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Weekly: We're Bullish on This Self-Inflicted Market Sell-Off; Plus Meta (Facebook), PayPal, Consumer Staples, and HPQ

publication date: Apr 14, 2022
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author/source: Brian Nelson, CFA
Dear members:
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This Valuentum Weekly is not taking on its traditional form for a number of important reasons as we want to hammer home some of our opinions in this volatile market environment.
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First, I want to highlight the Recession Resistant/Consumer Staples industry, which comprises 30 fine names, many with strong dividend growth prospects. All of their stock and dividend reports have been refreshed on the website for your convenience. The stock reports for the Recession Resistant/Consumer Staples industry can be accessed by link below this introductory note.
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Second, I wanted to address the sell-off that the markets have experienced to start 2022. The SPDR S&P 500 Trust ETF is down roughly 6% so far year-to-date. Nothing terrible, but a decline big enough to get one's attention. To me, the sell-off in the markets to start 2022 seems almost completely artificial. It seems like market commentators are just making things up to try to explain it, or rather cause it.
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Nothing really has changed since the bull market of yesteryear, in my humble opinion.
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Let me explain. Weeks ago, the market started worrying frantically about the Fed raising rates, but even today, after the Fed has started tightening, the 10-year Treasury stands near all-time lows at 2.7%, well below the 5-year high reached in October 2018. I think the market has gotten ahead of itself in worrying about what the Fed is going to do or not going to do.
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My note to the commentators: Let the Fed do what it's going to do, and stick to company fundamentals.
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Then, about the same time, the markets started to worry about how the indexes are too heavily weighted toward some of the largest, strongest companies -- and that investors should seek to rebalance. This drove even more selling in some of the best names out there, but to what end, I say? Well, it turned out most of these investors probably reallocated to emerging markets just in time for the Ukraine invasion (and the sell-off in Russian and Chinese equities).
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What good has emerging markets exposure been? During the past 10 years, for example, the iShares MSCI Emerging Markets ETF is up a whopping 6% on a price-only basis, while the SPY is up more than 220%! This has been and will likely continue to be just flat-out "di-worsification." Though others are using the top-heavy U.S. market indexes as a reason to rebalance, I actually like that the U.S. indexes are heavily weighted toward moaty, net cash rich, free cash flow generating large cap growth stocks!
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But some don't see it that way. These investors, however, are probably the same investors that heavily di-worsified into bonds the past decade, and might have even allocated some of their equity portion to small cap value and emerging markets. Ouch. The past 10 years have probably been terrible for them relative to just taking a long-term perspective in some of the largest and strongest names in the area of large cap growth, which we overweight in the simulated newsletter portfolios.
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Through late March, for example, a proxy for moaty, net-cash balance-sheet rich, free cash flow generating powerhouses tied to long-term secular growth trends, or large cap growth more generally, as measured by the SCHG, has outperformed the most widely-accepted asset allocation strategy, the 60/40 stock/bond portfolio (VBIAX), and the most widely-accepted quantitative methodology, small cap value (IWN), by approximately 330 percentage points and approximately 295 percentage points since the inception of the SCHG, respectively.
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That's huge relative underperformance!
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So let's recap -- the market sold off on talk about talk that the Fed would aggressively raise rates, and then worries about a too top-heavy S&P 500 with the index being too exposed to big cap tech, and then the selling sparked the inflation fear-mongers, which now has investors all worked up. The reality is, however, that inflation could potentially be positive for a great many names that have pricing power, and it may only hurt some of the weakest names that we don't like anyway.
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Given all this, and as I've said throughout this introductory note, the market sell-off seems almost entirely artificial. Worries about the Fed, index construction, inflation fears, and then of course there was the sell off in Meta Platforms, formerly Facebook, which made absolutely no sense to us. Meta has a huge net cash position, is buying back underpriced stock, generates gobs of free cash flow, and grew revenue 20% in the fourth quarter of 2021. 20%!!! Please be sure to read through the Meta Platforms (and PayPal) article that can be accessed by link below this introductory note.
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It's incredible. Almost everyone is wrongly panicking as if Meta has no new opportunities besides the metaverse. The company has a huge long-term opportunity in e-commerce, for one, and my goodness, why do most think the metaverse will fail? Meta had the most popular app with its Oculus VR app in Apple's App Store on Christmas! The product is a blockbuster! What is the market thinking? From our perspective, the metaverse in five to ten years' time may start to re-invent the gaming, education, and gambling industries, among many, many others.
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The market sell-off so far this year seems entirely self-inflicted and one driven by talk of talk, making little sense to me. This means that I continue to be bullish on stocks for the long haul and on large cap growth and big cap tech, more specifically. I love net cash rich companies (i.e. those with huge net cash positions on the balance sheet), and it's hard not to like stocks that generate tremendous gobs of free cash flow in excess of their dividend payouts. I remain flat-out bullish and think the pundits have gotten entirely too bearish.
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Many bears are now expecting a recession just because the 2/10 Treasury yield curve inverted for a few moments. Face palm. I'm just not worried. The curve has already steepened.
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With all of this being said, there are some articles I want you to read in this Valuentum Weekly. First, we'd like to bring attention to all of the work we are doing in the monthly High Yield Dividend Newsletter, an add-on publication to the regular Silver, Gold, or Platinum membership. You may have heard that Berkshire Hathaway took a sizable stake in HP Inc., but did you know that HP Inc. was the 'Spotlight' article in the December 2021 edition of the High Yield Dividend Newsletter?
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In addition to going through our refreshed Recession Resistant/Consumer Staples stock and dividend reports, and our latest thoughts on Meta Platforms and PayPal (PYPL)--both links provided below--please have a read of that sample edition of the High Yield Dividend Newsletter below -- and if you like it, subscribe to the High Yield Dividend Newsletter. Many, many members love the idea generation and simulated newsletter portfolio of that publication.
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That's it for now. I remain unconvinced that this market sell-off will materialize into something truly ominous, and I think first-quarter 2022 earnings season will help set things straight as companies begin to talk about forward guidance and their opportunities in the back half of 2022 and beyond. I remain bullish on stocks for the long haul and am not buying into (believing) all the bearishness. Stick to company fundamentals.
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Happy investing!
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Kind regards,
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Brian Nelson, CFA
President, Investment Research
brian@valuentum.com

