CWS Market Review – May 15, 2020
“Selling your winners and holding your losers is like cutting the flowers and watering the weeds.” – Peter Lynch
Shortly after I sent you last week’s issue, the Labor Department reported that the U.S. economy shed 20.5 million jobs during April. That’s a staggering loss. The unemployment rate jumped to 14.7%. That’s a level we haven’t seen since the Great Depression.
Federal Reserve Chairman Jerome Powell said, “Among people who were working in February, almost 40% of those in households making less than $40,000 a year had lost a job in March.” Interestingly, Powell made those remarks in an online speech. A sign of the times.
It doesn’t end there. On Tuesday, the government’s Consumer Price Index report showed that consumer prices fell 0.8% in April. In other words, we had actual deflation. That’s also something we had during the Depression. This is the second month in a row of lower prices. Core inflation was down 0.4% (see below) which is the lowest drop since the government started tracking the data in 1957.
Our last three issues have been devoted to earnings. This week, I want to shift back to the economy and stock market. While the economic news is quite dire, the stock market is holding up reasonably well. I’ll explain what’s going on.
I’ll also discuss the final earnings report we had this season, which was from Broadridge Financial Solutions. And I’ll close by previewing two earnings reports coming our way next week. These are for companies whose reporting quarter ended in April.
But first, let’s talk…basketball.
We’re Not Going Back to Normal
I want to talk about basketball and the three-point shot, but what I’m really talking about is economics and incentives—i.e., psychology and behavior. Bear with me for a brief digression.
In the 1979-80 season, the NBA introduced the three-point shot. It had actually been used in the old ABA. At first, the three-pointer was a complete flop. Few teams used it. The Los Angeles Lakers won the NBA championship that year and only made 20 three-pointers all season. That’s fewer than one for every four games. The next year, three-pointer attempts dropped by nearly 30%.
Then in 1994, the NBA decided to act. The league moved the three-point line forward by 21 inches to increase its popularity. Seen through the lens of economics, the authorities incentivized the tactic. The next year, three-pointers took off. Teams tried more three-pointers, and their success rate increased. Successful three-point shots jumped by 65%.
Here’s the interesting part. After three seasons, the league moved the three-point line back to where it had been. What did teams do? The number of attempts fell, but it was still far higher than it had been.
What happened is that teams had been incentivized to try a new tactic. They saw its benefit, and even after the incentive was removed, they still used the tactic. Once you see a new way of doing things, you may not want to go back. Nowadays, teams try twice as many three-pointers as they did in the mid-1990s when the line was 21 inches closer.
Now let’s look at the current economy. Imagine a student who has borrowed fantastic amounts of money to attend college. For the last few weeks, he or she has been taking classes online. Seems pretty easy. Just open your laptop and presto: you’re in class. What’s the benefit to leaving your house to go to class when technology can bring it to you? On top of that, there are other costs like commuting in a car on a congested highway.
Now let’s say you work at, for example, an accounting firm or publishing company. How many employees need to be in the physical office each day? I recently had an afternoon packed full of Zoom meetings. I’m sure many of you have had the same.
As the economy reopens, I don’t see us returning to status quo ante. Most companies will adjust, but some are in trouble. In 1978, Polaroid employed 21,000 people. It doesn’t anymore. The world changes very quickly.
The Plunge in Financial Stocks Gives Us Some Bargains
Financial stocks have been lagging badly recently. In fact, they lagged during the last gasps of the bull market earlier this year. They then lagged during the big plunge, and they’re lagging again during the market recovery. What’s going on?
I suspect that we’re getting used to a new world of low interest rates. In fact, I think there’s a good chance rates will soon go negative. When you have deflation—or rather, increasing deflation—that means that even when the Fed holds rates at next to nothing, real rates are increasing. Thanks to deflation, the Fed is tightening money by doing nothing. The financial sector is flailing.
Here’s a chart of the S&P 500 Finance Index divided by the S&P 500.
This has had a big impact on the three financial stocks in our portfolio: Eagle Bancorp (EGBN), Globe Life (GL) and AFLAC (AFL). I’m not worried about any of them. I think AFLAC is an especially good buy if you can add shares below $35. Based on Thursday’s close, AFL’s dividend yields 3.4%.
