(Source: Time and Date)
As we're entering June of 2020, we ask ourselves where we should put our money next. I certainly am no different.
The markets seem to change on a weekly basis in terms of what is still buyable and what isn't, and several companies I considered prime buys on a sector-specific basis only last month are now close to or actually overvalued.
Moving forward, picking still-undervalued companies that are likely to appreciate and grow is absolutely crucial given the potential for another downturn. Combining this with conservative and defensive metrics in these trying times is, in my opinion, of paramount importance. Gone are days of yield-chasing or trusting that 10-20%-yielders can guarantee a stable income going forward. My choices are different, even if on paper, my overall priorities haven't changed.
I've put a whole lot of capital to work during the past month, as you can see in my monthly portfolio update. It should be noted, however, that the company purchases are weighted very differently in timing. My purchases during the beginning of the month were very different compared to the last week.
In this article, the purpose is to highlight where we can safely put our money during June of 2020. I will pick one company per sector, though I may sometimes mention two if the situation warrants I believe that all of the companies mentioned merit closer looks from your side. The justification for this is a combination of fundamentally appealing qualities as well as a valuation that I perceive as excellent for the time.
Much like with previous looks, I will not be covering any oil or energy stocks. While I maintain my holdings and plan to do so, I've no desire to extend my positions here - and my work, I believe, should reflect that. I always want to eat my own cooking, and when I view energy as difficult to invest in because of an opaque future, I won't be putting positive spins on the sector in my articles, even if this potentially generates a lot of clicks.
This is not unique for the energy sector but can be found in airlines, travel, the car industry, and other extremely cyclical or affected industries at this time. I don't buy them - and I won't write about them at this time, at least not positively.
This article is about the responsible allocation of investment capital and we go alphabetically.
1. Basic Materials
Eastman Chemical Company (EMN) while not overvalued has lost a lot of its valuation-related appeal as a result of a recent price surge with stock prices now close to $70/share. This is a problem because out of the Class 1 Basic Materials companies I follow, the others all trade at a substantial premium already. Thankfully, there's another pick to be made - Applied Materials (AMAT). While I won't claim substantial undervaluation with regards to future clarity here given the potential China issues, I do see an above 10% undervaluation with regards to forecasts in AMAT. I have not yet written an article on the company, but metrics seem indeed favorable.
(Source: F.A.S.T. Graphs)
AMAT supplies equipment and services for semiconductor companies for products such as chips, display panels, smartphones, and solar products, and business is expected to boom back in the future years. There is some ambivalence to these forecasts - analysts aren't as accurate as we'd like them to be with a 45% miss rating. The upside is most certainly there, however, and we're looking at potential annual returns of 9-20% annually for the coming years if these forecasts materialize. Even trading sideways, we need hardly worry about the destruction of capital on these levels.
(Source: Applied Materials)
On quality. AMAT is A- rated, the dividend is ridiculously safe at a 29% payout ratio, and dividend growth is excellent on a five-year average basis with a 16% record. The dividend history is barebones at 14 years, but the company has an appealing "Wide" moat, and you have a three-year average forward PEG ratio of 0.79. Both quality and opportunity scores are relatively high, though the opportunity is weighed down by the modest 1.61% yield and the still relatively fair-value dividend. Given the higher degree of undervaluation, however, AMAT scores higher than its Class 1 peers at this time.
Still, EMN remains 7-8% undervalued and still yields 3.83%. You also have Celanese (CE) at 14% current undervaluation, though this may change by the time this article is published. While it's a Class 2 stock with a lower credit rating and only a 14-year streak, it's still excellent and yields 2.7%. Both are good alternatives to AMAT. This sector is becoming problematic as I see it, and the actual next company which can be considered truly appealing is a European one. I recommend you look into AMAT, however, as it is a "BUY" here.
2. Communications
Telecommunications is easier. Omnicom (OMC), despite some growth, remains substantially undervalued at 42% to my overall target, with growth potentials of 15-25% annually based on historically fairly accurate forecasts - FactSet analysts rarely (9%) miss any sort of forecast here on a recent historical basis.
