On the 24th March the S&P 500 has had its best day since 1933, so suddenly everybody is asking themselves, “should I buy stocks now? Is the worst over yet?”
The short answer to that is yes, now that valuations are better and volatility is coming down, it is time to start buying stocks again. The long answer, though, is it depends which businesses and how you intend to invest your money.
If you follow what the experts think, as we discussed last week, we are still in for further volatility. As a result it is a good idea to think carefully before making your first investment and to average your purchases out over a period of weeks or months.
What characteristics make a successful business in 2020?
There is absolutely no doubt that this is a challenging time to be a stock investor. After all, the markets keep rising, and just when you think we’ve had a recovery we end up with a gut-wrenching down day where stocks fall another 4%.
The cure to this is simple: buy amazing businesses that are partially, or fully, shielded from the Covid-19 pandemic. After all despite oil stocks falling over 50%, if the price of oil dips below $20 a barrel again that is going to do tremendous short- and medium-term damage to their business model. Oil companies, airlines, restaurateurs and the like are risky businesses at the moment because demand has collapsed.
Now’s the time to invest in the best businesses in the new world normal (post-pandemic)!
Peter Lynch – the famous leader of the Fidelity Magellan fund – managed a 29.2% annual return between 1977 and 1990. He advocated that you “invest in what you know,” and use what you identify in the real world as a way of homing in on quality companies. So let’s explore this is further detail.
The Best Brands in the World
In the 1990s my brother had a mix tape that he called his “better than the best” tracks. Now is the time to ensure whatever you invest in, now more than ever before, represents the absolute best quality business that can weather the storm.
Frugal Investors are proud to present to you an extensive line-up of world class American stocks! We invested in many of these businesses during the last great bull market, which lasted from March 2009 to late February 2020. In case you hadn’t noticed, though, the bull market is dead and we’re waist deep in a bear market.
For U.K. based investors we will shortly be coming out with a similar article (slanted towards the best-of-the-best British shares).
What we want is established, market leaders with good fundamentals, profitability, and ideally those that pay a dividend and will continue to do so throughout this crisis and beyond. They need to have strong brands and bourgeoning new products. In the event that the world experiences a period of poor returns we want the type of business that will out-perform.
Margin of Safety
The concept of the margin of safety was made famous by Benjamin Graham, in his canonical work The Intelligent Investor. Graham was Warren Buffett’s teacher and inspired a whole generation of security analysts and investors who used reasoned analysis to identify good businesses trading at discounts to their intrinsic value.
In order to determine the margin of safety, we first use a discounted cash-flow analysis to give the business an intrinsic value. That is the value of the future cash flows of the business discounted over time; in layman’s terms it’s what the ‘business is worth’ from a fundamental perspective.
Once we know what it is worth we compare that value to the current price for the security and we get a percentage value for the margin of safety. So if Chevron has an intrinsic value of $113 and trades for $69, then it is trading at a discount of 39.2%.
Ideally we want to find those businesses that have a 20% margin of safety and above, as a buffer. After all investing is about ultimately finding mis-priced businesses and buying them and holding them long term until they appreciate in value.
Here are some businesses trading at discounts to their intrinsic business value as of 28th March 2020:
| Business | Ticker | Analyst Rating (1-5) | Price Today | Margin of Safety | Target Price |
| Chevron Corp. | 5* | 68.78 | 39.20% | $60-$80 | |
| Bank of America | BAC | 4* | 21.6 | 34.20% | $20-$25 |
| American Express | AXP | 4* | 88.73 | 30.60% | $80-$90 |
| Disney | DIS | 5* | 96.4 | 25.60% | $90-$100 |
| Abbvie Inc | ABBV | 5* | 72.67 | 22.50% | $70-$75 |
| Pfizer | PFE | 5* | 30.90 | 24.6% | $25-$30 |
| Wells Fargo | WFC | 4* | 26.23 | 37.1% | $30-$35 |
| Berkshire Hathaway | BRK.A | 5* | 267,954 | 23.5% | $280k |
| 3M | MMM | 5* | 133.79 | 18.19% | $130-$135 |
| GOOG | 5* | 1110.71 | 15.80% | $1050 | |
| Coca-Cola | KO | 5* | 42.81 | 15.10% | $35-$40 |
| Restaurant Brands Int’l | QSR.TO | 5* | 56.64 | 14.10% | $45-$50 |
| McDonald’s Corp. | 5* | 164.01 | 11.30% | $140-$145 | |
| Microsoft | MSFT | 5* | 149.7 | 10.20% | $130-$135 |
| Johnson & Johnson | JNJ | 5* | 123.16 | 10.00% | $110-$115 |
| Stryker Corporation | SYK | 5* | 159.22 | 6.90% | $130-$140 |
| Abbott Laboratories | 5* | 74.56 | 1.20% | $55-$60 | |
| Apple | AAPL | 4* | 274.74 | -0.30% | $215-$220 |
Based on a 20% margin of safety there are nine businesses in this series that trade at a reasonable price, for a world class business. It is up to investors (yourselves) to determine what the crème-de-le-crème really are and when it is suitable to click the button and invest for the long term.
