Picks, Spills, and a Dunk

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Are these corrections, would you say, or would you call them more clarifications? Maybe we should let listeners be the judge, but we have two tidbits to start off with, right? I, I'm Jack Howe. This is the Barron's Streetwise Podcast. With us, our audio producer Jackson Cantrell. Hi, Jackson.

Hi, Jack.

We talked, I think, a couple of weeks ago about politics and the stock market, and we mentioned the number of presidents. And I got an email here from a listener in San Diego. I'll call him by his last initial, Mr. B. He writes, I listen to various podcasts while I'm puttering around my yard doing chores. Your podcast is my favorite. Thank you, Mr. B. In your last podcast, you said there have been 46 presidents, which creates a very small sample size when evaluating where your money would have increased more in value. Actually, there have only been 45 presidents, but 46 presidencies. Grover Cleveland served non-consecutive terms, so he was the 22nd and 24th president.

I, I call that a toss-up.

Here we go.

Hey, I'm sorry, but right now I'm looking at the National Archives website, and this is old, but it does say meet the 44 presidents from George Washington to Barack Obama. So there they are counting, uh, Grover Cleveland twice.

They count them twice?

Yeah.

And that's from the National Archives, you say?

Nationalarchives.gov.

Okay, well, you stick with them. I like Mr. B's fun fact here, and he goes on to say, and the Republicans and Democrats didn't exist in the earliest days, which makes the sample size even smaller. I know you and Jackson strive for accuracy, so thought you would like to know. Must be because you were on vacation that this slipped through. Love your show.

I'd say that's accurate.

Tough but fair.

Yeah, we'll have to calculate the WIG stock market results next week.

Thank you, Mr. B. Okay, this next one is particularly painful. The subject line of this email reads Grammar Police Warning, and this is from Mr. F in Atlanta. And he writes, I've been a fan of your cast— that's Jackson, that's short for podcast, I don't want to throw you off there— since I discovered it many moons ago. So imagine my chagrin when you admittedly, like many others, misused the phrase Begs the question. It means avoids the question, not raises the question. You and Jackson will nevertheless remain one of my must-hears forever. Thank you, Mr. F. Jackson, this one was a gut punch, I have to tell you, because I felt like maybe I've been using this phrase wrong for decades and it's time to go on an apology tour. I did a little Googling. And apparently this is a hot-button issue for many years. You would not believe how much has been written on the subject of the phrase "beg the question" by The New York Times and The Guardian. And there's a grammar blog called Sentence First by a fellow named Stan Carey, and so on. Merriam-Webster, the dictionary, has a long usage note on this subject titled "Beg the question: It's not begging at all." Begging the question means to elicit a specific question as a reaction or response. It does also say that there's a lesser used and more formal definition: to ignore a question under the assumption it has already been answered. And it explains that that one comes from a translation of an Aristotelian phrase—

oh boy—

rendered as beg the question, but meaning assume the conclusion. For those of you who are still with us, I think that means that the wrong usage has become more popular and thus has become maybe the right usage. But I don't really know. I'm out. I'm now a raise the question guy. I'm no longer a beg the question guy.

You'll take no part in these grammar wars.

