For a conservative medium-to-long-term investor, this is a very difficult market to find stock investments. Most markets are near all-time highs, and everything looks pretty darn expensive. Out of approximately 600 high-quality stocks that I actively track, only about a dozen of them are remotely close to "buy prices" by my estimate. This means that I'll probably be writing a lot of warning or bearish articles in 2022. But that doesn't mean there aren't a few interesting ideas in the market, and so I at least want to share some of those ideas before I start cranking out the bearish warnings. The truth is that I'm currently holding almost no cash and have about a 90% allocation to stocks at the moment. Last month I shared three food-related stocks that I own which I think could do relatively well over the next year or two: Jack in the Box (JACK), Tyson (TSN), and Cheesecake Factory (CAKE).
With Omicron still raging, CAKE has suffered a little bit, but TSN and JACK show early signs that they could outperform the S&P 500 this year and are off to a good start.
In this article, I'm going to share 5 different ideas for 2022. Three of them I haven't written about before, one of them I have mentioned in passing, and one of them, platinum, is a carry-over from 2020 and 2021. While my last article focused on food-related stocks, in this article all of the ideas are very different businesses. As a group, along with the three ideas from my previous article, I think they offer a pretty diversified basket of earnings-based and cyclical historical price-based investments. (REITs, and faster growth businesses, I don't write about publicly, and those ideas and strategies are kept exclusive to my private service, the Cyclical Investor's Club.)
With that, let's take a look at these five ideas.
The approach I use for my first three ideas is what I call a "Full-Cycle Earnings Analysis". I'll explain the process in more detail for this first idea, and then share shortened versions for the next two since they use the same process.
I recently wrote about PayPal's (PYPL) 2021 price decline, and that spurred several questions about my view on Global Payments. I have a general guideline that I adopted a few years ago regarding businesses that have recently participated in big M&A. That guideline is that if a business has made a purchase that is roughly 20% or more of their market cap at the time, then I wait about 3 years before I consider buying the stock. In 2019, GPN merged with Total System Services, and that triggered my waiting period before considering buying GPN.
There are three main reasons I use this M&A purchasing guideline. The first is that usually companies overpay for the businesses they are buying and it takes a few years for them to earn enough money to make up for the overpayment and also it often takes a couple of years for the effects of the merger to be reflected in earnings, which is a big part of my analysis. The second reason is that often there are competitive reasons a company feels compelled to have to make a big merger in the first place, so there is reason to believe there are competitive threats on the horizon that management sees but haven't yet been reflected in the earnings. And the third is that I mostly use historical earnings and market sentiment to form the baseline of my analysis, and a company can change a lot sometimes via acquisitions, which can alter the usefulness and accuracy of historical analysis. For all these reasons, I simply don't buy most stocks after big M&A. There are a few exceptions to this rule, but they aren't relevant to GPN.
As I noted above, I typically wait about 3 years after this sort of M&A, and we are around 2.5 years after this one, but since the stock price has corrected and appears to have potentially put in a bottom, I think it's reasonable to at least consider buying it at this point if the rest of the numbers work out.
As part of the analysis, I calculate what I consider to be the two main drivers of future total returns: Market sentiment returns and business returns. I then combine those expected returns together in the form of a 10-year CAGR expectation and use that to value the stock.
Before I begin this analysis, I always check the business's long-term earnings patterns in order to ensure that the business is a proper fit for this sort of analysis. If the historical earnings 1) don't have a long enough history 2) are erratic in nature, or 3) are too cyclical, then I either avoid analyzing the stock altogether or I use a different type of analysis that is more appropriate.
Global Payments has a full 20-year earnings history on FAST Graphs and over this time there hasn't been a single year of negative EPS growth. This is very rare to find, particularly when earnings growth has averaged double-digits. In some respects, stocks with this pattern are the easiest to analyze because there aren't a lot of earnings fluctuations to take into account.
In order to estimate what sort of returns we might expect over the next 10 years, let's begin by examining what return we could expect 10 years from now if the P/E multiple were to revert to its mean from the previous economic cycle. Since we have had a recent recession in 2020 (albeit an unusual one) I'm starting this cycle in fiscal year 2015 and running it through 2021's estimates.