American “Better Than the Best” Businesses
The United States is home to some of the best brands in the world. This list isn’t exhaustive, and in fact, our Global Dividend Aristocrats portfolio gains exposure to many brands backed by companies that have increased their dividends for more than 20 years. That being said let’s evaluate several of the biggest hitters and what they actually do.
Johnson & Johnson
EPS Record: 37 years
DPS Record: 57 years
Here is a gold standard business that managed to improve earnings per share by 9.2% during the Great Financial Crisis in 2008-9. After all, many of the pharmaceutical and personal care products that sit on your shelves come from this well-run giant.
Product Line-up
I know a quick glance at my family medicine cabinet will reveal Listerine, Sudafed, Calpol, Accuvue contact lenses and Johnson’s Baby Lotion. That being said its chief division is actually pharmaceuticals including treatment for immunological diseases, cardiovascular and metabolic diseases, and pulmonary hypertension. Those treatments for critical diseases are where Johnson and Johnson transforms our lives.
Earnings
The major earnings division is Worldwide Pharmaceuticals ($42.2bn) followed by Medical Devices ($26bn) and Consumer Goods ($13.9bn). JNJ has managed to successfully grow annual earnings from $3.35 per share (2006) to $5.63 per share (2019) apart from the talc powder cancer scandal in 2017. Expect a steady and slowly rising growth of 2-3% in earnings and 6.3% in dividends over the next 5 years.
Valuation
Fair Value: $136.79
Today Value: $123.5
Target Value: $110-$115
In terms of valuation JNJ had a PE of 25.9 last year, and now trades for a 2020 PE of 15.5. With a dividend yield set to rise to 3.6% next year and earnings set to grow 27% (depending on Covid-19 of course…!) we’re looking at Johnson & Johnson trading at a discount. This high return (ROE 33.2%) and high margin business (Op Margin 31.8%) has a long term place in your portfolio. Taking a 20% margin of safety, aim to pick up JNJ for $110 during any market weakness.
Leadership Position
Based on pharmaceuticals revenue JNJ is 4th worldwide; it is top-ranked in terms of overall market cap for a pharmaceutical conglomerate. The business is diversified, as well, with over 250 brands including household names like Tylenol, Band-Aid, Neutrogena and Acuvue contact lenses. Fair to say that JNJ is a market leader and set to remain one for a long time.
Pfizer
Pfizer is another heavyweight pharmaceutical company with 1500 scientists managing over 500,000 lab tests and at any given time 36 break through clinical trials. They focus on the development and commercialisation of novel drugs and vaccines. The company covers treatments for cardiovascular health, metabolism, oncology, and inflammation and immunology. In terms of ‘big pharma’ this is about as pure a play as you can get!
EPS Record: 5 years
DPS Record: 11 years
Product Line-up
The key products are prescription drugs that are used to treat ailments for people all over the world. These include Lipidor for lowering cholesterol, Celebrex and Lyrica for pain management, pneumonia vaccine Prevnar, and Enbrel for treating arthritis. Pfizer is also rapidly growing its drug line up for treating cancer and expects 6-7 drugs in this space to eventually reach 10% of revenue globally.
The vast majority of Pfizer’s revenue sits in Biopharmaceuticals ($39.4 bn), followed by its much smaller commercial science division Upjohn ($10.2 bn), and consumer healthcare ($2.1 bn). This makes Pfizer the world’s largest pure-play pharmaceutical company.
Product Line-up
The key products are prescription drugs that are used to treat ailments for people all over the world. These include Lipidor for lowering cholesterol, Celebrex and Lyrica for pain management, pneumonia vaccine Prevnar, and Enbrel for treating arthritis. Pfizer is also rapidly growing its drug line up for treating cancer and expects 6-7 drugs in this space to eventually reach 10% of revenue globally.
The vast majority of Pfizer’s revenue sits in Biopharmaceuticals ($39.4 bn), followed by its much smaller commercial science division Upjohn ($10.2 bn), and consumer healthcare ($2.1 bn). This makes Pfizer the world’s largest pure-play pharmaceutical company.
Earnings
The earnings situation at Pfizer has been decent, though not brilliant, over the past 14 years. Pfizer managed to grow EPS from just under $1 to $2.95 in 2019. That’s solid growth. At the same time it has experienced periods of strong earnings growth followed by periods of weak growth.
The company expects modestly lower EPS of between $2.82 and $2.92 this year (Covid-19 notwithstanding). This is a good business to pick up on a sharp discount when they post moderately bad earnings.