No, you'll have to continue this fight without me. We want to say a few words about big earnings movers and then Amazon dunking on Warner over NBA rights, and we'll have 4 stock picks from DA Davidson. Let's start with earnings. This past one was a topsy-turvy week for big tech stocks, a lot of selling there. It seems to have calmed down by the end of the week. Small caps did better. FactSet mentions, quote, myriad factors including stretched systematic long positioning, high Q2 earnings bar, particularly for big tech, AI scrutiny, or CapEx versus monetization, seasonal headwinds, and election uncertainty. We've talked about all those in recent episodes, including the AI scrutiny. For example, Apple with its new iPhone coming out in the fall— will it be an iPhone supercycle as customers go bananas for Apple's new AI features, or a customer is going to decide, as UBS predicts, that those new features aren't jazzy enough for now? Maybe shoppers will hold out for future applications that'll make more use of AI, and maybe Apple won't experience the iPhone sales boom this fall that the consensus seems to expect. Similar themes are playing out across big tech right now. Now, if we look at earnings for S&P 500 companies, I'd say pretty darn good so far. I'm looking at 206 of the 500 companies that have reported, and the blended earnings growth estimate— in other words, if If you take the companies that have already reported and the ones for which we only have estimates and you blend those together, you get 12% earnings growth for the quarter. And for revenue, you get just shy of 5%. And a higher than usual percentage of companies has been beating earnings estimates. I always watch the share price reactions to earnings reports more so than the percentage upside or downside earnings surprises. I think the prices are more telling. And mathematically, there haven't been larger than usual price movements on average in response to earnings, but there have been some individual doozies of late. I'll run you through a handful. Ever hear of a company called Dexcom, ticker DXCM? By midday Friday, that stock was down more than 40%. The company makes continuous glucose monitors for patients with diabetes. In its quarterly report, the company surprised to the upside on earnings but offered weak revenue guidance, and the reasons aren't quite clear. The CEO blamed part of it on a restructuring of the company's sales team. But are you thinking what I'm thinking here? If you are, then just know that JP Morgan's analyst was thinking it too. These days, when I hear about disappointing sales for companies that make diabetes equipment, or really anything related to obesity, I start to wonder Is this because of the obesity medications? JP Morgan's analyst expressed shock about the new sales guidance on the earnings call and asked whether obesity drugs are having an impact. The company said only that it has fewer new patients than it thought it would have at this point. I guess we'll look for more clarification there going forward. LKQ recently had a 12% drop in response to its earnings report. That's a company that's in the junk car parts business. Taking parts from vehicles that were in accidents and reselling them to garages for use in repairing cars that are still on the road. Revenue was sluggish there. The biggest shortfall was in North America parts and service. Repairable claims fell 7% year over year. JPMorgan writes that that's a function of lower accident frequency. Accidents were down by a low single-digit percentage year over year in the second quarter. Also, consumers electing to defer repairs due to rising insurance costs and moderating used car values. I suppose fewer accidents are always good news. And remember that used car prices had spiked. If they're coming back down to reality, maybe customers are deciding, you know what, instead of keeping this clunker going for longer, maybe it's time to buy another used vehicle. JPMorgan, by the way, is keeping that stock at Overweight. They say it has a historically low forward PE and that it's going to be prioritizing shareholder return over acquisitions. The PE there, if you're curious, let's see, I've got it at 11.2 times this year's projected earnings. Let's do a couple more. Edwards Life Sciences took a beating, down 31% after earnings. There's a revenue shortfall here related to something called TAVR, which stands for, Jackson, transcatheter aortic valve replacement. And it means what? It means you stick a long tube in and you go in through that tube and you replace a valve of the aorta.

Is that—

how close am I?

Yes, it's to avoid open heart surgery.

Okay, so results there were below expectations, and it seems to be that hospitals are devoting more of their time and attention to new technologies, including one called TMTT, which is also from Edwards Life Sciences. And TMTT stands for, Jackson?

That's the transcatheter mitral and tricuspid therapies.

Still a big long tube, but it's going to a different place.

Bingo.

One analyst called the results one step forward but two steps back for Edwards, and he downgraded the stock to neutral. And the last one, I suppose we can mention Ford. That stock was down 18% after earnings, worst day since 2008. And there are plenty of reasons to cite their continued high warranty expenses. Morgan Stanley's Adam Jonas, who is bullish on Ford, kind of sums up investor frustration there. Ford CEO said on the call that the company needs to do a better job to educate consumers on the benefits of electric vehicles, but Jonas says that Ford might want to speak with Hertz about their experience in maintaining one of the largest fleets of EVs. Hertz stock is down 60% so far this year. So I don't think that experience has been great. Jonas says that Ford believes that it has better uses for capital than share buybacks, but investors lack sufficient evidence to support this claim. In Jonas's opinion, a partnership in China is a prerequisite for making affordable electric vehicles in the US. He writes that US carmakers have potential paths to unlock shareholder value, but he doesn't believe that electric vehicles for now are one of those paths. But although Jonas recently downgraded GM to equal weight, he's sticking with Ford at overweight. He states that his conviction is being tested, that the stakes are high, and that the volatility is discomforting. And that's Ford, but a lot of carmakers have taken a beating lately, including Tesla. That stock, remember, recently sold off 12% in response to earnings. So it's not easy in autos right now, probably a subject we should revisit soon in this podcast. But for now, let me quickly pivot to basketball. You see what I did there, Jackson? Pivot. The National Basketball Association wrapped up its media rights negotiations and prices, as we have predicted, are way, way up. Walt Disney keeps a big package of games and so does Comcast. But Warner Bros. Discovery is out and Amazon is in. And that means that the Warner Channel TNT is ending its 4-decade relationship with the NBA. Jackson, you've seen that show, uh, Inside the NBA on TNT?