GPN's average P/E from 2015 to the present has been 22.36 (the blue bar circled in gold on the FAST Graph). Using 2021's forward earnings estimates of $8.16 (also circled in gold), GPN has a current P/E of 17.46. If that 17.46 P/E were to revert to the average P/E of 22.36 over the course of the next 10 years and everything else was held the same, GPN's price would rise and it would produce a 10-Year CAGR of +3.43%. If the mean reversion were to occur more quickly than 10 years, the return would be higher.
We previously examined what would happen if market sentiment reverted to the mean. This is entirely determined by the mood of the market and is quite often disconnected, or only loosely connected, to the performance of the actual business. In this section, we will examine the actual earnings of the business. The goal here is simple: We want to know how much money we would earn (expressed in the form of a CAGR %) over the course of 10 years if we bought the business at today's prices and kept all of the earnings for ourselves.
There are two main components of this: the first is the earnings yield and the second is the rate at which the earnings can be expected to grow. Let's start with the earnings yield (which is an inverted P/E ratio, so, the Earnings/Price ratio). The current earnings yield is about +5.71%. The way I like to think about this is, if I bought the company's whole business right now for $100, I would earn $5.71 per year on my investment if earnings remained the same for the next 10 years.
The next step is to estimate the company's earnings growth during this time period. I do that by figuring out at what rate earnings grew during the last cycle and applying that rate to the next 10 years. This involves calculating the EPS growth rate since 2015, taking into account each year's EPS growth or decline, and then backing out any share buybacks that occurred over that time period (because reducing shares will increase the EPS due to fewer shares).
We can see the increase in shares outstanding from their 2019 M&A, but even if we exclude that, the shares outstanding haven't experienced much of a decline during this period. Since we are using earnings per share, the increased share count is already included in the EPS estimates so we don't really need to make any adjustments here. I estimate GPN's earnings growth at about +21.77% over this period. I have a general rule for this sort of analysis that I never assume an earnings growth rate for the long term that's over 20%, so, no matter what 20% earnings growth is my maximum estimate. With GPN, I've decided to be even more conservative. First, analysts are only expecting 18% and 17% EPS growth in the next two years. Second, I think it's possible that GPN got an EPS boost this year from all of the stimulus money that has been pumped into the economy, and that stimulus will likely be reversing this year. And third, their big M&A in 2019, and the market sending this stock price dramatically lower over the past year for no fundamental reason, probably means there is more competition and disruption coming in the future than there has been in the past. Additionally, since this isn't traditionally a very cyclical stock, I will likely be holding this stock through the next recession rather than trying to sell it before the next recession, and I want to get the best price possible so that the drawdown I experience during the next recession will hopefully be lower. For those reasons, I am limiting my EPS growth estimate for GPN to 15% as a way to build in a little bit bigger margin of safety.
Next, I'll apply that growth rate to current earnings, looking forward 10 years in order to get a final 10-year CAGR estimate. The way I think about this is, if I bought Global Payment's whole business for $100, it would pay me back $5.71 plus +15% growth the first year, and that amount would grow at +15% per year for 10 years after that. I want to know how much money I would have in total at the end of 10 years on my $100 investment, which I calculate to be about $232.10 (including the original $100). When I plug that growth into a CAGR calculator, that translates to a +8.78% 10-year CAGR estimate for the expected business earnings returns.
Potential future returns can come from two main places: market sentiment returns or business earnings returns. If we assume that market sentiment reverts to the mean from the last cycle over the next 10 years for GPN, it will produce a +3.43% CAGR. If the earnings yield and growth are similar to the last cycle, the company should produce somewhere around a +8.78% 10-year CAGR. If we put the two together, we get an expected 10-year, full-cycle CAGR of +12.21% at today's price.
My Buy/Sell/Hold range for this category of stocks is: above a 12% CAGR is a Buy, below a 4% expected CAGR is a Sell, and in between 4% and 12% is a Hold. This puts Global Payments stock into the "Buy" category at today's price level. And I bought some myself last week with an approximate 1% portfolio weighting.
