If you already follow me and read my past articles, you probably know that I am rather bearish about the US stock market and the outlook for the next few quarters. We can't be absolutely sure that the US economy will enter a recession, and we also don't know if we saw the stock market's highs in July or if the major indices will set new all-time highs in the next few months again. However, with current valuation levels - especially in the United States - there don't seem to be much investment opportunities right now. The following article is taking as premise a person that wants to invest nevertheless and has to find great companies to hold for a decade or longer.
In the following article, I will first explain very briefly why I don't think, that now is the time to invest big - not for long-term investors and probably also not for short-term investors. But if you want to invest anyway - for whatever reason - I will show you how I search for stocks and what characteristics I pay attention to when searching for stocks which are a good long-term investment. Finally, I will present a list of 10 potential stocks that appear cheap right now and have a solid business model in order to qualify as a good long-term investment.
Stock market: Bearish
It is always difficult to know beforehand when a recession will happen. We know that the economy (and the stock market) moves in cycles and these cycles usually take about 10 years (sometimes a bit less, sometimes a bit more). So, we know that at some point, the downturn has to come, but we don't know when. To know when a recession might be upon us, we have to look at different early warning indicators like the bond market (and the yield curve), the federal funds rate or the initial unemployment claims. The inverted yield curve, for example, is a very strong warning signal as it has predicted recessions in the past decade very accurately. The Fed lowering interest rates for the first time since the financial crisis is also a strong warning signal: in the past decades, the initial interest rate cut was often followed by a recession, although there have been false signals.
Although not knowing when a potential recession might actually happen, after a run that lasted more than 10 years with the S&P 500 gaining almost 300%, I am very cautious right now to make any long-term investments as I see a very real risk of buying at the top and right before the stock market will enter a steep decline.
Searching For Stocks: Stability And Consistency
When searching for individual companies, we should focus on one major aspect: stability and/or consistency. We are looking at stable margins, consistent cash flows, and solid performance even during recessions (or at least a quick recovery after recessions). And although it might not be the case for the companies presented below in the past few years, all of these companies demonstrated over the past decades, that they have a good business model, and the companies show stability and consistency over a long time. Not all 10 companies mentioned below fulfill these criteria in the same way - some better than the others - but they all have good and solid business models.
In many cases, these companies are facing some challenges or risks, which probably led to the depressed valuations for these stocks while the overall stock market is still near an all-time high. Although acknowledging these risks, I am pretty confident these risks are rather short term and should not undermine the long-term performance of these companies. And, in this article, I picked stocks that not only pay a dividend but also have a rather high dividend yield right now and often have a long history of increasing or at least stable dividends.
Potential Portfolio: 10 stocks
In the following section, I will present a list of 10 potential stocks that are all trading close to its 52-week low, have a rather high dividend yield, and seem undervalued right now. The presented companies are mostly from the United States and include also some companies from Europe. Several of these companies have some form of risk or rather high levels of uncertainty associated with the business right now, which is often the reason the stocks are trading at depressed multiples. And although I don't have a crystal ball, I expect for most of these companies that the current problems will get resolved within the next few quarters and the stocks could trade higher again.
(Source: Own work/data from August 28, 2019)
Bayer AG (OTCPK:BAYZF)
The German pharmaceutical and life science company might be a surprising pick for some investors when talking about aspects like stability and consistency and an investment one can hold forever. And nobody can blame you as Bayer has only been in the news with horrible headlines in the last few quarters. After the acquisition of Monsanto, the number of plaintiffs claiming they have been exposed to glyphosate-based products manufactured by Bayer's subsidiary Monsanto increased to over 13,000. These plaintiffs are claiming that they have been exposed to Roundup and suffer personal injuries resulting from exposure to those products, including non-Hodgkin lymphoma (NHL) and multiple myeloma, and seek compensatory and punitive damages.
As Bayer is facing high potential fines and costs as a consequence of the lawsuits, investors are very cautious right now. But, first of all, Bayer is a very diversified business with the crop science business being only one out of four major business segments (pharmaceutical, animal health, and consumer health being the other three).
(Source: Bayer Investor Presentation)
Bayer also has a 150-year successful history and paid a dividend for several decades (at least since 1952). After the dividend was raised several years in a row, in 2018, the dividend was kept stable at €2.80 resulting in a dividend yield of 4.32% right now. And not only the dividend is attractive, but Bayer also seems fairly valued even if we consider high potential fines up to €20-25 billion.
Novo Nordisk (NVO)
A second company from Europe, which had some troubles the past few years is the diabetes giant from Denmark - Novo Nordisk. Especially, in the United States, the (political) pressure to lower drug prices and pressure from competitors led to a stagnating revenue for quite some time. Novo Nordisk also lost patent protection for some of its major products, and as new potential blockbuster hadn't been launched yet, the sales stagnated.
But the last quarterly results show signs of improvement. Especially 9% revenue growth compared to the same time frame last year should make us optimistic that Novo Nordisk can return to its former growth rate of high single-digit or even double-digit growth.
