The Weekly Summary
December was chaotic last year, keeping investors glued to their screens as we watched a miserable season turn into one of the biggest rebounds in recent memory. This time around, conditions are unusually quiet as a late Thanksgiving turns into a compressed holiday season. Wall Street is already looking toward the Christmas and New Year breaks. So are we.
After all, Santa came early and often this year. The market as a whole has rebounded 28% YTD, handily recovering all ground lost in the 4Q18 rout and then continuing to push into record territory. The S&P 500 has now rallied a healthy 12% past last year's peak, with more than half of that surge coming in the last four months. Whether the motive is relief that we've skirted another year without a recession or more straightforward optimism, the mood is as good as it gets.
If anything, we're inclined to urge a little caution here. When a full 44% of investors are actively bullish and the so-called "greed index" flashing at extreme levels, this is as good a time as ever to take a little profit and rotate the returns back into stocks that haven't flown as far as the rest of your holdings or offer a comparable return for lower risk. The perfect time to buy was a year ago when everyone but us was terrified that the trade war and the Fed had triggered the end of the world. While today this is not an awful entry point, a selective approach can be your friend here . . . we would definitely not pour money into index funds right now.
After all, while the active BMR universe is up 42% so far this year, our stocks have tangible growth on their side. Earnings for the S&P 500, on the other hand, have spent the entire year in a stall, so there's no compelling mathematical reason for the index to keep moving up without straining historical multiples to the bubble point. Right now the market as a whole carries an 18X earnings multiple, well above the 15-16X that investors have normally been willing to pay.
In exchange for those inflated fundamentals, investors are getting negative growth. Those companies are actually tracking lower earnings than they did a year ago, and are likely to keep deteriorating at least into the 4Q19 reporting season. After that, we'll simply have to see if the combination of lower interest rates and a truce in the global trade war shakes a little growth free. If not, stocks will look increasingly vulnerable to any external shock to sentiment . . . the higher the multiples get, the more precipitous the fall from grace becomes.
However, there's a lot to be said for a sympathetic Federal Reserve and any relief from the trade war. The White House estimates that even Phase One in a deal with China coupled with a new NAFTA accord will boost GDP growth 0.5% in the coming year, which is enough to drive a so-so economic expansion into something approaching spectacular. It's definitely far from the recession zone that everyone was worried about a few months ago.
You need growth to decline in order to realistically talk about recession ahead. No decline means no recession. And no recession means people who retreated to the market sidelines are now having a hard time resisting the urge to get back in before they miss out completely.
Remember, while earnings haven't moved up in the past year, they haven't dropped a lot either. The trade war has delayed a lot of new corporate investment initiatives without driving executives to pull the plug on any established cost centers. We haven't seen mass layoffs. No sprawling Financial conglomerates or prominent hedge funds have imploded the last time the Treasury yield curve briefly inverted.
And that curve is healthier than a few months ago. Barring a lot of dread around the coming election, the rate environment once again reflects lower risk in the short term and higher uncertainty farther out into the future, exactly as it should. The Fed has done its work well. Investors have a reason to cheer.
So what can go wrong? While we are always quick to accentuate the positive, we also acknowledge that other investors make errors when the mood swings too far in either direction. Expectations can get stretched to unsustainable levels, setting up the next inevitable round of disappointment, second guessing and nervous selling. That's ultimately a good thing for those of us who have been watching and waiting for a chance to buy great stocks on the dip. Throughout our career (collectively well past a half century actively in the market) the long-term trend always points up and the dip is always worth buying.
There’s always a bull market here at The Bull Market Report! Gary Jefferson has the week off and with the holiday approaching, we decided to use his absence to try something new with an in-depth review of Todd's Stocks For Success. We hope that you come away from this issue with deeper understanding of why our founder likes Berkshire Hathaway, CBRE and the Blackstone Group so much. He would buy any of these stocks on weakness.
The High Yield Investor takes the opposite approach, digging into what makes two of our worst YTD performers such valuable long-term holdings even if the stocks have lagged the market. That's right: it's time to talk in depth about Service Holdings Trust and Ventas. The Big Picture plays the middle, with a look at what's going on in the market as a whole as we approach the end of the year. Where are the opportunities? Which stocks are doing all the work and which ones look tired?