In the end, I think the story here is one where the market simply got ahead of itself when it came to how fast competition and disruption might come to GPN's business. I'm not an expert in this field, and those that think GPN will be subject to disruption might ultimately be correct, but the price is low enough now that with a track record like GPN has, I'm willing to place a bet in their favor. (The price has moved up a bit since I started writing this article, but as of the publication day, GPN should still be a reasonably good value.)
La-Z-Boy is a well-known furniture maker that really needs no introduction, but its stock tends to fly under the radar of many investors. It has a bit of an unusual earnings history and they have recently had to deal with supply chain issues. I think the supply chain issues will work themselves out and the stock has probably been punished for no good reason. Let's take a look at the metrics using the same process I used for GPN.
LZB's earnings history is a more mixed picture than Global Payments'. LZB experienced a very unusual streak of EPS declines from 2004 to 2009, and I'm not exactly sure what explains the full decline, though obviously, the Great Recession explains the final plunge in 2008. Since 2009, however, we have seen EPS for LZB steadily climb, and this year is expected to produce record earnings. My approach with LZB is one of cautious optimism, where I think they could have another year or two of good profits before the stimulus money wears off, and at that point, perhaps we need to think about taking profits if we have them. So, overall, there are some historical dangers to be aware of, but I think it's reasonable to still use an earnings-based analysis for the stock given the most recent history.
LZB''s average P/E from 2017 to the present has been 15.71 (the blue bar circled in gold on the FAST Graph). Using 2022's forward earnings estimates of $3.62 (also circled in gold), LZB has a current P/E of only 10.41. If that 10.41 P/E were to revert to the average P/E of 15.71 over the course of the next 10 years and everything else was held the same, LZB's price would rise and it would produce a 10-Year CAGR of +4.21%.
The current earnings yield is about +9.61%. I estimate an earnings growth rate for LZB at 9.25% based on the last 5 years of data. Next, I'll apply that growth rate to current earnings, looking forward 10 years in order to get a final 10-year CAGR estimate. The way I think about this is, if I bought LZB's whole business for $100, it would pay me back $9.61 plus +9.25% growth the first year, and that amount would grow at +9.25% per year for 10 years after that. I want to know how much money I would have in total at the end of 10 years on my $100 investment, which I calculate to be about $261.42 (including the original $100). When I plug that growth into a CAGR calculator, that translates to a +10.09% 10-year CAGR estimate for the expected business earnings returns.
If we assume that market sentiment reverts to the mean from the last cycle over the next 10 years for LZB, it will produce a +4.21% CAGR. If the earnings yield and growth are similar to the last cycle, the company should produce somewhere around a +10.09% 10-year CAGR. If we put the two together, we get an expected 10-year, full-cycle CAGR of +14.30% at today's price. This is significantly above my 12% buying threshold and so I think it has enough margin of safety to make up for some potential cyclicality as we near a cyclical top in 2023. I think there is 25-50% upside over the next year or two while the economy remains pretty strong. If the stock sees those sorts of gains over a short period of time, I might use a trailing stop to protect the downside since it does have a history of pretty big price declines during recessions.
CACI International has experienced some modest earnings cyclicality over the long-term, but the overall trend is clearly up with regard to earnings growth. I'll take account of the cyclicality it does have with my earnings growth estimates later.
CACI's average P/E from 2015 to the present has been 15.96 (the blue bar circled in gold on the FAST Graph). Using 2021's forward earnings estimates of $18.51 (also circled in gold), CACI has a current P/E of 14.96. If that 14.96 P/E were to revert to the average P/E of 15.96 over the course of the next 10 years and everything else was held the same, CACI's price would rise and it would produce a 10-Year CAGR of +0.66%.
