CWS Market Review – May 11, 2018

“Necessity never made a good bargain.” – Charlie Munger

The first-quarter earnings season is almost over, and it’s been a good one for Wall Street. Stocks, however, weren’t as happy as the results would suggest. Still, there’s been some positive news for stock investors.

The Dow has added 800 points in the last week. The S&P 500 has rallied four times in the last five sessions, and on Wednesday, the index closed above its 50-day moving average for the first time in three weeks. Still, the 200-DMA lurks. We’re less than 4% above it, and I suspect the bears are planning another strike.

In this week’s issue, I’ll go over our final earnings report for Q1, which was from Cognizant Technology Solutions. The IT outsourcer had a solid quarter. Unfortunately, the stock dipped on lower guidance. Still, I like CTSH a lot. I’ll have more to say later on.

I’ll also discuss the improving economy. Last week’s jobs report showed the lowest jobless rate since 2000. Of course, that was a terrible time for stocks, which is a good reminder that the economy and the stock market are hardly the same thing. Let’s take a closer look at the economy and see if we’re in the best climate in a half a century.

The Best Economy in 50 Years?

Last Friday, the government reported that the unemployment rate for April fell to 3.9%. That’s the lowest rate in more than 17 years. Actually, if we dig a little deeper, we can see that we’re very close to the lowest jobless rate since the 1960s.

Splitting out the decimals, April’s unemployment rate was the third-lowest since January 1970. The other two low months, both in 2000, were only a tiny bit lower than April. If the economy had created only a few thousand more jobs, then we could have said it was the lowest jobless rate since the 1960s.

To be fair, long-term comparisons like that are a bit sketchy. It’s not so much a question of one reading being better than another. Rather, the economy is very different today, and in many ways. Plus, a number of years ago, the government overhauled how it measures unemployment.

Still, I don’t want those points to obscure the overall picture. The U.S. economy is doing quite well. Real GDP for Q1 grew by 2.3%. That number will be revised twice more in the coming weeks. What about Q2? That’s hard to say, but I’ll note that the housing market continues to be healthy, and that’s probably the most important driver of the cycle. The Atlanta Fed currently pegs Q2 GDP growth at 4%, but we won’t get the official numbers until the summer.

Overall, this is good news for us as investors. What’s important to stress is how the stock market has changed. During an expansion, defensive stocks tend to lag. We’ve certainly seen that with stocks like Church & Dwight (CHD), Hormel Foods (HRL) and JM Smucker (SJM). As long-term investors, we can afford to take the proper perspective. It’s not that these companies are bad or that they’ve done something wrong. Rather, they’re in the wrong part of the cycle, and these cycles don’t last forever.

So what’s been doing well? One sector that’s been red-hot is Energy. This week, oil crossed above $70 per barrel for the first time since 2014. Remember that it was a little over two years ago when oil was trading around $26 per barrel. How times have changed! What’s interesting is that many Energy stocks initially didn’t rally with the uptick in oil prices. Oil stocks typically follow actual oil, but this time, it was almost like the stocks didn’t trust the rally.

However, that all changed two months ago, when Energy stocks start to rally. In fact, when you compare the rally to the broader market, it’s been a gem of a rally. Since mid-March, the S&P 500 Energy sector is up close to 15% while the S&P 500 is down less than 1%.

Some of the rise in oil is due to increased geopolitical tensions, but this is also a result of a stronger economy. Our Buy List doesn’t currently have any Energy stocks. That’s not part of a macro-economic prediction on my part. Instead, I just didn’t see any Energy stocks that I strongly liked. As a result, our Buy List may lag the overall market on days when Energy does well. I hope to find Energy stocks in a future Buy List, but I’ll never add a stock just for the sake of diversity.

With the improving economy, and rise in oil prices, we really haven’t seen a meaningful uptick in inflation. On Thursday, the government published its report on inflation for April. Wall Street had been expecting an increase of 0.3%. Instead, it was up 0.2%. During April, gasoline prices were up 3.0%, but that’s after falling 4.9% in March. In the last year, inflation is running at 2.5%.

If we look at the “core rate,” which excludes food and energy, inflation rose by 0.1% in April, and it’s up 2.1% over the last year. To me, this suggests inflation is well under control. Right now, the key for investors is to focus on high-quality stocks. Three of our Buy List stocks that look particularly good right now are Check Point Software (CHKP), Signature Bank (SBNY) and Carriage Services (CSV).

Now let’s take a look at our final earnings report for the first-quarter earnings season.

Cognizant Technology Drops on Lower Guidance

On Monday, Cognizant Technology (CTSH) reported fiscal Q1 earnings of $1.06 per share. That met estimates, although the company had been expecting earnings of at least $1.04 per share. Cognizant is an impressive company. Q1 was up from 84 cents per share one year ago, and their quarterly revenue rose 18.4% to $3.91 billion. Cognizant’s operating margin was just over 20%, which is nice to see. The company’s long-term target is for 21%.

