John Buckingham’s Post-Brexit Vote Stock Picks

John Buckingham, the astute value stockpicker who is chief investment officer of Al Frank Asset Management, isn’t as cavalier as Bobby “Don’t Worry, Be Happy” McFerrin in expressing his philosophy, but he certainly doesn’t fret about every short-term movement in the market. And that includes all the hammering and upheaval as a result of the Brexit vote. Instead, he focuses his energies on selecting profitable individual equities for long-term investing.

This has served him well. Through the first quarter of this year, the Al Frank Fund, which he has managed since its 1998 inception, boasts an annualized rate of return of 9.72%, vs. 6.35% for the Russell 3000 Index.

Safe to say, amid worries about Brexit, global economic growth, U.S. interest rates and terrorism, the aging bull market is indeed a stock picker’s market. So, in an interview with Buckingham, ThinkAdvisor takes a peek inside the mind of an equities bargain hunter.

Though not without concerns about the short term, he sees some splendid opportunities for long-term investors that have been triggered by Britain’s decision to leave the European Union.

The fund manager, who is editor of The Prudent Speculator newsletter, discusses his three-pronged process of stock picking, names sectors and specific equities he likes and offers keen observations on what’s up with Apple, one of his major holdings — and in whose stock Warren Buffett just invested $1 billion.

Buckingham, 50, scrutinizes hundreds of stocks for AFAM’s money management clients, its propriety mutual funds’ shareholders and its newsletter subscribers. The firm manages $600 million in assets.

Though mutual funds have fallen in popularity, AFAM’s funds — the Al Frank Fund and the Al Frank Dividend Value Fund, the latter launched in 2004 — are up year to date 1.23% and 1.48% respectively.

Buckingham is focused on a three- to five-year outlook. Holding on to picks “through thick and thin” has been “the key” to his long-term investing success, he argues.

He began working part time at AFAM during his senior year at the University of Southern California and has been at the firm ever since. In 1989, two years after graduation, he was named the firm’s research director. A year later, he became chief portfolio manager.

ThinkAdvisor recently spoke with Buckingham, who was on the phone from his office in Aliso Viejo, California. Though he expects no let-up in market gyrations in the near term – likely manifested by a post-Brexit turbulent summer in stocks – the Forbes blogger is fairly upbeat about the second half. “The time you don’t want to worry is when everybody is freaked out about something,” he says. “You can drive yourself bonkers. The time to worry is when everything looks to be OK.”

Here are highlights from our conversation:

THINKADVISOR: What are your thoughts about stocks given the carnage the Brexit vote created?

JOHN BUCKINGHAM: Considering that the major market averages closed only modestly below where they were six trading days [before the vote], I’m impressed with how well stocks held up. Brexit doesn’t alter my long-term positive view: Equites have become [even] more attractive as interest rates have fallen. Equity valuations remain reasonable within the context of extraordinarily low interest rates. The markets have been overcoming crises ever since they were created.

What’s your outlook for the stock market in the second half?

I’m optimistic, though I’m a little less sanguine about the near-term prospects for stocks [than I was before the vote]. It wouldn’t surprise me to see a turbulent summer. Volatility is also likely to be higher because of interest rates, global economic growth and the health of corporate profits.

What are chances of another market correction this year?

High. Anybody who tells you there isn’t a chance isn’t looking at market history. On average, we’ve had 10% declines about once every 10 months going back to the 1920s. As many investors have recently learned the hard way, far more money has been lost in anticipation of a market correction than in the corrections themselves.

What turns you on about investing in stocks?

I’m a guy who likes to play the odds. It’s the best way to invest. That’s why I’m a value investor. The nice thing about the stock market is that it’s not like Las Vegas, where the longer you play, the more you lose. With the market, the longer you stay invested, the more your chance of success.

What’s your approach to picking stocks?

We use a proprietary algorithm to screen 2,800 candidates, including several hundred ADRs that are actively traded. It’s a three-step process: First we screen on metrics that have a history of being good predictors of performance, including price-to-sales, price-to-tangible-book-value and price-to-earnings. Part two is a qualitative review of the underlying business and its prospects. The third part is a determination of a “fair” long-term valuation three to five years hence. Stocks make our buy list only if they trade for a substantial discount to our target price.

Where are some specific opportunities in international investing that the Brexit vote and fallout created for long-term investors?

Stocks like Manpower, Whirlpool, Total, Ericsson and Delta Air Lines, which were especially hard hit. I believe the selling was overdone.

Apple is one of your largest holdings. What’s going on with that company?

Apple has been a horrendous performer, though it’s still a fantastic company. Over the last 12 months, it’s down 21%. But since we bought it, in around 2000, it’s been a great performer.

What’s been the problem this year?

Investor expectations were higher than what they were able to produce. The new phones didn’t sell as well, though I believe that they’re a step forward. The jury is still out on the watch, but it’s a new product and will take time to be adopted. Apple’s earnings weren’t that bad. But Carl Icahn, a major investor, decided to dump all his Apple stock because he thinks that growth in China is going to be a problem for the company. And a lot of people followed him. But I believe there’s tremendous growth potential for Apple in China.

How do you think Apple stock will do in the second half?

Apple is fine. It has a huge fan base, a long history of developing and producing innovative products. It doesn’t have to grow dramatically because of where it is from a valuation perspective in terms of P/E ratio and factoring in all the cash on its balance sheet, totaling about $30 per share. A company like that, at a very inexpensive valuation with a great balance sheet and a generous dividend yield, excites me. We’ve trimmed our target price to $137 but remain a big fan of the stock. If I didn’t own Apple, I’d buy it. Right now, we have enough; but if it fell by $20 or $30, we might look at buying more. You’ve sold Apple over the years. What chiefly prompted that?

We sold about 5/6 of it along the way at various times. It was risk management and risk mitigation. No matter how much we like a company, we never want to see any of our positions become too big. So, if Apple, say, doesn’t perform well, that doesn’t mean we’re going to do poorly.

What’s the biggest threat to the market?

The health of corporate profits, which is the most important driver of stock prices. Lots of things could impact that in the short run, such as the strong dollar, continued declines in commodity prices – which was the key headwind in Q1 – or turmoil in Europe as a result of Brexit. But we expect profits to be higher this year than last and higher in 2017 than in 2016.

Where do you see the biggest opportunities in stocks?

Dividend-paying stocks are where investors should be steering their money. We like 25 stocks that are yielding more than the 30-year Treasury. A dividend equity portfolio has the potential for capital gains and for dividends to increase, whereas government bonds don’t increase. [But] the strength of the dollar and the potential for more EU-Leave referendums are renewed headwinds that hurt the attractiveness of stocks – [while] the plunge in interest rates adds to their appeal, given generous dividend yields.

Where are you invested?

Stocks that are trading at P/E ratios in the low teens or even below. We’re buying dividend-paying stocks that yield above what the S&P 500 is yielding. There aren’t a lot of great places to go for income. But the yields in our portfolio are close to 3%. We’re now at a 1.5% yield on the 10-year Treasury, and the S&P 500 is yielding 2.2%. Very rarely do we see yields on stocks eclipse those on benchmark government bonds. So if you’re selective, you can get higher yield, undervalued stocks.

What sectors do you like?

The “safer” ones, like utilities and consumer staples, are things I would not emphasize, even though we have some exposure to them. What I would be going into are areas that have performed poorly: financials, heath care, various parts of technology and consumer discretionary.