Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar Research Services’ chief US market strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead. Good morning, Dave. Happy Monday. This week you’ll be watching for the CPI and PPI numbers.
What are the expectations given the in-line PCE reading that we saw in late November?
On Our Radar: Inflation and Earnings
David Sekera: Good morning, Susan. You know, I just can’t believe it’s Dec. 9 already, but Happy Holidays to you and to everyone else out there who’s viewing this program. So, let’s get into it. CPI, it looks like that gets released Wednesday morning before market open. The consensus estimate for headline CPI on a month-over-month basis is two tenths of a percent and three tenths of a percent on a core basis, which puts us pretty much in line with the Cleveland Fed Nowcast of 0.27%.
Looking at it here on a year-over-year basis, headline consensus estimate of 2.7% and then core on a year-over-year basis 3.3%. It looks like inflation is still relatively sticky here in the short term. Then on Thursday before market open, we have PPI. It looks like both on a month-over-month basis for headline and core, the consensus is three tenths of a percent.
I did talk to Preston Caldwell at the end of last week. He’s the head of our US economics team here at Morningstar. And from his viewpoint, assuming inflation comes in at expectations or even slightly better, he’d still hold to his base case looking for a 25-basis-point cut at the Fed meeting in December. But he thinks that after that, the Fed may then move to an every-other-meeting pace where they probably skip in January, cut in March, and so forth over the course of next year.
Dziubinski: Turning over to earnings. We have a few companies reporting this week that we’ve talked about on the show before. The first being Adobe ADBE, which has been a pick of yours a couple of times this year. How does the stock look heading into earnings, and what will you be listening for?
Sekera: Stock still looks pretty good to us. It’s a 4-star-rated stock, trades at a 13% discount to fair value. Now it did look like I had a pretty good week last week. It traded up pretty significantly after DocuSign DOCU released their earnings. It’s a company with a wide economic moat, although High Uncertainty. But, of course, in that tech sector, pretty much everything’s at least a High Uncertainty.
But I would note this is probably one of the few companies where we can point to already offering AI services in their product offerings. So, I think on the conference call, people are going to be listening for just any color or commentary that management may give on engagement with that AI offering, or if they have any other additional AI offerings in the works all of that will be very closely scrutinized.
And just taking a quick look at our financial model here this morning, for our compound annual growth rate for the next five years for the top line you’re only looking for 11%. I think anything that they talk about that could cause our analytical team to revise their estimates upward on the top line would be definitely a positive or a tailwind for the stock, in my point of view.
Dziubinski: Now we also have Broadcom AVGO reporting this week. Again a big semiconductor name, AI beneficiary. The stock looks about fairly valued. What’s Morningstar think about the company and what will you want to hear about on this call?
Sekera: It’s really been a huge AI beneficiary. I actually looked at the charts here., and going back to the beginning of 2023, we’ve increased our fair value estimate by 150% since then, and even still, that stock is trading at a 16% premium to fair value, which puts that into the bottom of the 2-star territory, 1.2% dividend yield.
But I note the stock actually traded up 11% last week. I took a quick look through, and I didn’t see any news really that prompted that. So, again, starting to get to be a little overvalued, in our point of view, but still a strong company with a wide economic moat, Medium Uncertainty. As you note, it’s been riding high on its artificial intelligence business.
So, any commentary that they provide there won’t be important only for its own valuation but for all the AI-levered stocks. Looking at the rest of their business lines, VMware, that’s also been growing well. So, we’re looking for continued solid to strong guidance there. But I did talk to our analyst at the end of last week on this one.
And he noted that I think a lot of people, including himself, are going to be listening for any commentary on their non-AI chip business. That’s really a more cyclical part of the market that’s been beaten down pretty hard. So, if we get any glimmer of hope for a turnaround, I think that could send this stock as well as any other non-AI semi stocks higher.
They’ve really just been languishing as the global economy has had relatively more abundant economic outlook. And he noted here like one good example of other legacy networking stocks that could do well if we do start seeing that turnaround would be Cisco CSCO.
Dziubinski: We also have Costco COST reporting this week. And in the past you’ve noted that Costco is more overpriced than Nvidia NVDA. Is that still true heading into earnings?