(Source: F.A.S.T. Graphs)
The potential upside for this company really depends on where in the forecasts the earnings go, but the one thing I believe is clear when we look at Omnicom is that there is a very fundamental undervaluation of the company here. I've written articles on Omnicom where I detail its business and operations, and why I believe it will be stable going forward. Omnicom, unlike other media/communications companies, has affirmed its annual dividend, making the 4.71% yield a safe bet in today's unsafe world. At current undervaluation, the upside is between 14% and 25% annually depending on where earnings go.
The company remains BBB+ rated, still trades at no more than ~9X earnings, and 10%+ EPS yield with a 1.88 three-year forward average PEG ratio. The streak here is 30 years, and while it lacks a "Wide" moat, it is considered Narrow as one of the "Big 4" in the industry. Omnicom, next to Comcast (CMCSA), remains the premier communications opportunity I see today, and its combined opportunity and valuation score of 3.6/4.3 confirms this, with Comcast coming in at 3.2 (due to lower yield, higher P/E, and other metrics).
So despite seeing some recovery during the past week/s, Omnicom still trades at a significant undervaluation that I believe merits your attention. The company is still very much buyable. If you want a more conservative media conglomerate with exposure to TV, there's Comcast, which at 2.33% yield and 22% undervaluation is also an excellent pick.
My communications pick, however, remains Omnicom, and it is a "BUY".
3. Consumer Discretionary
Not much has changed in Consumer Discretionary in a month. The opportunities have grown less and smaller. Whirlpool (WHR) has recovered significantly and the yield has dropped below 4%, but it remains my first pick in the sector due to still seeing a 23% undervaluation to a target fair value of $150/share.
It's important to note that analysts forecast a significant headwind in EPS during 2020 (as expected) due to the coronavirus and related issues.
(Source: F.A.S.T. Graphs)
The potential here is for the short-term returns to actually go negative if the company's share price follows suit in terms of its earnings. My own cost basis is substantially below the current price, and as such, I'm actually slow to add more Whirlpool at this price. Long-term, however, this price is still one that I consider excellent as things will most likely turn around as early as 2021.
I've covered the company's operations and earnings extensively in separate articles. This is one of my go-to consumer discretionary investments, and despite its Class 2 status, it's one I consider extremely safe long-term.
Whirlpool remains BBB rated, with a very safe dividend, a very low sub-10X P/E ratio, and excellent overall metrics, such as a 30% payout ratio, 11% dividend growth, and a nearly 30-year streak. The moat is considered narrow, and the EPS yield is still above 10% at today's price.
Out of other stocks in the same sector, only Leggett & Platt (LEG) comes close to matching Whirlpool at a 12% undervaluation. The yield is higher at nearly 5%, and the dividend is still "Safe" if we look at SimplySafeDividend ratings. However, the nearly 50-year streak is weighed down by a substantially higher payout of over 60%, the dividend growth is only 5% and the opportunity in terms of long-term upside is smaller. My monthly pick here is Whirlpool, but I own both - and I will continue buying both when opportunities present themselves.
4. Consumer Staples
Consumer staples remain a tricky investment prospect at this time, given the overvaluation of every Class 1 stock I follow except one - Archer-Daniels-Midland (ADM). My view is that this stock is a truly underappreciated gem which most investors, for some reason/s, seem to overlook. I've been buying ADM on a near-weekly basis for the past month, slowly building my position in this giant.
While the yield is now below 4%, the company's fundamental appeal and excellent qualities remain. An A grade credit rating enhanced by a Very Safe dividend, a 44-year streak, and a less than 55% payout ratio in terms of EPS. The three-year forward PEG ratio is 0.81, marking it extremely appealing and even though some may argue the company is close to fair value, I argue that we rarely see this company trading at anywhere close to these earnings multiples while at the same time expecting a significant earnings growth in the coming years. Take a look.
(Source: F.A.S.T. Graphs)
Potential returns range from 10% to 25% annually here if we consider the premium valuation even somewhat indicative in the long term. There is some uncertainty baked into the forecasts here, as analysts have a less-than-perfect overall accuracy with a 45% miss rate. However, the long-term trends for this company have long been positive and I expect them to continue to stay this way.