Finally, a scheduling note ahead of the Christmas holiday. The market will close early on Tuesday and stay shut until Thursday morning, so news will be light and our News Flashes will probably taper off a bit. We'll use the time to reflect on the year that's gone and cement our thinking on the year ahead. Ideally we'll also be able to update the site a little and perform other housekeeping as we get the portfolios in position for 2020. We'll be in touch either way, but as always, we wish you a happy holiday and the best possible experience as an investor.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: Big Rally, Narrow Bench
While the last few months have been great for the S&P 500 and our stocks as well, the gains remain restricted to a narrow field of relatively safe bets. Investors simply aren't thinking outside the box right now. They're content to park their money in a few big stocks that don't require a lot of patience or even conviction. While we'd love a little of that capital to flow immediately to a few of our smaller and more neglected recommendations, we don't mind in the slightest.
For one thing, we already recommend many of the leaders. Just seven BMR stocks account for 40% of the S&P 500's gains for the past quarter, and Apple (AAPL: $279, up 2%) alone contributed almost half of that upside. If you weren't bullish on Apple in the last few months, you missed the boat. We were right to keep the giant in our sights, and it gave us everything we hoped to see. Apple has surged a full 77% this year, recovering $700 billion in market capitalization along the way.
Microsoft, Alphabet and to some extent Facebook, Berkshire Hathaway, Johnson & Johnson and Visa also contributed a significant amount to the market's gains in the last few months . . . not to mention the year as a whole. Big stocks got big because the enterprises driving them were some of the most dynamic companies around. This year, they got even bigger. All are hitting all-time highs. How far can they go before taking a break? We'll simply have to see, but as long as earnings keep outperforming everyone else around, the stocks have all the room they need.
Then there's Amazon (AMZN: $1,787, up 1%), which is as dynamic as ever but the stock hasn't gone anywhere in the last quarter. It's also down 12% from its peak, so there's no sense of straining any kind of historical limit. When investors come back, this can once again be a $2,000 stock and a trillion-dollar company. And in that scenario, the S&P 500 gets enough of a boost to break another record. No other stock has to do any work. Amazon can do it on its own.
We see that story play out again and again. A full 3 in 5 S&P 500 constituents are actively lagging the market and the lower you go on the market food chain, the rarer true leadership gets. A staggering 85% of the stocks on Wall Street have underperformed the S&P 500 this quarter. Most are doing okay. True losses are limited. They're simply getting left out.
But the market will never tolerate an imbalance for long. Sooner or later, one or more giants will hit a wall and the money that's flowing to them now will rotate into smaller stocks. When that happens, we'll have a reason to cheer. On average, our recommendations are still down 12% from their 52-week highs, let alone lifetime peak levels. We've come a long way back in the last few months without even clearing what are still formally correction conditions from late in the summer, when Technology took a huge step back. There's money to be made here.
Look at Roku (ROKU: $137, up 3%). It's up close to 350% YTD but is 22% off its peak. That's an opportunity. Even though a handful of giant companies are doing most of Wall Street's work, plenty of smaller names keep breaking records as well. Splunk (SPLK: $151, up 5% this week), for example, is once again within sight of an all-time high, set in early December, capping a year that's literally run rings around the market as a whole. This stock has gained 44% YTD but the ride has been wild. We've seen it plunge from above $140 to below $110 twice this year, so the moral here is to hold on tight through the retreats.