“We achieved solid financial results in the first quarter and progressed our shift to digital services and solutions,” said Francisco D’Souza, Chief Executive Officer. “Cognizant has built the capabilities and scale to help clients digitize their offerings, create personalized customer experiences, instrument their operations, and modernize their IT infrastructure. This digital-at-scale value proposition is winning with clients and positioning us well to deliver a strong 2018.”

Now for guidance. Cognizant expects Q2 earnings of at least $1.09 per share and revenues between $4 and $4.04 billion. Wall Street had been expecting $1.12 per share. Cognizant also lowered its full-year forecast. Originally, CTSH was expecting earnings of at least $4.53 per share. Now they expect at least $4.47 per share.

“First quarter results demonstrate solid execution of our plan to drive sustainable revenue growth while increasing margins,” said Karen McLoughlin, Chief Financial Officer. “Our full year 2018 non-GAAP diluted EPS guidance reflects a higher than originally anticipated effective income tax rate due to the updated interpretation of the U.S. Tax Cuts and Jobs Act of 2017. Our strong balance sheet and cash flows continue to support both our capital return program and our investments in the business to drive future growth and continue our shift to digital services and solutions.”

The stock dropped 5% on Monday. This is a classic case of having a good quarter on the books but the Street focusing only on guidance. Cognizant’s CFO spoke with Barron’s and she had many good things to say. Karen McLoughlin noted that Cognizant’s higher-margin “digitization” services revenue rose 27% last quarter. This now makes up 29% of the company’s total revenue.

I’m not worried at all about Cognizant’s business. CTSH is a buy up to $81 per share.

Buy List Updates

That’s it for our Buy List earnings reports, but our stocks with April quarters will report soon. Both Ross Stores (ROST) and Hormel Foods (HRL) are due to report on May 24. I’ll preview them in next week’s issue. Now I want to provide updates on some of our Buy List stocks.

On May 2, Cerner (CERN) released a disappointing earnings report. At one point early in trading on May 3, Cerner was down more than 10%. Since then, CERN has rallied for five-straight days. On Thursday, it closed 4% higher than where it was before the earnings report. Sure, it makes no sense, but this is why I stress investing in high-quality stocks. The good stuff always shines through.

Moody’s (MCO) broke out to a new high on Thursday. It’s now our best performer on the year with a gain of 17.7%. Here’s their investor presentation for Q1.

I also wanted to say a few words about Alliance Data Systems (ADS). This is turning into our problem stock for 2018, and I wanted to make sure you understand what’s going on.

The loyalty-rewards stock has been in a world of pain lately. Last Friday, ADS dropped as low as $192 per share. Four months ago, it was as high as $278.

Everyone, it seems, expected them to lower guidance in their Q1 earnings report. Instead, the company beat earnings by a good margin and reiterated their full-year earnings forecast of $22.50 to $23 per share. If that number is accurate, that means the stock was recently trading for about eight times earnings. Still, that news didn’t placate the critics, and ADS fell after the earnings report.

There are a few concerns with Alliance’s business. One is that short-term rates are rising. Clearly, that’s going to impact their business, but that’s a regular feature of being in the credit-card biz. Another issue is that their delinquencies have been rising. The company blames the issue on hurricanes, which may be a good reason, but it’s not an excuse. It’s still a business problem. Alliance is also more aggressively leveraged than its peers. That’s not a problem during good times, but it can be a major headache when the dial turns.

Ultimately, I think ADS suffers from “once bitten, twice shy” effect. So many on Wall Street were so blindsided by the financial crisis that they’re now oversensitive to anything that hints of the old bubble. This needs a reality check. The problems in play during the housing bubble were wholly different from what we’re seeing with ADS. Their balance sheet is in far better condition than those of Lehman Brothers and others back in the day.

I’m not looking past the real problems ADS has, but we need proper perspective. Fortunately, the shares have rebounded in the past week. I’m sticking with ADS. This could be a big turnaround for us.

FactSet (FDS) increased its quarterly dividend by 14%. The payout will rise from 56 to 64 cents per share. This is the 13th year in a row that FDS has raised its dividend. The dividend will be paid on June 19 to holders of record at the close of business on May 31. FDS is a buy up to $207 per share.

Wabtec (WAB) has been improving lately. Here’s a PDF from their recent investor conference. This is a good intro if you’re not familiar with them. Wabtec is a buy up to $93 per share.

That’s all for now. Next week will be fairly quiet for economic news. The retail-sales report comes out on Tuesday. That’s often a good indicator for consumer spending. On Wednesday, we’ll get a look at industrial production and housing starts. The March IP report finally reached an all-time high. Industrial production is still recovering from the big tumble it had in 2015. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on May 11th, 2018 at 7:08 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.