I've seen it, yeah.

Got Charles Barkley, Shaquille O'Neal, Kenny the Jet Smith, and Ernie—

Ernie Johnson Jr. Ernie Johnson, right.

He— I saw a clip the other day, he tried to pat Shaq on the back, he got about to the back of his knee. Anyhow, that's a beloved show and its future is now in doubt. There was talk that Amazon might try to recreate the show. TNT, by the way, cried foul over its right to match Amazon's offer, so we'll see what happens there.

Ernie Johnson Jr. is 6'1".

You are joking.

That's—

Mr. Johnson, I'd like to take back the crack I made about your height. It's just that you look like a lawn figurine standing next to Shaq. I don't know. Okay, so this deal for Amazon is not at all what I would call transformative, but it's modestly good. It'll cost an estimated $1.8 billion a year over 11 years, and Amazon can easily make that money back. It can raise the cost of its Prime membership by a few bucks a year. Remember, that gets customers both the shopping privileges like fast delivery and the Prime Video, which will include NBA games. It can also sell more Prime memberships. And since Prime customers tend to do 2 to 3 times the shopping of non-Prime customers on Amazon, Amazon also stands to make more money on sales of general merchandise, and it can sell advertising against those games. B of A Securities took a look at this deal and it remains bullish on Amazon, but it didn't make any change to its price target, to its earnings estimates, and so on. For a company of Amazon's size, I'm not sure how much this moves the needle. Although B of A did point out that basketball is the most international of the big popular US sports. Jackson, I know you love a good factoid. Guess the percentage of young adults in Italy that watch NBA games.

Oh man.

Italy, young adults, NBA games.

I don't know, 8%?

39%. No way. Don't be ridiculous, sir.

Wow.

39%. This is a popular sport overseas.

I watch approximately 0% of Italian basketball.

It doesn't go both ways. You're right. This gives Amazon a good opportunity to drive international Prime subs. OK, for Warner, this change of possession is a much bigger deal. Jackson, do you see again what I did there?

It was a steal, but the question is, can Warner rebound?

All right, well, I got to stop you there.

Yeah, that didn't feel good.

Macquarie promptly downgraded the stock to neutral from outperform, and the analyst there conceded that the stock is very cheap already, but he wrote, we don't see a good fundamental investment case now. Macquarie reckons that ad revenue could drop sharply starting late next year, bargaining power with cable bundlers will take a hit, and perhaps even more important, Max— that's the streaming service— it will be weaker on sports, giving customers less of a reason to subscribe. Sometimes bad news can be good news, and one thought on Warner is that the news here might be bad enough to prompt a breakup. And if that's something that could ultimately unlock a higher stock price, this might be good news in disguise for deep value investors. But I tend to think that when the best news is that the news is so bad that it might turn out to be good, that's not really a great reason to sound the rally horn. That, of course, is the value trap horn. Gotta be careful with the pronunciation there. Value trap horn, not value trap porn. Those are two totally different things. Where was I? You'll have to be the judge over which way this will work out for Warner. And that, let's see, is earnings and some transcatheter stuff and car accidents and the NBA. And next up, our 4 top stock picks from DA Davidson. That's next after this break.

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Welcome back, Jackson. We've already talked about the National Basketball Association, but that's not the only NBA that is relevant to today's episode.

I'm intrigued.

Well, there's also the National Bison Association. Of course, each year they put on a gold trophy show. I had no idea about this. It's a bison beauty pageant. I mean, I don't know if beauty is the right word here. They say they judge on overall health and appearance. If you're looking to enter, I can tell you that this past year the fees, it was $110 for a single animal entry. I presume they're talking about 2-year-old bulls there, and the minimum weight guidelines are 1,200 pounds. Or different fees for smaller animals. You could do 5 heifer calves for $300.

