Now is the time to focus on value stocks, says canny stock picker John Buckingham, AFAM Capital’s chief investment officer, chief portfolio manager and editor of its “The Prudent Speculator” investment newsletter, dubbed this year by Barron’s “The little newsletter that crushed the market.”
In an interview with ThinkAdvisor, the value investor reveals his five top picks of undervalued stocks for 2018 and why he likes to buy equities that “Amazon has scared everybody out of,” as he puts it.
After a year in which growth stocks ruled, value will reassert its historical dominance in 2018, the result of an increasingly stronger economy and because amid rising interest rates, value has historically generated better returns than growth, according to Buckingham.
The asset manager, who is AFAM’s director of research, uses a proprietary screening mechanism that evaluates and ranks 3,000 companies.
“The Prudent Speculator,” tracked by Hulbert Financial Digest — and which Mark Hulbert calls “one of the most successful investment newsletters of the past four decades” — is, since its 1977 inception, up 17.9% annualized vs. the S&P 500’s 11.1%. The firm’s Al Frank Fund has outperformed since its 1998 launch, realizing an annualized rate of return of 10% vs. the S&P 500 at 7%.
All of Buckingham’s top picks for next year are likely to do well in the short run, he says. In part, they stand to benefit from increased earnings, anticipated as a result of the Trump tax package.
Indeed, corporate tax cuts will potentially help firms attain higher earnings, some of which are expected to be deployed to raise wages and for share buybacks, dividends and capital investment.
As a value investor loving beaten-down stocks, Buckingham remarks: “We’re happy that Amazon does what it does because it often creates opportunities in its wake.” For example, this past June, when the behemoth announced it would acquire Whole Foods, the stock of supermarket operator Kroger fell 10% in addition to a 15% drop a day earlier on an earnings warning. “So far, Kroger has done very well for us,” Buckingham says.
His top picks for next year reflect a broad diversification of inexpensive stocks that are trading at lower fundamental earnings multiples than they have historically or in relation to their peers.
ThinkAdvisor recently interviewed Buckingham, on the phone from AFAM offices in Aliso Viejo, California.
Here, in alphabetical order, are his five top picks for 2018 and what he has to say about them:
CAPITAL ONE (COF) — My primary focus is on the big credit card issuer’s lending business. Capital One hasn’t seen the gigantic appreciation of some other financial names; but it ranks very high in our scoring system. Earnings have been sensational of late, and there’s substantial potential for earnings growth. The stock is trading at 13 times earnings. Capital One pays a relatively high tax rate, in the 29% to 30% range.
The concerns about credit card companies are default and delinquency rates, but right now those are near historic lows. A stronger economy will offset the risk of higher interest rates and a greater default rate. And with firms potentially handing out bonuses to employees as a result of the tax cut — AT&T, for example — people probably will pay down their credit cards.
Capital One also benefits from a stronger economy because higher interest rates historically have been a favorable environment for financial firms.
FEDEX (FDX) — This is a GARP stock — growth at a reasonable price. If you believe that Amazon is going to continue to rule the world, they of course have to ship the stuff. No one can compete with FedEx in the ability to deliver packages and make a very handsome profit doing so. We think we’ll continue to see substantial growth from their business of delivering packages.
If you truly see e-commerce as a long-term trend, FedEx is certainly an excellent company to invest in. Earnings that came out a few days ago were terrific and better than expected. They’re $12.30 on a trailing basis, and analysts are starting to ratchet up their numbers. I saw one estimate of over $20 a share by 2020.
Right now, the stock is trading at 20 times earnings, a little below the overall market. But forward multiples will come down considerably.
This company pays a very high tax rate also. In a conference call, [management] said that because of the tax cut, they’ll see a 30%-40% increase in earnings in the next year.
FedEx is a blue chip company poised to continue to benefit from the trends that have bolstered firms like Amazon. We think that, with their unrivaled distribution network, FedEx will continue to be the big dog in package delivery.
TUTOR PERINI CORP. (TPC) — A construction company whose stock is small cap — but not micro-cap. Market capitalization is more than $1 billion. The firm has big contracts for massive projects that it may be building over a number of years. It has a substantial backlog of $7.5 billion, which just rose 12% on a year-over-year basis.
There’s been lots of [President Trump’s] talk about infrastructure building; and we think that at some point, we’ll have it.
The kinds of things Tutor Perini builds around the world include a joint-venture tunnel project for hydroelectric generation in Canada and a U.S. embassy renovation project in Uruguay.
The interesting thing about this company is valuation. Of the five stocks I’m discussing here, this one is the “cheapest.” It’s trading at about 13.5 times trailing earnings and below book value.
The consensus forecast for earnings in 2018 is $2.58; for 2019, $3.13 — and this is a $26 stock. Their increased backlog should provide some comfort that those numbers are attainable because the contracts are already on the books.
The company doesn’t pay a dividend, though a few years ago they had a special dividend that paid out $1 a share. Their tax rate in the last four quarters has averaged about 30%. So, with the tax reduction, they could possibly initiate a dividend or have another special dividend.
WALT DISNEY (DIS) — This is another GARP stock. A blue chip company with unparalleled content, Disney is a marquee name that trades for only 19 times earnings. Its tax rate is in the 31%-32% range.
You can’t put a price tag on Mickey Mouse or “Star Wars”! And the announced acquisition of 21st Century Fox, bringing Fox properties under the Disney umbrella, meshes with the firm’s initiatives to get more heavily into streaming entertainment and sports. Disney’s ESPN has struggled, but now they’re adding Fox Sports Networks, which creates a much more appealing sports streaming service.
No one has proven they can monetize content better than Disney because they don’t just “make a movie.” For instance, they put “Frozen” in a theme park, thereby boosting attendance. “Frozen” is due to open on Broadway this spring. “Star Wars” land [called “Galaxy’s Edge”] is being constructed in Disneyland. Numerous Disney movies have toy tie-ins. So they create a property and make a fortune off it.
Further, they have a history of acquiring assets at very good prices and then monetizing those assets. Two examples: “Star Wars” and Pixar. They didn’t pay a whole lot for “Star Wars” — about $4 billion. I can assure you that they’ve made much more than $4 billion from it. For Pixar, they paid about $7 billion. Just about everything Pixar puts out turns to gold.
WILLIAMS-SONOMA (WSM) — The home goods retailer, with Williams-Sonoma, Pottery Barn and West Elm stores, has been a Wall Street darling, but the stock has fallen both in terms of price and the valuation investors have been willing to pay on concerns that Amazon is taking over the world of retailing. What most people don’t realize is that over half of Williams-Sonoma’s revenue is generated online. So this high-quality company is already a major online player.
This is a very reasonably priced dividend-paying stock, which is trading at 15 times earnings, well below the market and its historical norms, which range from 18 to 21. With a 3% dividend yield, it [provides] a nice income stream.
The company pays a fairly high tax rate, 33% over the last four quarters. So the tax-rate cut represents a significant potential increase in earnings, which are already projected to show decent growth over the next three to four years.
Williams-Sonoma has been punished excessively by the concern about retail in general and fears about Amazon, as well as how the new tax law might impact housing, something we don’t see as a major headwind.
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