The current earnings yield is about +6.69%. I estimate an earnings growth rate for CACI at 16.36% based on the last 5 years of data. Next, I'll apply that growth rate to current earnings, looking forward 10 years in order to get a final 10-year CAGR estimate. The way I think about this is, if I bought CACI's whole business for $100, it would pay me back $6.69 plus +16.36% growth the first year, and that amount would grow at +16.36% per year for 10 years after that. I want to know how much money I would have in total at the end of 10 years on my $100 investment, which I calculate to be about $268.99 (including the original $100). When I plug that growth into a CAGR calculator, that translates to a +10.40% 10-year CAGR estimate for the expected business earnings returns.
If we assume that market sentiment reverts to the mean from the last cycle over the next 10 years for CACI, it will produce a +0.66% CAGR. If the earnings yield and growth are similar to the last cycle, the company should produce somewhere around a +10.40% 10-year CAGR. If we put the two together, we get an expected 10-year, full-cycle CAGR of +11.06% at today's price. That's slightly below my 12% threshold for a buy. And it's also worth noting that analysts expect high single-digit EPS growth over the next few years and I used a 16% growth rate which is more optimistic. But even so, CACI doesn't follow normal market cycles very closely, and while it's not exactly counter-cyclical, even if we assumed slower growth going forward it would be fairly valued here and probably half the price of most stocks in the market. So, for investors who perhaps have extra cash or who are looking to take risk off of more cyclical or expensive holdings in their portfolios, CACI is a pretty good value here, and it's possible they could experience better growth than analysts currently expect.
Phillips 66 has much more predictively cyclical earnings than the last three ideas, so it requires a different form of analysis.
Because of M&A, Phillips 66 only has data going back to 2012, so I'm going to use Valero (VLO) and HollyFrontier (HFC), two other refiners I own and have written about, as proxies for the absent longer term data, but I thought I'd sum up my thesis in the FAST Graph above first.
I'm going start with a bigger picture view of "reopening" stocks in general because I think some contest is required. Since the beginning of the pandemic in February of 2020, I have been medium-term bearish on many reopening stocks. I sold my one airline position, RyanAir (RYAAY), in mid-February of 2020 and I've been bearish on airlines and cruise lines and most oil stocks since then if one plans to hold them for the medium or long term. In terms of public articles, Carnival (CCL) has been the key public example I've used to explain my reasoning. I wrote my first bearish article on Carnival on April 2nd, 2018 before the pandemic started.
On February 25th, 2020, just as the pandemic was starting and many authors were suggesting buying Carnival as a value stock, I warned investors Don't Buy Carnival Yet. That turned out to be a very good call as well.
And Carnival was basically my proxy for all of the big cruise lines. On the airline front, I used Southwest (LUV) as my public proxy for the group, and again I first warned investors in April 2018, but then also warned them again as the pandemic was beginning on March 6th, 2020 in my article Re-Evaluating My Bearish Southwest Airline Sentiment. Here is how it has done.
I bring both of these examples up 1) because I have written several times publicly about them, and 2) because I have had a broad investing theme that refiners have been a better cyclical pandemic reopening play than airlines and cruise lines because the refiners offer similar upside potential over the medium-term of 3-5 years, without the same downside potential. Because of this broad theme, I overweighted my refiner positions with the money I might otherwise have spread around to airlines and cruise lines. My last public article where I shared this theme was a bullish article on Valero on October 8th, 2020, The Cycle Will Turn Up. Valero is a Buy.
Since that article, Valero has nearly doubled and handily outperformed LUV, CCL, and SPY.
I bring all of this up for three reasons. The first is that the broad theme that refiners offer more upside potential with less downside risk than airlines and cruise lines now has growing evidence to back up the claim. The second is that this dynamic was totally predictable all the way back in February and March of 2020. And the third is that PSX typically trades similarly to VLO, but right now its performance is lagging, and so it could play catch up during the final cyclical push higher in 2022.
(And just for the record, regarding Carnival. It is up since my last bearish article on August 20th, 2020, but it is underperforming Valero, and longer-term, because of all the debt CCL has taken on, I expect it will still be many years before the business fully recovers.)
Back to Phillips 66. Typically, for deeply cyclical stocks like PSX, I like to have enough data to cover two recessions for me to feel comfortable buying it. Leading into March of 2020, I didn't have data for any recessions for PSX, so while I bought my first tranche of VLO and HFC during the March 2020 sell-off, I didn't buy PSX until later in the year on 11/16/20 (and I added to VLO and HFC on that day as well). Part of the reason I felt comfortable doing that refiners typically perform very similarly over time.