As a general rule, a stock is impacted by three variables: the overall stock market, the industry group, and the nature of the company itself. The last one is the most important in the long run, but the first two can play a big role in the near term. Even the best stocks will get swept up by a ferocious bear market. That’s why, as a stock-picker, I like to look at the best names in the weakest sectors.
In addition to AFLAC, there are a few good bargains on our Buy List. I like Middleby (MIDD) below $60 per share. I also like Stryker (SYK) here. The last earnings report was quite good. Now let’s look at our final earnings report for the Q1 earnings season.
Earnings from Broadridge Financial Solutions
On Friday, Broadridge Financial Solutions (BR) reported fiscal Q3 (ending in March) earnings of $1.67 per share. That was five cents below Wall Street’s estimate.
The CEO noted that recurring revenues rose 9% and adjusted EPD increased by 5%. That’s quite good in this environment. Traders didn’t seem terribly worried about the earnings miss as the shares initially advanced after the earnings report. On Tuesday, the stock briefly cracked $120 per share.
This report was actually a bit reassuring to me because Broadridge had bombed the previous report. The company also updated its guidance for this fiscal year which has just one quarter left.
Broadridge expects recurring revenue growth of 8% to 10%. They expect overall revenue growth to be at the low end of their range of 3% to 6%. BR lowered its EPS growth range from 8% to 12% down to 5% to 7%.
Let’s do some math. Last year, the company made $4.66 per share, so the new range means they expect earnings between $4.89 and $4.99 per share. Since BR has already made $2.88 per share in the first nine months of this fiscal year, that implies Q4 earnings of $2.01 to $2.11 per share. Wall Street had been expecting $2.11 per share.
Broadridge Financial Solutions is a buy up to $130 per share.
Earnings Preview for Hormel Foods and Ross Stores
We have two earnings reports scheduled for May 21. Let’s start with Hormel Foods (HRL). The Spam people ended their fiscal Q2 on April 30.
For Q1, Hormel made 45 cents per share which matched Wall Street’s expectations. For the quarter, organic sales were up 4%. The company reiterated its full-year 2020 forecast for sales ranging between $9.5 billion and $10 billion and EPS between $1.69 and $1.83.
What’s interesting is that Hormel does a lot of business in China, so they were one of the first to see an economic impact from the coronavirus. For Q2, Wall Street expects earnings of 42 cents per share. Hormel hasn’t, as of yet, changed its full-year guidance.
Hormel is a classic recession-resistant company. The stock is holding up well against the market this year (see below). Remember that Hormel is a lot more than Spam. The company owns several strong brands.
Ross Stores (ROST) is also due to report next Thursday after the closing bell. We’ve come to expect Ross’s strategy of low-balling guidance and then delivering better-than-expected results.
In March, Ross reported fiscal Q4 earnings of $1.28 per share. That was above the company’s guidance range of $1.20 to $1.25 per share.
For any retailer, the key stat to watch is same-store sales. For Ross, that figure rose by 4% last quarter. Ross has been expecting same-store sales growth of 1% to 2%. For all of 2019, Ross made $4.60 per share. That’s up from $4.26 in 2018. Annual sales rose 7% to $16.0 billion.
Operating margin, another key for a company like Ross, came in at 13.3% for Q4. I know that may sound low, but for Ross’s business, it’s quite good. In March, Ross raised its quarterly dividend by 12% to 28.5 cents per share. Ross has raised its dividend every year since 1994.
The company shut all of its stores on March 20. It also furloughed most of its employees, although there was no change to their health benefits. Barbara Rentler, the CEO, has decided to forgo any salary. The Chairman of the Board did the same.
Ross’s Q1 guidance had been for $1.16 to $1.21 per share. On March 19, they withdrew that. Honestly, I’m not terribly concerned about Ross’s result because it will show an operating loss. No one can make a profit when all their stores are shut. Still, I’m very confident that Ross will do well once the economy reopens.
That’s all for now. There will be no issue next week. I’m taking off for Memorial Day. There’s not much on tap for economic news next week. The housing-starts report comes out on Tuesday. Of course, we’ll get another jobless-claims report on Thursday. The existing-home sales report is also on Thursday. The stock market will be closed on Monday, May 25 for Memorial Day. 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 Eddy Elfenbein on May 15th, 2020 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.
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