A steal.

They need to weigh 400 pounds each. Please note, and I can't stress this enough, quote, uniformity of the group of heifers will not be a main judging point, but could be used to break a tie between one or more pens being considered for an award, end quote. Why am I talking about bisons, if that is the plural of bison? Probably not. It's because on an earlier episode of this podcast, I talked about D.A. Davidson's new list of quality companies. Which they call best of breed bisons. We talked about how Davidson has adopted the bison as its mascot. I opined on why it's good to choose a large North American mammal for a mascot for a U.S. financial company, about how the bull and the elk are already taken. Bears are too bearish. The moose looks ridiculous. Let's be honest with each other. Fat snout, hand-shaped antlers. Looks like a kid drew them. The bison is perfect. And D.A. Davidson now has a long list of best of breed bisons., and as a new initiative, it has identified a subset of these that it feels particularly strong about. These, as you'll hear in a moment, are its Gold Trophy Bisons, and that's named after this contest. And I wanted to hear about some of these picks, so I reached out recently to Tom Diffley. He's the director of institutional research at D.A. Davidson. Jackson, any more background we need here? I've got some more notes here on minimum weights for yearling bulls or age verification by looking at adult incisors.

I think probably just jump to the call.

Let's do it. We look at every company on 12 criteria. You have to meet 8 of the 12 criteria to qualify, and we try to figure out what the intrinsic value of these names are over a long period of time. And then when there's some kind of a disruption in the name and it trades at a significant discount to that intrinsic value, that's when we put it on the gold trophy.

So you're looking for companies that screen as being cheaper than they should be. Is there any kind of momentum part of this? In other words, what about names that are maybe out of favor but have been out of favor for a long time. How do you avoid, as they call them, value traps?

That's a good question. We, uh, we probably won't know for 2 to 5 years. That's the time frame here. You know, we think we have some good names. They are a little depressed for, you know, certain reasons near term. Uh, they might go a little lower before they start to recover. And so this is not a call on, you know, what the stock's going to do next quarter by any means. It's all about just having, you know, 50, 100% upside to their intrinsic value over a long period of time.

And there are not many of these, right? If there are 55 Bison, how many Gold Trophy ones do we have?

Well, 4 months ago we had our first tranche of Gold Trophy. There were 6 in that tranche. At the time it was, you know, 3 banks and 3 industrial names. And then this current list, there's only 4 names on this current list. And so we have 10 out of the 55 of our best-of-breed Bison or Gold Trophy right now.

Okay.

Can you tell me about some of these?

Yeah, absolutely. So we have 4 names. They vary from $1 billion market cap custom truck CTOS to $35 billion market cap Estée Lauder. In the middle there is Crane. Crane NXT is a very interesting name. So this is the dominant player of currency material and technology. Essentially, they've been supplying paper for almost 150 years to the US government. And, uh, you know, they make all that technology that goes into the, the fibers, the, the watermarks, you know, the strips, what have you. And so This is a name that is a recent spinoff from Crane Holdings. And so it's under the radar and one that we think there's, you know, a good 60% upside to their intrinsic value.

The cash is getting fancier, as you say, you know, the watermarks and so forth, but aren't people using less of it? Don't people use more of the digital payments or the credit cards or what have you? What makes this something that you think is gonna be a good long-term business?

Yeah, that's a great question. I mean, turns out that cash currency is still growing at 3% a year. And you mentioned the real important part, and that's just, it's getting more complicated. So if you look at a $100 bill today, it has a lot of different features on it. In 2 years, we're going to see the $10 bill go to those features. And then 2 years after that, we go to the $50 bill. And so it's essentially redoing all of our currency over the next, you know, 5+ years with all of these great new technologies.

Tell me about some of the others on the list. You mentioned custom truck.

That's a smaller company.

I'm not sure that I'm familiar with that.

It is. That's our smallest one. It's a, a billion-dollar market cap. Uh, they essentially make all the bucket trucks and the diggers, uh, that service electrical line transmission lines. So, you know, if you're building a new data center, you're trying to fix the grid, you need to have these bucket trucks and diggers and equipment.