Over the past 5 years, they have traded very similarly, with VLO breaking out a little bit the past 9 months. In particular, the drawdown in 2020 was very similar, which is usually what I use to guide my cyclical purchases. Because of this similarity, I felt it was reasonable to use VLO's historical drawdowns and recoveries as a guide for PSX as well.
You can see the similarities on the drawdown chart. Typically, it takes about 3-6 years for VLO to recover off the bottom, and if one buys near the bottom, 200%+ gains are not an unreasonable expectation. Of course, this cycle we do have some potential worries of electric vehicles and extended work-from-home schedules dampening fuel demand over the short term, and then also over the longer-term, but I think over the medium-term of the next year or two, a return of 50% from today's price is very reasonable, and unless we have a very bad recession before then, the downside risk is fairly limited. PSX continues to seem like a good bet to me. Frankly, I don't see many other stocks with a +50% potential upside over the next 2 years. (I have a more involved process than historical price cyclicality when it comes to determining when to buy deep cyclicals. If you read the Valero article I linked above, the same process was applied to PSX, and while we aren't near the bottom of the cycle, we also should have some room left until we near the top.)
If I was mostly right about refiners last year, then I was mostly wrong about Platinum, which, while positive since I made two overweighted purchases in 2020, has drastically underperformed the wider market.
I've grown to view Platinum as a combination of gold and auto-maker. I avoided most auto-makers during the heart of the pandemic for the same reasons that I avoided airlines and cruise lines, but it turned out that government stimulus money and a move from cities to suburbs and country-side produced a very high demand for autos. So I was wrong for avoiding the auto stocks. (Though did eventually buy some auto suppliers toward the end of 2020.) The part of platinum's performance that is tied to internal combustion engine production has been held back because of supply chain issues and a lack of semi-conductors. So, while demand for new cars is strong, the demand for platinum has been held back because the production of new cars has been held back.
We can see how PPLT and US auto sales follow a similar pattern. The good news on this front is that new auto sales should pick back up in 2022. If they do, PPLT could see a 30-35% rise, just to take it back to early 2021 levels before the supply chain issues started.
If PPLT returned to its all-time highs it would produce a 100% return.
Personally, I think PPLT has a very good chance at a 50% return over the next two years as things get back to normal, and, at the very least, it is unlikely to experience much more downside from here.
While I write a lot of bearish articles on Seeking Alpha that warn investors about potential downside risks, I'm currently almost fully invested in stocks, and, at least for the first half of 2022, I'm still pretty bullish on the economy. I think there is probably one more leg up for many reopening stocks and there are some fairly valued stocks worth holding that don't have a ton of downside risk. Last month, I shared some food-related stocks, and this month I shared a pretty good mix of stocks that might have gone unnoticed by investors, but that still have a good risk/reward.
Using my methods of valuation, I don't suggest taking portfolio-weighted positions larger than 1% or 2%, because my approach obviously doesn't include a deep dive into every business risk. But over the medium-term, spread out among enough stocks, the methods I use produce very good returns.
If you have found my strategies interesting, useful, or profitable, consider supporting my continued research by joining the Cyclical Investor's Club. It's only $30/month, and it's where I share my latest research and exclusive small-and-midcap ideas. Two-week trials are free.
This article was written by
My analysis focuses on the cyclical nature of individual companies and of markets in general. I've developed a unique approach to estimating the fair value of cyclical stocks, and that approach allows me to more accurately buy near the bottom of the cycle.
My academic background is in political science and I hold a Bachelor's Degree and a Master's Degree in political theory from Iowa State University. I was awarded a Graduate Research Excellence Award in 2015 for my research on conservatism.
Disclosure: I/we have a beneficial long position in the shares of JACK, TSN, CAKE, PPLT, PSX, VLO, GPN, LZB, CACI, HFC either through stock ownership, options, or other derivatives. 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.