Berkshire Hathaway (BRK-B: $226, flat last week but setting an all-time high)
This stock is a must-own. If you believe in America, then Berkshire is the place to put your money where your mouth is. The stock is worth $553 billion, making it one of the top 10 largest companies in the world. Do you want to know what they do? Well, here it is, straight from Yahoo Finance. Breathe it all in:
Berkshire Hathaway Inc., through its subsidiaries engages in insurance, freight rail transportation, and utility businesses. It provides property and casualty insurance and reinsurance, as well as life, accident, and health reinsurance; and operates railroad systems in North America. The company also generates, transmits, stores, and distributes electricity from natural gas, coal, wind, solar, hydro, nuclear, and geothermal sources; operates natural gas distribution and storage facilities, interstate pipelines, and compressor and meter stations; and holds interest in coal mining assets. In addition, it offers real estate brokerage services; and leases transportation equipment and furniture. Further, the company manufactures boxed chocolates and other confectionery products; specialty chemicals, metal cutting tools, and components for aerospace and power generation applications; flooring, insulation, roofing and engineered, building and engineered components, paints and coatings, and bricks and masonry products, as well as offers homebuilding and manufactured housing finance; recreational vehicles, apparel products, jewelry, and custom picture framing products; and alkaline batteries. Additionally, it manufactures castings, forgings, fasteners/fastener systems, and aerostructures; titanium, steel, and nickel; and seamless pipes and fittings. The company distributes newspapers, televisions, and information; franchises and services quick service restaurants; distributes electronic components; and offers logistics services, grocery and foodservice distribution services, professional aviation training programs, and fractional aircraft ownership programs. In addition, it retails automobiles; furniture, bedding, and accessories; household appliances, electronics, and computers; jewelry, watches, crystal, china, stemware, flatware, gifts, and collectibles; kitchenware; and motorcycle accessories.
Here are the company’s top five holdings:
Comprising 24% of the Berkshire Hathaway portfolio, Apple represents Buffett's largest holding, with a whopping 250 million shares in the tech giant, as of November 2019. Currently worth approximately $65 billion, in 2018, Apple surpassed Wells Fargo to capture the #1 spot after Berkshire Hathaway purchased additional shares of the Steve Jobs-founded company in February of that year.
Bank of America
Warren Buffett's second-largest holding is in Bank of America, valued at $27 billion and comprising 13% of his portfolio. Buffett's interest in this company began in 2011 when he helped solidify the firm's finances, following the 2008 economic collapse. Investing in Bank of America, which is the nation's second-largest bank by assets, falls in line with Buffett's attraction to financial stocks, including Wells Fargo & Company and American Express (see below).
The Coca-Cola Company
Buffett once claimed to consume at least five cans of Coca-Cola per day, which may explain why the Coca-Cola stock is his third-largest holding. But one thing is for certain: Buffett appreciates the durability of the company’s core product, which has remained virtually unchanged over time, with the exception of the ill-fated "New Coke" formula rebranding, in the mid-1980s. This makes sense, given that Buffett started buying Coca-Cola shares in the late 1980s, following the stock market crash of 1987. Presently with 400,000,000 shares, valued at $22,000,,000,000, Coca-Cola accounts for 10% of the portfolio.
At 9% of his portfolio, Buffett currently holds shares valued at over $19 billion. Although this is Buffett's fourth-largest position, Wells Fargo previously occupied the top slot for many years. A series of scandals that began in 2016, including the creation of millions of dummy bank accounts, unauthorized modifications to mortgage plans, and the fraudulent sale of unnecessary car insurance, has hurt the bank's reputation.
This company is the third financial services company to make Buffett's top five list, occupying 8% of the portfolio. Valued at nearly $18 billion, Buffett acquired his initial stake in the credit card company in 1963, when it sorely needed capital to expand its operations. Buffett has since been a savior to the company, many times over, including during the 2008 financial crisis. With 12.5% average annual return over the past quarter-century, American Express has proven to be a valuable asset.
We’d like to say THEY COVER IT ALL. Again, if you believe in America and free enterprise, you might just want to buy one share of the A series – it’s only $340,000 per share! (A good friend of ours used to call us up at the office back in our Morgan Stanley days in the 1990s and would leave a message: “I just called to place an order for 100 shares.” That’s when the stock sold for $35,000 a share, so 100 shares was worth $3.5 million. He thought this was hilarious! Well, how about now? 100 shares is worth $34 million! HAHA.
What’s the point about all of this hilarity? Get a piece of this company. 10 shares. 100 shares. 1000 shares. Whatever you can afford. You’ll never regret it. Our Target of $230 is about to be breached. We hereby raise it to $255. Our Sell Price remains the same: We would not sell Berkshire Hathaway.