Sekera: Still true. And I just don’t get it. I like Costco. It’s a great company. I personally enjoy shopping there. It’s a company with a wide economic moat and a Medium Uncertainty. But you know the stock trades at 49 times next year’s projected earnings. You compare that to Nvidia, which only trades at 33 times next year’s earnings.
When I take a look at the valuation of the stock, it puts it well into 1-star territory. Trades at an 84% premium to our fair value. Thinking about this quarter, is there any reason why Costco won’t do well this quarter? Not that I know of. But once the market loses faith in the growth rate of this stock, I think this is one where there could be potentially a lot of downside at some point in time in the future.
Is P/E Really Useful?
Dziubinski: Let’s pivot over to a question from one of our viewers. Before we do, though, I’d like to thank everyone who tuned in for our viewer mailbag episode last week. And I’d encourage viewers to send their questions our way because you never know when we might answer your question on the air. Email us at the morningfilter@morningstar.com.
And as a reminder, Dave, can I provide personalized investment advice. And a question from Eric. Eric notes that you talk about a stock’s p ratio on occasion, but you also say that Morningstar doesn’t take PE ratios into account when valuing stocks. So why not? And what are the most important metrics Morningstar uses to value stocks instead?
Sekera: That’s exactly correct. We do not use the PE ratio in and of itself as a basis for determining valuations. In our view, when we think about what a stock should be worth, the intrinsic value of a stock is technically just the present value of all of the free cash flow that would accrue to shareholders over its lifetime.
We use a standardized discounted cash flow model in order to calculate that. Essentially that model just calculates the present value of that future free cash flow stream, which is then discounted at the weighted average cost of capital. So, PE, in my opinion, and the way I try and talk about is it’s just a shorthand way to try and estimate intrinsic valuation or really kind of reflect that.
A lot of people will use that forward PE. They apply it to the one-year forward earnings multiple. And, of course, when you think about PE ratios here, the higher the PE the higher the assumed growth rate. But I think there’s a lot of problems with trying to use PE as a valuation tool in and of itself, as opposed to just using it as a tool to try and convey what the valuation of a stock might be.
For example, when I think about a PE ratio, it doesn’t account for differential in growth prospects over different periods of time. It just assumes an average growth rate over the future. So, when you think about it, some stocks may have very rapid growth in the short term that might fade very quickly.
Or maybe you have faster growth in the future if earnings growth is slow, for whatever reason, for the next couple of years. I don’t think the PE ratio also accounts for the differentials between free cash flow versus GAAP earnings. And then lastly, I just think you have to be careful using a PE ratio.
Sometimes they can tell you the wrong thing at the wrong time. For example, a company that’s very cyclical may actually have a very low PE ratio and look cheap. But that might also be the same point in time that the economy is running hot, and the market knows that its earnings will end up falling over the next couple of years.
Or conversely, that PE might be really high after the stock has already fallen and the market expects earnings then to ramp up as the economy recovers. So, again, it’s a way I try and use it to try and convey relative fair value. But it’s not how we actually calculate the fair value of a stock.
Dziubinski: So then, Dave, given all that, why do you talk about PE at all for some stocks? You did just mention it for Costco.
Sekera: In a format like this it’s just very hard to try and quickly communicate to investors how to do a DCF evaluation. You essentially need to walk through all of the inputs, all of the assumptions, the entire projected time frame that we model out.
And I don’t think I’ve ever actually tried to argue a stock should trade at 18 times or versus a 20 times but use it as a way to try and highlight those situations, especially where we think valuations have just really gotten significantly out of whack. It’s one of those things I think PE is best used as a relative value measure more among companies in a similar sector with similar business lines, similar outlooks. More for a relative value perspective than it is necessarily for an absolute value perspective.
At the end of the day, I still recommend going to morningstar.com. Read the research that’s published by the equity analyst. Take a look through the company’s SEC filings. Read through the management discussion and Analysis section. Listen to a couple of earnings calls. Make sure you fully understand the investment thesis of a stock before investing in any particular company.
New Research and Market Outlook
Dziubinski: Well, thanks to Eric for that very thoughtful question, and of course, to you, Dave, for your thoughtful response. Let’s turn to some new research from Morningstar, starting with Okta OKTA and Zscaler ZS, two cybersecurity companies that reported earnings last week, and regular viewers of the Morning Filter know that you love the cybersecurity sector, Dave.
