After a prolonged bull run, investors are wary of the toppy US stock market.
The latest sign of valuation concerns, according to Russ Mould, investment director at AJ Bell, is Berkshire Hathaway’s (BRK.B) record cash pile, which today sits at just shy of $130 billion.
Boss Warren Buffett has already warned of the difficulty he and partner Charlie Munger have been having in the pursuit of good acquisitions at sensible prices. And Mould notes that the last two instances of Berkshire significantly building up cash reserves, in 1998-99 and 2005-07, immediately preceded stock market crashes.
“Buffett and Munger then applied that cash, buying assets at much lower valuations as markets melted down,” notes Mould, “to great effect, judging by the subsequent returns and renewed growth in the cash position.
“Investors may, therefore, perhaps like to take note of how the ultimate contrarians are once more sitting on the sidelines as stock markets rise.”
That is not to say all US firms are over-priced, and there are still compelling headwinds. The economy continues to expand, with a GDP growth reading of 4.1% for the second quarter of 2018, the best since Q3 2014, thanks in part to tax reforms. Unemployment is running at a multi-decade low, while business confidence is booming.
David Coombs, head of multi-asset investments at Rathbones, says his equity positioning is currently biased to growth and quality names – leading him to invest in US domestic stocks, and away from those focused on the UK economy.
A recent trip to the US, Coombs tells Morningstar.co.uk, reinforced his views. He says his potential investments must possess “a very clear customer value proposition” in order to they’re not “disintermediated by e-commerce”.
He notes that one thing that came through in meeting with company management was their willingness to change and adapt their strategies towards e-commerce, something few UK firms do.
“It’s interesting that Home Depot is raising sales in DIY and Homebase is going bust,” he muses.
“Home Depot have embraced e-commerce, seen the challenges and have changed course to adapt and embrace and beat. Here, we don’t execute or react as quickly, or allocate capital as efficiently. And that’s why US companies get into the portfolio and a lot of Europeans don’t.”
Coombs has recently added three US companies to his portfolios. We profile the trio below.
Ecolab (ECL)
Ecolab provides a wide range of services to the hospitality, healthcare and industrial markets. These include laundry systems, pest control and repair services.
Its chemicals products, used by hotels and restaurants for dishwashers and cleaning bedding, in particular offer “a very good customer value proposition”, says Coombs, by reducing costs. Clients range from big corporates like McDonalds to smaller, independent Bed & Breakfasts.
Last week the Minnesota-based firm announced a 7% rise in sales for the second quarter, with profits up 19% to $351 million. It also confirmed it would cut costs to the tune of $200 million, which will lead to plant closures and staff reductions.
The news sent shares up modestly on the day, with gains of around 5% in the past week to $147. Shares are up 10% on the year and almost a third since the start of 2016.
Morningstar analyst Lee Davidson has a three-star rating, suggesting shares are fairly valued with a fair value estimate of $141.
Amphenol (APH)
Amphenol designs and manufactures connectors, cables and sensor-based products for a range of electronic devices used in places such as airplane cockpits and fridges. It’s another firm with a customer value proposition predicated on reducing costs for end clients.
Recent Q2 results smashed analyst forecasts, showing record revenues and adjusted earnings. Full-year guidance was also increased. After a challenging year-to-date during which the share price hasn’t moved much, the news sent the stock up 7.5%. it currently trades at $93.
Morningstar analyst Brian Colello, though, has a fair value estimate of $83 and two-star rating on the stock, suggesting slight over-valuation.
US Bancorp (USB)
US financials have become all the rage in recent years as they complete their post-crisis period of self-help initiatives. But it’s mainly been confined to the larger banking corporations – the Wells Fargos, Citigroups and JPMorgans. Others have been overlooked somewhat.
US Bancorp is one such firm. Despite less interest, it will benefit just as much from rising interest rates, and is more savvy in dealing with millennials, as well as attracting new customers, notes Coombs.
It’s a very conservative and does not play in any sub-prime market. “They have one of the highest ratings of any US bank,” he continues.
It may be “a bit boring”, but that’s no bad thing for any investor, particularly one focused on an absolute return objective. “It’s not going to be as exciting as Citigroup or Goldman Sachs, but on a risk-adjusted basis, which is ultimately what I’m trying to do, it’s a stock that makes sense to me,” Coombs says.
As if to reinforce this point, recent Q2 results, in which profits rose 17%, failed to excite investors. While the stock has recovered from the 18-month low hit in May to $53, it’s still 9% lower than the record high it hit in February.
With a $54 fair value estimate, though, Morningstar analyst Eric Compton says it’s fairly valued. “US Bancorp was already one of the most well-run banks we cover,” he explains. “So, while other banks are improving and playing catch-up operationally, US Bancorp has less room for improvement because it was already so optimised to start.”
Sell Discipline
With an eye on the customer value proposition, Coombs says he’s not afraid of selling out of a holding if he sees a deterioration it that. One he has recently sold for that reason is Colgate (CL).
He explains the reason for the sale: “There’s this common myth or belief that the big consumer staples get all their growth from emerging markets. Everyone thinks these big Western brands are the premium brands in emerging markets and see exponential growth; that isn’t the case, actually.
“What happened to Colgate was they lost out in Russia and China to local premium brands. We saw that the value proposition just wasn’t there anymore and sold the stock.”