The Blackstone Group (BX: $56, up 4%; dividend = 3.5%)
The market cap of this behemoth is $67 billion. Just a year ago at $30, the stock was worth $36 billion, so this 85% run-up this year has added over $30 billion to their stockholders’ net worth. The company manages over $550 billion of assets. Run by Steven Schwarzman since inception in the mid-80s, Blackstone has 2,500 employees in 24 offices worldwide and their portfolio companies employ over 360,000 people across the globe. Schwarzman’s new book is about his life and the rise of this company: What It Takes – Lessons in the Pursuit of Excellence. If you like financial books like this, it’s a real page turner.
Would we buy shares today? Yes, absolutely. If anyone can make money in the market today it is this firm. Revenues are strong, rising from $4.2 billion in 2015 to $6.8 billion in 2018. Revenues may drop a bit this year, but this is normal for a alternative asset management firm like Blackstone. In fact, we expect them to almost double profits this year compared to the banner year they had in 2018.
Our Target of $60 is fast approaching and our Sell Price of $40 must be raised, so consider it done. $50 it is.
CBRE (CBRE: $61, up 3%)
No dividend here, but with the stock up 50% this year, we’ll take it. The company is worth $20 billion and they are at the peak of their success. It’s a very quiet company – they are not splashy like Apple or Google. Just solid, keeping their nose to the grindstone and saving money for their customers, day in and day out.
They are real estate specialists. How do they make their money? Many ways for sure, but one typical transaction might be a deal they did a few years ago. They were working with The Texas Department of Transportation who had 600 facilities across the state. CBRE came in and suggested that they only needed 300 and would help them consolidate and dispose of the ones that didn’t work. They won the bid, saved Texas countless millions, and in fact, after the buildings were liquidated, returned hundreds of millions of dollars back to the state. And guess who earned commissions on all the real estate they sold? That’s right: CBRE brokers were happy to oblige. Everybody won, which is the only way to go. They have replicated this process over and over again.
Another deal we heard about was bid on and won by CBRE by offering to take on a massive reorganization for a large NYSE company. They said that there would be no fee unless the firm saved $17 million in the first year. Guess what? The company saved $20 million, signed a long-term contract with CBRE and the profits continue to roll in to this day.
The High Yield Investor
Performance across our Real Estate portfolio has been uneven this year, but it’s crucial to keep these stocks’ strategic role in mind. They aren’t here to provide huge wins or even keep up with a market in the grip of a full-fledged bull run. All we want from them is a strong dividend yield and a little room for upside.
In other words, they need to be compared to their peers elsewhere in the sector. On that respect, we’re beating the benchmark on dividends, which is the most important thing. Our active REIT recommendations are set to pay back 6.7% next year if you buy in now. The Real Sector sector as a whole will only give you a 3.2% return. And forget about earning that much in the Treasury market.
We’re here to get that enhanced income stream at roughly the same level of risk that something will go catastrophically wrong. Over the coming year, we’ll review each company’s cash flow to make sure they can make their quarterly payments. Odds are good that if any of our REITs gets into trouble, the sector and the market as a whole will be feeling the burn as well. In that scenario, a strong defense holds up best, so these are the stocks we want in our portfolio anyway.
Either way, the more income we can squeeze in the good times, the better our position will be the next time the Real Estate world shudders. That’s why we only wince a little to see our REITs tracking “only” a 12% total return this year when the sector as a whole and the broader S&P 500 show significantly bigger paper profits. These aren’t trading opportunities for us to buy and sell according to the way the momentum tides turn, which is the approach you’d need to take with either a Real Estate sector fund or the S&P 500 to convert those paper gains into cash.
And with the exception of a few momentum-driven superstars, the REIT world hasn’t actually had a spectacular year. Only four gigantic stocks account for 60% of the sector’s real performance. We don’t recommend them because they aren’t interesting from a yield perspective . . . in fact they barely pay more than the S&P 500. They aren’t income stocks. Last year they moved like growth stocks, but in our Portfolio we had a full plate of better growth opportunities moving a lot faster. Factor those oddities out and the sector funds underperformed the BMR REIT portfolio by 3 percentage points, all of which came from dividends. As a group, our Real Estate stocks did no better and no worse than everyone else. The quarterly checks took us over the top.
But we concede that Service Properties Trust (SVC: $24, up 2%; yield = 9.0%) and Ventas (VTR: $57, up 4%; yield = 5.2%) have been a drag on the portfolio, with dividends roughly cushioning the impact of declining stocks. As far as we’re concerned, that short-term disappointment is a long-term opportunity.