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From the December 2021 edition of the High Yield Dividend Newsletter: Our High Yield Spotlight for December 2021 is the computer and printing giant HP Inc---2.8%yield---as the firm’s sleepy business model is starting to show signs of life. HP is a tremendous free cash flow generator focused on returning excess cash flow to shareholders, and its outlook has improved considerably of late, even in the face of major supply chain hurdles and headwinds from the coronavirus (‘COVID-19’) pandemic.
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Our reports on stocks in the Food Retailing industry can be found in this article. Reports include BUD, CL, CLX, CPB, COST, FDP, GIS, HRL, K, KDP, KHC, KMB, KO, KR, MDLZ, MKC, MO, PEP, PG, PM, SJM, TAP, TGT, TSN, WMT, CHD, SYY, ADM, LANC, CASY.
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Rising interest rates and the impact that has had on the market's discount rate implicitly used within the enterprise cash flow pricing process has pressured the value of equities with long free-cash-flow growth tails--stocks that are expected to grow at a meaningful premium over global economic growth over the coming decades. The rapid increase in the 10-year Treasury rate, no doubt, has had a profound impact on the equity values of long-duration cash-flow companies such as those held in the ultra-speculative ARK Innovation ETF, for example. However, established big cap tech firms and many fintech entities shouldn't necessarily be as impacted by rising interest rates as those of many currently money-losing speculative innovation names that won't generate meaningful levels of free cash flow for 5 to 10 years, maybe longer. For example, shares of companies such as Apple Inc. or Microsoft Corp. should only have but a muted impact from rising rates; these companies have huge net cash positions and are already generating strong free cash flow. It can even be argued that higher inflation/rates will afford Apple and Microsoft pricing power to raise product and software prices. While we might expect the ARK Innovation ETF to be down nearly 40% year-to-date and more than half during the past 52 weeks, we don't think it makes a lot of sense for some of the strongest, large cap growth names to be off ~12%, on average, year-to-date. We think the market, in many instances and especially within the area of technology, is throwing the baby out with the bathwater. Shares of Meta Platforms Inc, formerly Facebook, and PayPal Holdings Inc are two such names that the market has been beating down too much, in our view. Though some weakness in Meta Platform's and PayPal's shares can be expected in the current market environment, year-to-date declines of 30%+ and 40%+, respectively, are a bit much. That said, during the past few months, we have reduced our fair value estimates for both Meta Platforms and PayPal for good reasons. For starters, Meta Platforms is investing heavily in the metaverse, a digital universe, and is scaling up its data center capacity to support its efforts on this front (which is driving its capital expenditure and operating cost expectations up sharply in the medium-term). Meta Platforms is not expected to make a meaningful amount or any money on these investments for some time. PayPal is facing headwinds from hefty customer acquisition costs to grow its active user base amid rising competitive threats. We also think that we may have been too aggressive within our valuation model when we built in too much earnings leverage during the next five years at PayPal. Said another way, the fintech company’s mid-cycle operating margin is not what we once though it was--as PayPal will find it difficult to meaningfully expand its margins in the current environment. However, putting it all together, these pressures and others have all been reflected in our current fair value estimates (and fair value estimate ranges) for Meta Platforms, which sits at $367 per share, and PayPal, which sits at $152 per share. Both companies are included as ideas in the Best Ideas Newsletter portfolio, and we are beginning to see signs of a rebound underway. For long-term investors, we think Meta Platforms is a no-brainer at current prices, though we may be a bit more cautious on PayPal, which is now more of a "show-me" story, given recent hiccups. All this having been said, let's dig in to why we still like Meta Platforms and PayPal.
