Taking Stock

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By Tony Crowell
By Tony Crowell
Growth Plus Value

U.S. companies are reporting their best earnings growth in more than 20 years. Around 80% of the companies that have so far reported their quarterly earnings beat the forecasts of stock analysts. This is the best quarter for topping estimates since 1994. The overall year-on-year rise is running at 20%, a rate last seen in 2010 during the initial recovery from the 2007-2009 Great Recession.

Despite this good news, investors are skulking. Since the earnings season began in mid-April, the market averages are down 1%-2%, leaving them flat for all of 2018. Such contrary behavior usually reflects psychological factors, polite terms for the continuing emotional conflicts between investor fears and greed.

Investor grumpiness may stem from a perception that more than half the increase in first quarter profits came from lower tax rates. The centerpiece of the tax overhaul was a cut in the corporate tax rate from 35% to 21%. Household spending actually declined but business investment is strong.

Apple (AAPL-$177), the largest company by market cap, is a poster child. Aided by tax savings, it boosted its dividend while announcing a $100 billion stock buyback. Its tax costs a year ago were $3,7 billion. This year, its tax costs declined by $1.3 billion while overall pretax income increased by $1.5 billion. Apple, the largest position in my clients’ portfolios remains a buy.

Another factor overhanging the market is the almost certain prospects of further rises in interest rates. In March, the Federal Reserve raised the key federal funds rate from 1.5% to 1.75%, the sixth increase since 2015. Its May meeting kept rates steady while indicating another increase ahead in June with two or, possibly, three more by the end of the year.

Interest rate increases invariably slow economic growth, thus some commentators feel the first quarter may have seen the best growth this year. Company forecasts for the coming months are more optimistic but higher rates bring a small cloud rising over investor spirits.

These factors are bringing a shift in investing analysis from growth toward value. Growth strategies, which I have emphasized for years, favor stocks in companies that can produce earnings that outshine average growth. Nvidia (NVDA-$232), which offers an increasingly broad array of sophisticated microprocessors, has grown at a 50% rate in recent years. I recommended it in this column in December 2016 at $87. Like Apple, its growth rates must slow through its increasing size but its success reflects inherent strengths. It is our second largest position and is also a buy recommendation.

Valuation is always a significant factor in analyzing stocks. As market emphasis changes, a stockpicker’s palette must add less vivid tones. Recent buys included RoyalDutch Shell (RDS.A-$69), Diamondback Energy (FANG-$126) and Merck (MRK-$57). I am adding ConocoPhillips (COP-$65), the Houston-based oil and gas producer.

The company operates globally and its sales and earnings are expanding with recent energy price growth. Next quarter’s earnings report is due in three months and should show $.85-$1.00, up from $.14. Analysts expect around $3.35 for all of 2018, up from $.60. The current dividend yield is 1.7% with one increase over the past year and more to come.

Teva Pharmaceutical (TEVA-$18), the large Israeli maker of generic drugs has been undergoing restructuring in response to competitive reverses in the U.S. generics market. It reported on Thursday better-than-expected earnings and continuing progress on its restructuring plan. It increased its outlook to $19 billion annual sales with earnings per share in a $2.40-$2.65 range. Not yet a buy pending further progress, its stock is on our watch list.

Investors worried about rising interest rates should avoid chasing higher present yields from lower quality bonds or Real Estate Investment Trusts. Rising rates will pinch their results and better bets are available in quality stocks with rising earnings capable of success in a higher rate environment.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622



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