I'm picturing these— some people call them cherry pickers or, or aerial work platforms. These are things where A person gets up and this big kind of folding arm lifts them high up in the air to do some work on the electricity lines.

Exactly. And, uh, we think this is going to be a great play on just the infrastructure build-out over the next 5 years. And Custom Truck is vertically integrated. They design, build, sell, rent. And so they're a dominant player in this space with 50% recurring revenue, mid-20s EBITDA. We just like it long-term.

Aren't there very big equipment makers that play in that business or in a similar business. I'm surprised that the company— I think this is being a pretty capital-intensive business, making machines like that. How is such a small company such a major player in that business?

If you think about it, I mean, they're pretty specialized trucks. And so, you know, historically hasn't been a huge market and it's just becoming bigger over time. And so they've been able to just create a dominant position in this niche market.

Got it.

And there were 4 that you added, so that's 2 of them.

What are the other 2 that you added?

So one software company, Dynatrace, it's observability software. So essentially it looks at all the application software and your IT infrastructure and makes sure everything is running smoothly. And it's sold off quite a bit this year along with some other enterprise companies. But we think this is one that, you know, they're a dominant player. They have both strong growth and strong margins. And you know, we think that this one bounces back very quickly over the next couple years.

What does the software do for Dynatrace?

So it, it's a layer you put on top of your software to make sure that your applications are running smoothly, that your IT infrastructure both in the cloud and in these hybrid networks are running smoothly. And so it's essentially a, a way to look at all of your dispersed pieces of software, making sure everything's running well.

And I guess they sell to big businesses and, and like other software companies, is that one with pretty good cash flow?

Oh yeah, no, very strong cash flow. Really good margins, you know, upper quartile decile for margins and growth combined.

And what's the fourth one?

And the fourth one is Estée Lauder.

What do you like there?

Pure play in prestige beauty. They have 24 brands. The top 6 brands account for 50% of their revenue. It's Estée Lauder, Clinique, Tom Ford, names like that.

Is that one that's a growing business or one that generates a lot of cash flow, or what are the financial attributes of that that you like?

Key here is that it's a leader in scale, quality, and marketing. Um, and the reason that it's been hit lately is just their growth in China had slowed. And so because of the economic situation in China and COVID, that business really dropped off over the last year. And so this stock has been hit, you know, along with that. And we think that, you know, that's just a temporary issue that gets resolved over time. And they are a leader in prestige beauty, and that is a nice growing space.

What do you think of the US stock market here? You have any thoughts on the broad market? We've had quite a run. It's a run that's been dominated by some of these big tech names, and it leaves me wondering, are we due for a pause? Are we due for a— things gotten too expensive? What do you think happens here for US stock investors?

We cover 400 names here. A lot of them are small to mid-cap. There's a lot of really good values in our small to mid-cap range right now. And so You know, I think it's more likely than anything you're going to see just a sector rotation. You're going to get some of the high flyers with crazy valuations being a little weak over the next couple of quarters. And I think you rotate into some of these more value-type names.

Are you hearing any concerns out there? What people want to know from you, what they're, what they're wondering, what they're— what do you think investors want to know most about right now?

You know, a lot of the questions come back to, you know, the next couple of quarters and is this going to be a soft landing? Or are there going to be a few chinks that drive us into a short recession? You know, in general, most of our conversations with clients go back to just kind of the economics of the individual companies today and how we think they set up for the next couple of quarters. You know, what we're seeing essentially is that the business trends are, are pretty positive for a lot of these mid-cap names.

Thanks for those ideas, Tom. We'll be watching them with interest., and thank all of you for listening. Particular thanks to our listeners, Mr. B in San Diego and Mr. F in Atlanta for sending in your comments. If you have a comment, you can reach me at jack.hough, that's H-O-U-G-H, at barons.com. If you have a question you'd like answered on the podcast, go ahead and tape a voice memo on your phone and you can send the file to that address. Anything to add, Jackson?

North American mammals are spoken for, but we're looking for streetwise Mascot suggestions.

I'm voting skunk. See you next week.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.