Sekera: Oh, that I do. I really like the fundamentals and how the cybersecurity is set up. Taking a look at the companies that reported last week, we had Okta, a nice pop in the stock after earnings there. In fact, that was enough to put that stock into the bottom of the 3-star range, coming up from 4 stars. But it’s still about 15% undervalued. When I look at our cybersecurity names I think it’s still the most undervalued here. Looking at the quarter, sales grew 14% year over year. Margins expanded 600 basis points to 21%. And then our analyst also noted that management raised its sales and adjusted margin outlook for 2025.
So, everything’s looking pretty good here. However, the increased guidance was in line with our expectations already. Our $100 fair value estimate is unchanged following the news. The other stock that reported was Zscaler. Now that is a 3-star stock. We left our $213 fair value unchanged. Interestingly, the stock slumped after earnings. I think the market was disappointed by some slower billings growth.
I think we’ve had some turnover on the sales team, but looking forward, we still forecast sales growth will rebound over the next couple of quarters as the new sales team gets up to speed and ramps up. Taking a look at our model, we’re still projecting over 20% compound annual growth rate for revenue and earnings over the course of the next five years.
And it looks like the market pretty quickly came back around to our view. Looks like that stock recovered at the end of the week and is actually now higher than it was pre-earnings.
Dziubinski: Then neither stock is a buy today. But maybe keep them on a watch list.
Sekera: Well, definitely keep them on a watchlist, although I wouldn’t argue if you wanted to start to scale into a position. Okta here. I would just say if you do that, keep some dry powder, that way you can dollar-cost-average in if we were to see any kind of retreat with a broad market selloff over the next couple of months or next couple of quarters.
Dziubinski: Salesforce CRM also put up some great results last week, and the stock was up after earnings. Looks like Morningstar raised its fair value estimate on the stock a bit, too. Why the fair value boost? Is there an opportunity here today?
Sekera: Overall, as you noted, pretty strong results for earnings. But more importantly, our analyst noted here that he expects revenue acceleration in the coming quarters. And I think that really lifted our fair value up to $315 a share from $290. Now it’s a 3-star-rated stock. But I would note it’s a pretty much the top end of that 3-star range.
Any moves higher here you’ll take it into that 2-star territory. He also noted there’s just a lot of excited excitement about Agentforce. He thinks that actually represents probably one of the better long-term opportunities out there, to transition from what he considers to be a mostly human agent labor force to a mostly virtual agent pool.
Dziubinski: We had both Dollar Tree DLTR and Dollar General DG report last week. Results were pretty grim for these two retailers the quarter prior. So, was the news any better for the most recent quarter?
Sekera: That’s a yes and a no kind of answer. So, Dollar Tree, there is no change to our fair value estimate. Results were essentially in line; same-store sales were up 1.8%. Not necessarily knocking the cover off the ball, but at least going in the right direction. But we did see operating margins on a adjusted basis expand to 40 basis points, getting up to 4.5%.
Again, things going in the right direction there. However, at Dollar General, we lowered our fair value by 10%. That really is a combination of both incorporating the impact from some-store remodeling and increases in cost of labor at the same time that spending in lower-income households remain under pressure. Same-store sales were up 1.3%, moving in the right direction, but just barely positive.
But unfortunately, profitability was lower than our forecast. So, overall, the story in the sector is still somewhat the same as what we’ve been talking about really since the beginning of the year. Still seeing that ongoing shift in purchasing patterns. The rate of inflation may be slowing, but the compound impact of inflation over the past two years with wage growth lagging, you can see how much it’s taking its toll on lower-income households and to some degree even middle-income households, so that spending is shifting toward low-margin consumables and less on the high-margin discretionary goods.
The long-term investment thesis here, and maybe it takes a little while for it to play out, but once wage inflation starts to catch up to inflation overall, spending patterns will end up normalizing. We’ll see that spending shift back to discretionary items, which of course then will end up leading to an increase in operating margins over time.
Dziubinski: There’s clearly a lot of short-term uncertainty here, but does either stock, either Dollar Tree or Dollar General, look attractive for a long-term investor?
Sekera: Well, it’s interesting. I actually looked over the history of these stocks, and both of these stocks started the year in well into overvalued territory. Both were rated 2 stars at the beginning year. But they’ve been hit especially hard. Dollar General is down over 40%. Dollar Tree is down 50%.