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We were blown away by the phase II results released March 31 at Vertex Pharma for its non-opioid, non-addictive pain killer, the NaV1.8 inhibitor VX-548, and we think the molecule has the potential to provide a solution to the widespread opioid crisis in a meaningful way. According to the U.S. Department of Health and Human Services, tens of thousands of deaths each year are “attributed to overdosing on synthetic opioids.” The company’s phase II results for VX-548 provide “proof of concept” in order to push the study to more advanced studies, and we are highly encouraged. We also note that the long-term revenue and earnings potential for VX-548 is not included in our valuation model for Vertex Pharma and would offer pure incremental upside to our fair value estimate. VX-548 could be a game-changer in the fight against the opioid epidemic, in our view.
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On a price-only basis, shares of Johnson & Johnson are up ~2% year-to-date through the end of regular trading hours March 22, while the S&P 500 is down ~6% during this period. We include shares of Johnson & Johnson as an idea in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios, and we love the company's resiliency in the face of whatever challenges are thrown at it. Investors now have a much better idea of what Johnson & Johnson’s legal settlement liabilities could end up looking like as compared to where things stood a year ago, and while the pending spinoff of its consumer health operations has fundamentally altered its proposition as a straightforward dividend growth opportunity, the stock continues to hold up in an otherwise tumultuous environment. We're not counting J&J out by any means, and the stock remains a core holding in both the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio.
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Those of you that have been long-time members of Valuentum (thank you by the way!) know that we are huge fans of Warren Buffett. We include Berkshire Hathaway Inc (BRK.A) (BRK.B), specifically its Class B shares (ticker: BRK.B), as an idea in the Best Ideas Newsletter portfolio. Recently, Buffett (CEO and Chairman of Berkshire) released his latest annual letter to shareholders, which included plenty of important information regarding the conglomerate’s financial performance and investing practices at-large. One of the things that stuck out in Buffett’s latest annual letter to shareholders, a topic that he has brought up often in the past, is his belief in betting on America. In the letter, Buffett notes that “our country would have done splendidly in the years since 1965 without Berkshire. Absent our American home, however, Berkshire would never have come close to becoming what it is today.” For reference, Buffett took control of Berkshire back in 1965. We are also big believers that the number one place for investors to be invested is in U.S. equities. Specifically, large cap U.S. tech stocks with “moaty” business models, fortress-like balance sheets, incredible free cash flow generating abilities, and growth outlooks underpinned by secular tailwinds represent some of our favorite ideas alongside U.S. energy giants (a shorter term tactical play in the face of the ongoing inflationary environment) and high-quality U.S.-focused firms like Berkshire. We appreciate Buffett’s longstanding commitment to utilizing discounted free cash flow analysis to locate and invest in undervalued enterprises based in the U.S.
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Tickerized for XLP, SPY, EEM, SCHG, FB, PYPL, HPQ, ERUS, IEUR, MCHI, FXI, KWEB, ACWI, ACWX, EFA, HEEM, IEMG, VWO

Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.  

Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.

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