(Source: Financial Post)
All of this means that Archer-Daniels-Midland is my Consumer staple investment of choice in June of 2020. While there are lower class investments that show us excellent valuations and opportunities, such as Altria (MO), Philip Morris (PM) and Walgreens (WBA), most of these come with disclaimers or sizeable risks/poor expected growth which make them, in relation to ADM, not as good investments in my eyes. This is also why these stocks are Class 2 and 3 and not 1 like ADM.
However, the buying opportunities in Home Depot (HD), in Lowe's (LOW), and companies such as Coca-Cola (KO), these are gone - and we'll need to wait for them to return or accept a high premium to buy stock in these companies.
My choice - ADM. It's a "BUY" at this time.
5. Financial
Much has changed in the financial sector valuations over the course of the last month. Ameriprise Financial (AMP) has shot up, pressing yields below 3% and potential undervaluation to "only" 22% compared to almost 40-50% only months ago. My position has appreciated significantly, but at this time I'm careful to load up more compared to other financial stocks. Other companies have started to shine in comparison, and two of them are Aflac (AFL), and most of all, the Reinsurance Group of America (RGA).
RGA is showing us an undervaluation much higher than Aflac, but Aflac is higher than AMP. RGA comes in at an undervaluation of over 65% at this price, and it's not hard to see why. I've spoken to RGA being undervalued before, but AMP was a better choice in my eyes then. Now, however...
(Source: F.A.S.T Graphs)
If we assume that these forecasts are even slightly indicative, which the analyst earnings hit/miss ratios of only 9% miss over time would suggest, then we're looking at potential long-term (three-year) returns of 60% yearly at a return to normal valuation of P/E 14.2 (from 8.4X today). An amazing opportunity.
RGA engages in the reinsurance business, offering individual and group life and health reinsurance products as well as asset-intensive and financial reinsurance products. It serves markets and insurance companies in the US, Latin America, Canada, Europe, the Middle East, Africa, and the Asia Pacific region. It's one of the largest global life and health insurance companies in the entire world, with an insurance base of around $3.5 trillion.
I've not yet written a specific article on the company, but recent trends and undervaluations have made me done a deep dive into the company, and as a result of this, I've started a small stake which I intend to build going forward. I will also be publishing a company-specific article on RGA.
Until then, it's A-rated, with a very safe dividend trading at around 7-8 times earnings, with a yield of 3%. The company has a 25-year streak, 16% five-year average dividend growth, and a payout ratio of less than 21% of LTM EPS. This makes it one of the safest bets in the insurance or reinsurance markets, and this is shown with its SimplySafeDividends rating of 99/100 - it doesn't get higher than this. My scoring system puts RGA at 3.5/4.3, which is now on equal footing with AMP and Aflac, but given its undervaluation, I consider RGA to be the far superior choice in Class 1 finance we can find today.
It's my pick for this time, and Reinsurance Group of America is a "BUY".
Wrapping Up
Going into June, we're slowly starting to recover from the coronavirus-induced drop. Despite having severe exposure to cyclical financials such as Swedish banks, my portfolio is now solidly in the green, and steaming ahead of comparable local indexes. This also means, sadly, that the amazing opportunities that were available only months ago are now all but gone.
We're down to investing in "fairly" valued high-class companies for the most part. If this trend continues and the market continues to climb, we'll be down to investing in either slightly overvalued qualitative companies or having to climb down the ladder into classes 2, 3, and starting to touch on class 4 quality stocks to find appealing undervaluation. While the companies found here are in no way "bad", they also don't share the qualities that make the above-mentioned stocks so appealing.
As I look back at the crisis and my investment and spending, I'm very pleased with the quality of the positions and companies I've managed to build up. Almost 10% of my cash position was invested since mid-February of 2020, and after May's cash injections, I stand at around 5.5%, with my pace of investments slowing down somewhat.
However, I believe it crucial to keep investments continuous and flowing, as I don't need a 5% cash position to keep my life as I want it - and there are still great opportunities available. Because of this, I'll keep pointing out the companies that I believe present the best opportunities for risk-conservative investors.
In the next part of this small series, we'll look at the remaining five sectors - which should be equally fun.
Until then, thank you for reading - and consider investigating more in the companies I've presented here. They really are, I believe, excellent deals.