At this point for long-term investors, we do think the market has sold off too much. Both are undervalued. Both trade at somewhat similar discounts to fair value. However, the Dollar Tree rating is 4 stars. And that’s because we rate it with a High Uncertainty. That High Uncertainty requires a greater margin of safety to get to the 5-star territory, whereas Dollar General is a 5-star-rated stock because the Uncertainty Rating there is a Medium. I would just note that the short term looks to me like the Dollar General fundamentals might be the weaker of the two. But either way, I do think this is probably a situation that from an investor point of view, it will require some patience waiting for wage growth in lower-income households to catch up over time to the broad inflationary pressure we’ve seen over the past two years.
Dziubinski: We’ve also talked about Brown-Forman BF.A BF.B. A on the show before, and the stock soared last week after posting better-than-expected results. Was Morningstar as enthusiastic as the market with the results? And are there any changes to the fair value estimate on the stock?
Sekera: Our fair value is unchanged, remained at $55 a share. I think the takeaway here is that results were in line with our own estimates. But as you noted, the stock was up as the results came in better than the market expectations. But even more importantly, I think the management’s comments that sales trends know look on track to rebound in the second quarter of fiscal 2025 after we’ve seen an extended period, or a slump, really over the past year. I think that going forward is really what’s going to help support the stock in the in the near term. It is a 4-star-rated stock that trades at a 19% discount to fair value.
Dziubinski: What about tariffs in Brown-Forman, Dave? Is that an issue for the company.
Sekera: We shall see. I mean it’s really very cloudy to figure out at this point in time what tariffs may or may not be implemented. Specifically here, our analyst noted that 7% of the company’s sales are from tequila, so that, of course, could be negatively impacted by a tariff on imports from Mexico. But really, I think the bigger concern would be if tariffs are put in place on the EU and if we saw retaliatory tariffs put in place on US imports.
That would take its toll here on the top line. Whiskey sales to Europe make up about 15% of the company’s total sales.
Dziubinski: Dave, you published your final stock market outlook of 2024 last week, and viewers can access a link to your outlook beneath this video. What do you expect in terms of market behavior for the rest of the year?
Sekera: Barring some exogenous shock that hits the markets, I think the US markets just want to coast into year-end. And I think there’s probably pretty limited upside here. We’re already up I think 29% year to date. But with those kinds of returns, I think portfolio managers and traders generally just want to lock it in.
They just want to close out the year with those gains. Over the next two weeks before the holiday, we will probably see some tax-loss selling here and there, some window dressing. But generally, I don’t think a lot of people are going to want to take any large directional bats or just really take any large positions one way or the other.
Dziubinski: Do stocks still look overvalued?
Sekera: They do. In fact, it just appears with the market continuing to keep drifting upward, we are getting out further and further into overvalued territory above a composite of our valuations. Right now it looks like stocks are really priced to perfection, trading at about a 5% to 6% premium over a composite of our fair values, which a lot of people may say, “Yeah 5% to 6% isn’t that much.”
But when I look at our price/fair value metric going all the way back to the 2010 time frame, less than 10% of the time we’ve been at this much of a premium or more.
Dziubinski: Do you think investors should be worried about today’s market valuation, or do you think maybe the market rally still has some legs?
Sekera: Valuations are, of course, a major concern, in my mind. But I still think at this point most investors should probably remain market-weight. I just think this is one of those times that valuations can probably remain high for a period of time until earnings growth catches up. When I look at the macrodynamics, of the market.
I still think the tailwinds that we have right now overwhelm the headwinds. So, looking into 2025 here, looking at the estimates coming from our US economics team, they’re still projecting inflation to moderate over the course of 2025, getting down to below the Fed’s 2% target. They’re still looking for the Fed to ease over the course of next year, getting the fed-funds rate down to 3.00% to 3.25% by the end of 2025. Of course, globally, we’ve still got the European Central Bank easing as well, a whole host of monetary and fiscal stimulus coming out of China. And the long-term interest-rate perspective, they’re looking for the 10-year Treasury yield to get down to 3.6% by the end of next year, as well.
And of course, we still think we’re in this soft-landing environment for a slowing rate of economic growth, but no recession. And then lastly, of course, now we’ve got all the expectations of what President Trump may or may not do. I think everyone’s looking for an extension of the 2017 Tax Cuts and Jobs Act.
