financial crisis was excluded, the overall figure jumps to +12.56%. While history has no guarantee of repeating itself, it is squarely on the plus side of share prices heading up to the election.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
In this week’s HYI, we’re going to cover the muni funds in our portfolio. Munis are a bit different from traditional bond funds in a number of ways. First of all, they invest in government-owned securities, so they are tax free entities, which means the dividend returns on munis are actually much higher on a taxable basis, depending on what tax bracket you’re in. Secondly, munis have their own yield curve, which is different from the traditional bond yield curve. So a few months ago when the Treasury bond yield curve inverted, munis benefited significantly because many bondholders fled to the safety of munis, which had a steeper yield curve (and still does).
One of our muni funds, Invesco Municipal Trust (VKQ: $12.14, down 1%, Yield = 4.8% tax-free, the equivalent of 7.4% taxable) is up 8% on the year. And with a 4.8% non-taxable yield, that translates to a healthy double-digit return thus far. Invesco is a blue chip name in the bond market, and investors have been flocking to blue chip munis like Invesco ever since the traditional bond yield curve inverted. Invesco received a nice bounce when that happened, though it has tapered off just a bit as the yield curve slowly steepens.
Invesco is well-diversified, with only one holding comprising more than 1% of the total portfolio. Currently, the stock is trading at an 8.6% discount, which is slightly higher than its 8.4% discount average. Investors are getting a slight deal at the moment, based on the average discount-to-NAV over the past year.
By rule, the company can only invest up to 20% of its portfolio in non-investment grade securities. Also, 45% of Invesco’s bonds are long-term (more than 20 years in maturity), while 35% are medium-term (10-20 years). As a conservative CEF, Invesco trades within a very tight range. Over most of the last decade, the stock has fluctuated between $12 on the low end, and $15 on the high end (with a brief exception during 4Q18 when the bottom fell out). So we’re at the low-end of the trading spectrum right now.
With a low expense ratio and management fee of 1% and .55%, respectively, Invesco is an inexpensive option to own a safe, dependable muni fund that provides tax-free dividends, and is currently trading at a relatively big discount. Plus, the dividend is extremely safe given the low payout ratio (just 47%). And that’s what long-term High Yield Investors should be on the lookout for – safe, dependable dividends.
Another example of a blue chip muni fund with a safe dividend is Nuveen AMT-Free Municipal Credit Income Fund (NVG: $15.99, down 2%, Yield = 4.9% tax-free, the equivalent of 7.6% taxable). Like Invesco, Nuveen is another brand name among CEFs. The stock has appreciated more than Invesco – 14% YTD. Nuveen offers a similar yield – 4.9% at the moment (tax free, of course – the equivalent of a 7.6% taxable yield). But note that that Nuveen’s expense ratio is a bit higher than Invesco’s, at 2.4%.
Nuveen is currently trading at a 5.7% discount, which is a bit lower than its 52-week average of 6.6%. That said, this is a brand name company, and investors are still receiving a $1.00 discount to the NAV, which is currently just over $17.
Nuveen is also well-diversified, with just three of its holdings comprising over 1% each of the total portfolio. And the management fee is low at .45%, as is the payout ratio at only 15%. This is another safe, dependable muni to park your money. Although the stock is near its 52-week high of $17, the NAV continues to increase thanks to reinvestment into munis in the wake of the yield curve inversion. So as long as that discount remains intact (and we think it will), the stock should appreciate to reflect the rising NAV.
One final stock we’re taking a look at this week is Office Properties Trust (OPI: $32, down 2%, Yield = 6.9%). Recently as you know, Government Properties merged with Select Income REIT to form Office Properties Trust and acquired a portfolio of mostly industrial retail space. However, the fund still owns and operates a considerable portfolio of Real Estate that is leased to both the federal and state/local governments, so Office Properties has indeed benefited from the inverted yield curve.
The stock is up 16% YTD, and the yield of 6.9% puts us over 20% in ROI for the year so far. The stock has been on a major upswing since June, rising 33% over the past few months alone. We still have plenty more upside to go in order to recapture our pre-merger price, but this is a more diversified company with a portfolio of Industrial Real Estate – the fastest growing sector of all Commercial Real Estate (CRE) at the moment.
Office Properties had a strong 3Q19, with revenue of $167 million, for a 58% YoY increase. FFO came in at $1.45, which beat the average market estimate by a nickel. FFO is the key metric of health for a REIT, since it doesn’t include depreciation and amortization, which REITs often manipulate to avoid paying out too much in dividends.
The story with the company right now is consolidation, as Office Properties continues to offload underperforming assets. During 3Q19, Office Properties offloaded a dozen properties totaling more than $300 million in sales. Since the average occupancy rate for the offloaded properties was a low 71%, this ticked up the total occupancy rate to 93.3%, which is good news. The occupancy rate has been rising all year, and will continue to rise, which will be reflected in FFO.
The current climate of lower interest rates benefits Office Properties. With the economy booming, more businesses and government entities will be leasing out office space, and that helps increase both the rent and the occupancy rate in the long run. Plus, thanks to the Select Income REIT merger, Office Properties now has exposure to non-government CRE. Industrial space isn’t prone to the kinds of setbacks that traditional retail space is, with Amazon rapidly capturing market share and sending traditional brick-and-mortar retailers out of business. More and more Tech companies are leasing Industrial space to store servers, processors, and other important hardware components, which is why Industrial space is the fastest growing segment of the CRE market.
The stock ended last year in the $30-$40 range, and given the macroeconomic tailwinds and management’s continued disposition of underperforming properties, we are expecting the stock to get back up towards the $40 mark in 2020. Office Properties also offers a stable dividend, and is reducing its overall leverage by offloading those properties. So we view this stock as a great way to collect 7% per year, while simultaneously capturing expected price appreciation.
Todd Shaver, Founder and CEO
The Bull Market Report