(Source: Novo Nordisk Investor Presentation)
In 2018, Novo Nordisk paid an annual dividend (split up in two payments) of DKK 8.15, which is resulting in a dividend yield of 2.38% for the stock right now. In case of Novo Nordisk, it is not so much the dividend that makes the stock interesting - it is the business model of Novo Nordisk, which is one of the best I know. The combination of patent-protected products, high levels of innovation, and growing demand for its products due to an increasing number of diabetics and obese people should lead to growth for many more decades for Novo Nordisk.
3M Company (MMM)
The US industry giant 3M Company also saw its stock price slump during the last months as the company is facing some challenges. Aside from several lawsuits the company is facing right now, there are also growing concerns that the company might not be able to grow at a similar pace as in the previous years. And 3M is also a company that is affected by economic downturns and will be among the first that see sales decline when the economy cools off.
But over the long run, 3M can rely on its wide economic moat, that is based on patents, on branding and on switching costs as well as economies of scale, and I think the moat is pretty stable and will ensure above-average growth even if 3M has trouble to grow right now. 3M Company is also interesting for its dividend as the current dividend yield is 3.49% and the company is also among the dividend aristocrats. With 61 consecutive years of dividend increases, the stock is definitely interesting for dividend investors. Of course, we don't know if the stock has already reached its bottom (probably not), but it seems to be fairly valued right now.
Target is certainly not a company with an extremely wide moat around its business (as it has always been difficult for retailers to create stable moats). But Target has a long and successful history and showed stable performance over several decades. Especially, due to its strategic investments in the past few years, the company seems to be on track to continue its growth path and still compete with Walmart (WMT) and the industry giant Amazon (AMZN). In the last few quarters, Target has delivered solid growth rates again (5% revenue growth in the last quarter) and could beat analyst's expectations several times, which resulted in the share price doubling within the last two years.
Target is generating about $76 billion in annual revenue, and although it had trouble to increase its revenue in the past years (only 1.8% annual growth on average for the last decade), earnings per share could increase almost 6% annually due to share buybacks. Target is certainly not a company with extremely high growth rates, and currently, the stock is not even close to its 52-week low, but it is still interesting for its dividend and because of its status as dividend aristocrat. Target is not a growth company, but a steady performer, that has raised its dividend for 51 consecutive years and, currently, has a dividend yield of 2.56%.
Gilead Sciences (GILD)
Another company that has a few rough years behind it is Gilead Sciences. With the launch of Harvoni and Sovaldi, Gilead Sciences was extremely successful and, in the years between 2011 and 2015, the company could increase its revenue from $8.4 billion to $32.6 billion within four years. In 2015, Harvoni and Sovaldi were responsible for almost 60% of Gilead Science's revenue and as sales of Harvoni and Sovaldi declined dramatically in the years 2016 and 2017, so did the overall revenue. The following chart shows the sales of Harvoni and Sovaldi between 2015 and 2018.
(Source: Own work)
Right now, it seems like Gilead Sciences was able to slowly start its turnaround as revenue could increase 4.0% in the first quarter of 2019 and at least 1.2% in the second quarter. After revenue declined for several quarters, this is a good sign for the company. Aside from revenue, Gilead Sciences could also increase GAAP EPS: 31.6% growth in the first quarter and 5.8% growth in the second quarter. Especially, sales for Biktarvy are growing with a very high pace, and in the second quarter, the company could report sales of $1.1 billion after only $185 million in the second quarter of 2018.
Gilead Sciences is also interesting for its dividend. With a quarterly dividend of $0.63, the stock has a dividend yield of 3.92%. And as the stock is currently valued for a moderate growth rate of 2% from now until perpetuity and $27.1 billion in cash and cash equivalents on its balance sheet (also $24 billion in long-term debt) as well as $7.4 billion in annual free cash flow and extremely low capital expenditures (about $900 million), the stock could be a good long-term investment.
CVS Health Corp. (CVS)
CVS is a pharmacy retailer with about 10,000 stores, and with CVS Caremark, the company also is one of the big pharmacy benefit managers in the United States. In November 2018, CVS acquired Aetna, a health care insurance company. However, investors seem to be very pessimistic about the acquisition and have sent the stock down in the last few years. Investors seem to be concerned about the huge amounts of debt, CVS currently has on its balance sheet and the challenge to integrate Aetna, which CVS is facing right now. Due to a goodwill impairment charge, CVS had to report a loss in 2018 (GAAP numbers) - something that hasn't happened during the last two decades. In 2019 and 2020, CVS is also expecting growth to be only in the low single digits (non-GAAP numbers), which might scare investors a little bit. But CVS is confident it will be able to grow EPS in the low-double digits again from 2022 going forward, and for a company that might be able to report double digit EPS growth over the long term, the stock is severely undervalued right now.
(Source: CVS Investor Presentation)
CVS is currently paying a quarterly dividend of $0.50 resulting in a dividend yield of 3.34% and has been a stable dividend payer for many years. As management is currently focusing on repaying the outstanding debt, it will keep the dividend only stable right now and probably start increasing again in 2022.