I think people are pricing in a higher and higher, probably of cuts to the corporate business tax and potentially personal tax rates, looser regulatory burdens. So, we’re also looking for a big ramp-up in mergers and acquisitions next year, especially in the tech space.
Dziubinski: Now, you also say in your new outlook that you think there’s one wild card that could upset things. Tell viewers what that is and why.
Sekera: At this point, I think probably the biggest threat to the US markets in the short term next year would be the potential imposition of tariffs. Now we’re just kind of in this wait-and-see mode. How much of this is campaign rhetoric? How much of this are they really going to end up implementing at the end of the day?
And, of course, President Trump is always a bit of a wild card. Is he going to come out swinging on day one and implement huge tariffs across the board, try and force other countries to the table to negotiate and get concessions? Or is this the art of the deal? Is this really just more of a negotiation tactic?
Maybe he starts off with a couple small limited tariffs here and there and uses that as kind of a hammer to try and get people to come to the table, use the threat of additional tariffs in order to get concessions. It’s going to be a matter of how much and how fast is it implemented, what geographic regions are going to be included, what products are included.
And just as important as far as what’s included, what’s going to be excluded? Are there different areas or different countries that maybe we exclude, different allies that we don’t have tariffs on? Are there specific products that might be excluded? So, a huge wide range of outcomes on individual stocks I mean from anywhere. Being the most negatively impacted would be those companies that have a high percentage of their products internationally sourced.
Looking at the note on Best Buy BBY from [Morningstar senior analyst] Sean Dunlop, he noted that 60% of Best Buy’s products come from China, another 20% from Mexico. So, again, that would be very negative for that company. Companies that can’t pass through those costs and see the operating margin contract, that would be negative there.
But there also could be beneficiaries. Those companies that have a lot of domestic sourcing, especially if they’re sourcing domestically, it comes at the expense of other competitors who’s sourcing maybe comes internationally. Those companies that have strong pricing power could benefit and see earnings growth there as well. And then lastly, just from an economic point of view, Preston [Caldwell] believes that tariffs would be a drag on the GDP forecast over the short term.
But he noted here, too, that the ultimate impact on inflation and interest rates would also then depend on what kind of response we see, both from a fiscal as well as a monetary point of view. So, huge wild card for next year, one that we will track very closely. And as we know more, we will price it into our valuations.
But at this point, I think it’s too early to tell exactly what’s going to happen.
Dziubinski: As 2024 is winding down, Dave, how should investors be thinking about their equity portfolio positioning in terms of market capitalization and investment style?
Sekera: Positioning with the kind of the valuation that we have out there is increasingly important. We still look for an overweight in that small-cap category, trades at a 8% discount. Probably about time to move mid-cap to an underweight position as well. That’s creeped up to being a 5% premium, which is also the same as the large-cap category. That’s also at a 5% premium. We’ve been recommending to be underweight large caps for a little while now, and when I look at large-cap valuations, the last time we were at this much of a premium or more was back in 2018. And if you remember, that was right before the market corrected late that year.
Historically, small caps tend to do well when the Fed is easing monetary policy and interest rates are coming down. And that’s still the environment that we think that we’re in. Taking a look at our valuations by category. The value stocks are at fair value. That’s probably the most attractive part of the market by there. So, again, overweight.
I’d market-weight core stocks. Those are trading at only a 2% premium. And looking for an underweight and growth stocks or at least a good area to take some profits. Growth stocks trading at a 17% premium. Rarely have they ever traded at this much of a premium. The last time they were up this high was in 2020 and early 2021 during the disruptive technology bubble.
I think as we see the economy lose steam over the next couple quarters, you probably have a slowdown in growth rates for earnings for growth stocks. I’d look for rotation into value and away from growth.
Stocks to Sell and Buy
Dziubinski: It’s time for the picks portion of our program. This week, you’ve brought viewers some tax swaps to make, specifically three tax-loss candidates and three stocks to replace them. Given how well the market’s done, Dave, do investors really have that many tax-loss candidates? Where might they find them?
Sekera: To be honest, there’s actually not a lot of them out there. With the markets at all time highs, even what I consider to be a lot of low-quality stocks have all been bid up over the course of the year. So, as you mentioned, very tough to find losses in most portfolios on a year-to-date basis.