Service Properties is down 14% from its 52-week high, which is roughly in line with our other REITs. There’s no special downside here. While the sector as a whole has retreated 5% from its peak, our higher-yield REITs are down a collective 11%, so this is nothing shocking. The only disappointment here is the fact that the stock didn’t soar enough earlier in the year to cushion recent weakness. Changing the company’s name from Hospitality Properties Trust while shuffling the property portfolio in September wasn’t helpful either.
What we’re left with on Service Properties is an anemic multiple of 6.4X Funds From Operations in a world where bigger Hotel REITs command a 10.5X FFO multiple, and even in the cloudy Retail segment leading REITs are worth 12.1X FFO. These comparisons simply aren’t sustainable in the long term. Either this company is 60-90% undervalued relative to its peers or the rest of the sector is due a hard fall.
Admittedly, Service Properties isn’t perfect. Expanding its Retail presence at a moment when a lot of malls are struggling feels counterproductive to many investors and neither the growth rate nor the operating efficiencies stack up well against other REITs. That’s okay. It’s why management decided the company needed to make big changes in the first place . . . and as far as we’re concerned, big changes present opportunities as well as risks, provided of course that execution goes well.
Ventas is a similar story. The mood here simply got too negative back in October when management warned that Assisted Living occupancy had taken a “precipitous” step down and will stay soft for the coming year. Competitors are simply capturing too many residents, leaving a few Ventas operating partners scrambling to adjust.
It stings. But management sees a recovery just over the horizon, possibly as early as the next earnings call next month. If so, that’s less of a long-term nightmare than a bit of quarter-to-quarter noise. It’s definitely no reason for the stock to drop 22% from its peak and stay there. We did the math and Ventas might see a 2% year-over-year decline in Funds From Operations in 2020. That’s far from a company killer. This is the same company that came into 2019 warning us that FFO would drop 4% over the next 12 months and soared from $57 to $73 anyway.
While it will take time for the numbers to start moving in the right direction again, we trust management to do the right things in the long run. Meanwhile, all of our REITs revolve around bringing in enough cash to pay the dividend. All Ventas needs to make that happen over the next year is to generate at least $0.80 per share every three months. Anything else is extra funds available to plow back into the business or even distribute to shareholders. From what management has told us, we’re confident the company will bring in that $0.80 per share plus at least $0.13 as a cushion. The dividend is not going down. And that means investors can count on a 5.4% cash return next year independent of where the stock goes. If Ventas drops 5.4%, you break even while broader REIT portfolios end up with a dividend-adjusted loss. Should REITs do well, the upside here is magnified.
That’s true of Service Properties as well. Management can pay the $0.54 dividend out of current cash flow even if for some mysterious reason 2020 FFO falls a full 45% below our target. Unless that disaster happens, shareholders will lock in a base 9% return here next year. The stock can retreat in the meantime, negating all or part of that income, but it can just as easily rally and provide a much bigger return. Either way, that 9% base is as sure as anything else in the market right now.
Of course rare disasters can happen. Ventas didn’t even flinch from its dividend obligations in the 2008-9 crash, so unless conditions have deteriorated beyond that point, we feel pretty good about management’s ability to keep the quarterly checks coming. Service Properties suspended its payout in 2009 and resumed it at a 40% lower level in 2010, so history is a little cloudier on that side of our REIT portfolio. Should we see that history start repeating, we’ll take appropriate steps to protect BMR subscribers.
But it’s going to take a lot of disaster to make that happen. Over the past decade, neither of these companies has missed a payment or even cut the dividend a penny per share. Instead, they’ve kept generating more and more cash for shareholders. If you bought Ventas before the 2008 crash and held on, you’d be earning 8.6% here now, and if you had the foresight to buy the dip, your effective yield would be closer to 20% today.
Service Properties now carries a higher yield going into the crash a decade ago. We don’t see that kind of catastrophic risk ahead for this company. Even if the nightmare scenario happens, long-term shareholders who bought the dip have more than recovered their capital and earned a lot of money along the way. That’s what it’s all about.
Todd Shaver, Founder and CEO
The Bull Market Report