BASF is another company trading near multi-year lows as the business is faced with several challenges. In the past few months, BASF had to announce it will cut 6,000 jobs, and it also had to lower the guidance. After expecting earnings per share of €5.20 before, the company now lowered its own guidance to €3.96 for the full year. In the last quarter, the company especially had to report a sales decline for its chemicals segment (22% decline) and the materials segment (16% decline). BASF is a cyclical company and is affected by economic downturns which are causing the current decline for the stock. But when looking at the big picture, BASF is a very stable and diversified business with a long, successful history.
(Source: BASF Investor Presentation)
And BASF is also interesting for dividend investors as it has been paying a dividend at least since 1990. The company had to lower the dividend in 2009 after the financial crisis, but since then, BASF increased the dividend every single year. The company is paying an annual dividend of €3.20 and has a dividend yield of 5.56%. It might be possible that BASF has to cut its dividend again - as it happened during past recessions - but over the long run, BASF is definitely a good long-term investment and interesting for dividend investors. And although it isn't a company I would buy right now, it seems to be fairly valued.
United Parcel Service (UPS)
United Parcel Service was founded in 1907 and is one of the biggest US distribution companies. It provides letter and package delivery, specialized transportation, logistics, and financial services. The company is operating internationally and is providing its service in over 200 countries. Over the long term, the core business of UPS seems to be protected pretty well by a wide economic moat that is resulting from a dense and complex distribution network, which is hard to match for any new competitor - especially in the United States. And despite additional competition from new potential entrants like Amazon, UPS can probably increase its revenue with a stable pace - especially as the overall market will continue to grow.
UPS is also interesting for its dividend as the company is paying a quarterly dividend of $0.96 resulting in a dividend yield of 3.32% right now. According to its own investor presentation, the company had a stable or growing dividend for almost 50 years, which is demonstrating stability. And although UPS could not join the ranks of dividend aristocrats, it is very interesting for dividend growth investors.
Although the AT&T we know today was founded only in 1983, AT&T is actually one of the oldest companies in the United States, and before 1983 (when the company was broken up), it was one of the most powerful monopolies that ever existed. Today, AT&T provides telecommunication, media, and technology services worldwide, and although the company is not nearly as successful as during the first eight decades of the 20th century, it shows still a solid performance. Over the last decade, revenue grew 3.25% on average and earnings per share increased 2.81% on average annually.
Similar to all the other stocks mentioned in this article, AT&T is especially interesting for its dividend. With a current quarterly dividend of $0.51, the dividend yield is 5.88%, making the stock very interesting for every investor seeking a passive income. Additionally, AT&T increased the dividend for 16 consecutive years, although the average growth rate was only about 2.3% annually during the last decade.
Wells Fargo (WFC)
Wells Fargo & Company is a very diversified financial services company and the third-largest commercial bank in the U.S. in terms of deposits ($1.3 trillion in December 2018) and provides retail, commercial and corporate banking services to individuals, businesses, and institutions. The company operates through three segments: Community Banking, Wholesales Banking and Wealth and Investment Management. Following the scandal in 2015, the company had three difficult years including the imposition of $185 million in fines in 2016 for improper sales practices. Revenue was also rather stagnant during the last decade and Wells Fargo is certainly not a growth company anymore and we should not expect too much in the years to come. And over the short term, the lower interest rates will lead to some trouble for Wells Fargo, but over the long run (next 10, 15 or 20 years) we can expect interest rates to rise again (according to the long-term debt cycle; see Ray Dalio for example) which is positive for Wells Fargo.
Among the big US banks, the company is especially interesting for dividend investors because of its dividend yield. Currently, the company pays an annual dividend of $2.04 resulting in a dividend yield of 4.54%. Like many other banks, Wells Fargo had to cut its dividend during the financial crisis, but since then Wells Fargo increased its dividend nine consecutive years and has also been a consistent dividend payer in the years before (with several years of consecutive dividend increases).
I presented 10 stocks that might be fairly valued and especially attractive for dividend investors. But not all ten are equally good picks right now - Target, for example, had a good run with its stock price doubling in the last two years and although the stock still seems to be fairly valued one might wait probably for a pullback. And of course, my overall bearish sentiment remains and while some stocks - like CVS Health or Bayer - seem to trade at very depressed multiples, every single one of the above-mentioned stocks could drop lower if the macro picture should continue to get worse in the next few months. Like I said above, I probably won't invest right now, but if someone wants (or has) to invest in single stocks right now - for whatever reasons - this list contains some companies I probably would choose from right now.
A few of the above-mentioned companies - i.e. CVS Health or Novo Nordisk - are also among the stocks with a superior business model and a wide economic moat, that I cover in my marketplace service: Moats & Long-Term Investing.
If you want a watch list of wide-moat companies, extensive background information on wide-moats and a chatroom where members can ask questions and exchange opinions, please check out my marketplace.
Disclosure: I am/we are long CVS, NVO, TGT, GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.