You need to look back over multiple years in order to find stocks where you might have some embedded losses. I did a quick screen. I looked for stocks that had losses year to date over the past two or three years as well. And then also looked for those that were rated 1 or 2 stars, those stocks that we think are overvalued. And most of what I found were really only contained within that small-cap category. So, I expanded that search, and I also looked for stocks that are currently rated 3 stars and then picked out a few that—and again, this is my own personal opinion—probably have a pretty low probability of really taking off here in the short term.
Dziubinski: All right. Well let’s get to it. Your first stock to sell is DocuSign. Now this stock is up 80% this year, Dave. How is this one a tax-loss selling candidate?
Sekera: DocuSign peaked at around $300 a share in early 2021. Of course, it was bid up during that disruptive technology bubble. Stock just got crushed. It dropped into 4-star territory and remained there for much of 2022 and 2023. As you noted, it’s rallying this year. It’s bounced well off of its lows. But at this point, we think it’s probably rallied too much.
This is one that if you happened to buy during that disruptive tech bubble, now might be a good time to exit. I think at this point you can realize those tax losses if you have them. Plus, you then are able to sell this stock as it’s well above its intrinsic valuation. Now, I’d note they did report pretty solid earnings at the end of last week.
In fact, we bumped up our fair value to $80 a share, but stock closed at $107 last Friday. It’s a company with no economic moat, a high uncertainty. At this point, it’s a 2-star stock trading at a 34% premium.
Dziubinski: Dave, the stock you suggest buying in its place is Adobe. And you must really like Adobe because it’s the second time we’re talking about it today.
Sekera: Well, and I’m also going to note here, I’m taking a bit of a risk recommending this one right now. They do have their earnings coming out after market close on Wednesday this week. So, if for whatever reason they were to miss earnings and that stock sells off, I might look stupid here. But having said that, Adobe is one of the very few large-cap tech stocks that we think is undervalued.
It’s rated 4 stars, trades at a 13% discount to fair value. And so while large-cap tech stocks overall as a category are overvalued, I still think that investors do need to have some exposure in a diversified portfolio in that category. In this case, I think Adobe meets the bill. It’s a company with a wide economic moat, which is supported by switching costs.
Our analytical team has noted that in the software space, the more critical a function it is, the more touchpoints you have in an organization, the higher the switching cost for a software vendor. And that’s what we see here. I’d also note, too, that the company has what we consider to be an Exemplary capital allocation. Now, I don’t talk about capital allocation. Not very much. But in this case, I’d note only 20% of our equity research coverage has Exemplary Capital Allocation Rating. So, just kind of another factor in its favor here. But long term, when we think about our investment thesis, Adobe is the dominant player in content creation across print, digital, and video.
Our analytical team had noticed that they did introduce Firefly in 2023. They think that’s an important AI solution that will attract new users over the next couple of years. Looking at our financial model, top line growth, you know, compound annual growth rate over the next five years of 11%, add in a little operating margin expansion that we forecast to come up with 13.2% compound annual growth rate for earnings for the next five years.
Now, the stock does trade at 27 times earnings. So, it’s certainly not cheap. But relative to a lot of other situations we see in tech, it seems pretty reasonable to us.
Dziubinski: Now your next sell candidate is Intel INTC. And Intel stock has been really a train wreck this year. And the company’s CEO retired just last week. So fill in viewers.
Sekera: Intel is a 3-star-rated stock, but it trades really almost right on top of our $21 fair value. I’d also note that not only has the stock been under a lot of pressure, but the company did halt its dividend. So, no dividend payment on this one, at least for the foreseeable future.
We rate the company with no economic moat. And actually, I have to note here, we actually stripped Intel of its narrow economic moat back in August 2023. In fact, this was a company we had a wide economic moat rating on back in August 2022. Since we started taking that moat rating away, that stock is down slightly over 40% since August 2022.
And we also have a Very High Uncertainty Rating here. Essentially, the short story is unfortunately for Intel, they fell behind in the semiconductor upgrade cycle, and now they just have to spend a boatload of capital expenditures just to try and catch back up. Now, we still think they will be the leader in traditional semis used in PCs and servers for at least several more years.
But I think our analytical team is very concerned that Intel’s best days may be behind it. In fact, this might be one of those ones that’s transitioning from what we consider to be traditional technology into now legacy technology. They just have to catch up on a manufacturing basis with Taiwan Semi TSM, and that’s just to be able to pull even, much less try to become a leader again.
So, while this one is at fair value as far as where the stock is trading, in my opinion, I just don’t think you’re going to miss much on this one in the short term. This stock is at its lowest price since 2013. So, I think in this case there are a lot of losses to harvest.
And I think at this point you can reinvest that money in a better story.
Dziubinski: All right. And you think that better story is Microsoft MSFT. Why is that, Dave?
Sekera: Microsoft is really not much of a discount. Only a 9% discount to fair value, but enough to still kind of keep it into that 4-star range. So maybe it’s kind of creeping into the bottom of 3 star, but it’s a company that still has that wide economic moat, only a Medium Uncertainty Rating. And really, I mean, the company’s still just heading on all cylinders.
Last quarter, our team noted that their productivity and business process business was up 13%, their PC business expanded 17%, their intelligent cloud business up 21%, and of course, that’s where the real attraction lies for Microsoft. They’ve done just a really great job capitalizing on the rapid increase in demand for AI computing power. We’re still seeing demand increase for, you know, the hybrid cloud, hybrid cloud environments in general, and specifically in this case for their cloud platform, the Azure business.
Now, we think that the Azure business has been capacity-constrained over the past couple of quarters, so we expect that with as much capex as they’ve been spending there, we’re looking for capacity expansion to accelerate growth over the next couple of quarters. So even with that additional capex spending, they’ve been able to hold their margins. So again, just a much better story, you know, in this case.
Dziubinski: Your final stock to sell this week is Franklin Resources BEN. Now here’s a company and a stock that are having a terrible, horrible, no good, very bad year. The asset manager has been experiencing outflows, stemming in large part from controversy at its bond shop, which is Western Asset Management.
Sekera: Nice, Susan. I like the children’s book reference there. For those of you who don’t know, that’s Alexander and the Terrible, Horrible, No Good, Very Bad Day. Excellent book if you have young children to read to. But getting back to the story in this case, it’s not just that, it’s the terrible, no good, very bad decade.
This stock is down 60% over the past 10 years. And you highlight it is experiencing outflows stemming from controversy at its bond shop Western Asset Management. Looks like what was going on here is a portfolio manager was steering winning trades to their high-fee funds and then steering the losing trades to their low-fee funds.
But it looks like to me issues appear to be running even deeper and longer than that. We currently rate the company with no economic moat. We stripped them of a narrow economic moat in September 2024, and we had lowered them to narrow from wide back in September 2018. The stock is down 26% year since Sept. 18.
Currently, it is rated 3 stars and trades almost on top of our fair value. Granted, it does have a very high dividend yield of about 5.8%. But from a principal perspective, in my opinion, I just don’t think you’re going to miss out much on this one in the short term.
Dziubinski: The stock to buy in its place, sort of this asset-manager swap, would be BlackRock BLK. BlackRock looks fairly valued according to Morningstar. But why do you like it as a replacement idea anyway?
Sekera: Essentially, this is just a swap idea. You know, you pull out a couple percent of fair valuation pickup. But as you noted, BlackRock is a 3-star stock, only, trades a few percent below our fair value. And it only pays a 2% dividend yield. So, not necessarily that attractive on a swap basis that way. But it is a wide economic moat.
You’re picking up switching costs, you’re picking up intangible assets. And our analytical team noted that the barriers to entry in the asset-management business really aren’t all that significant. But the barriers to success are extremely high. It takes a very long time period, a lot of skill to not only put together a long enough track record of investment performance to really start gathering assets, but to then have enough assets under management to build the scale necessary to be able to compete. Here you have all of that.
I think you can capture the tax losses in BEN, pick up BlackRock, swap out of a slightly overvalued stock for a slightly undervalued stock. And you pick up the wide economic moat in that swap.
Dziubinski: All right. Well thanks for your time this morning, Dave. Viewers who’d like more information about any of the stocks Dave talked about today can visit morningstar.com for more details. We hope you’ll join us for The Morning Filter next Monday at 9 a.m. eastern at 8 a.m. central. In the meantime, please like this video and subscribe to Morningstar’s channel.
Have a great week!
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The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