Valuation
In terms of valuation Pfizer trades at a discount to intrinsic value of 24.6%
and, perhaps owning to a slightly spotty earnings record, is well within the
buy range of $30-$35.
Leadership Position
It is important to own industry leaders who have a record to leadership spanning, ideally, decades. Based on pharmaceuticals revenue Pfizer is number one worldwide; it is top-ranked in terms of overall pharmaceutical business because of the size of its main segment. Don’t expect a huge amount of diversification though, as in recent years Pfizer has sought to reduce the size of its other two divisions and focus even further on pharmaceuticals, including taking a leadership position on cancer-fighting drugs.
Coca-Cola
The dominant world soft drink maker needs no introduction and has been a household staple for almost 133 years. Based on a study by Interbrand in 2015 Coca Cola is the third most valuable brand in the world behind Apple and Google. Coke products are sold in over 200 countries and come in nine different core products and flavours, but there are a few surprises here…
EPS Record: 45 years
DPS Record: 56 years
Product Line-up
The Coca Cola company markets, manufactures and sells (1) beverage concentrates and syrups; and (2) finished beverages. They work with 225 bottling partners worldwide to bring these products to market across 200 different countries globally.
What you didn’t likely know is that Coca Cola has a wide range of drinks that extends beyond Coke itself:
This includes Innocent Smoothies and Juices, Simply Juices, Dasani waters, Sprite, Powerade, and minority stakes in Monster Energy and Full Throttle. Even more than that: Costa Coffee, the well-renowned British coffee chain, was acquired by Coca Cola in 2018. It’s a profitable and highly ingrained coffee and restaurant chain throughout Great Britain and Northern Ireland, with lucrative contracts that place it in hospitals and cities throughout the U.K.
Product Line-up
The Coca Cola company markets, manufactures and sells (1) beverage concentrates and syrups; and (2) finished beverages. They work with 225 bottling partners worldwide to bring these products to market across 200 different countries globally.
What you didn’t likely know is that Coca Cola has a wide range of drinks that extends beyond Coke itself:
This includes Innocent Smoothies and Juices, Simply Juices, Dasani waters, Sprite, Powerade, and minority stakes in Monster Energy and Full Throttle.
Even more than that: Costa Coffee, the well-renowned British coffee chain, was acquired by Coca Cola in 2018. It’s a profitable and highly ingrained coffee and restaurant chain throughout Great Britain and Northern Ireland, with lucrative contracts that place it in hospitals and cities throughout the U.K.
Earnings
All of the businesses that we include in this list have great earnings – after all, there’s no being the best of the best without a rock-solid balance sheet and evidence of being a profit and cash flow machine. That being said: Coca Cola is in a league of its own. Earnings per share were $1.02 in 2005 and doubled to $2.07 in 2019. For an established mega-cap business that has been around for 133 years that’s impressive and consistent growth. They haven’t acquired silly businesses to achieve that, either; instead they have spent the last 15 years carefully acquiring drinks brands and building out their distribution channels. That has been under-pinned by rewarding shareholders with a dividend that has been paid since 1964. Impressive!
Valuation
I mean pinch me: I am dreaming. Due to the Covid-19 crisis this world-class beverage company trades below fair value. There is a 15% margin of safety at today’s price. With a 4.2% dividend yield and the prospects of long-term growth, it’s a well-priced business. I plan to wait until it drops back under $40 per share (perhaps this week!) and buy it for the long-long-LONG term. Looking at the above graph you can see why this is undervalued: even in 2009-2010, coming out of the global financial crisis, it still managed to grow revenue and profit. At $40 this is a buy-and-forget-forever company.
Leadership Position
Coca-cola is an undisputed leader in its industry – enough said!
Bank of America
This investment banking and financial services titan is a visible part of society, servicing nearly 11% of US bank deposits with the remainder shared by Citigroup, Wells Fargo, and JP Morgan Chase. The Bank is also the second largest wealth manager worldwide through Bank of America Merrill Lynch, earning it the title of “World’s Best Bank” in 2018 by Euromoney.
EPS Record: 10 years
DPS Record: 5 years (previous: 25)
Products & Services
The Bank of America customer operation was the number 1 in mobile banking, online banking and digital sales last year according to Dynatrace’s 2Q19 Online Banker Scorecard. Within consumer banking they operate 4302 financial centres, 16,626 ATM machines, and have 38 million online users. Turning to business clients BOA has existing relationships with over 77% of Fortune 500 companies and 95% of the US Fortune 1000.
The Bank is more than just a consumer facing company. Net income from their Global Banking and Global Markets divisions is considerable: through their global operations they provide a full spectrum of corporate and investment banking solutions to small and medium sized businesses across the US and abroad.
Earnings
You probably remember this little thing called the Global Financial Crisis, in 2008-2009, right? When Lehman Brother’s collapsed BOA was hit very hard and its share price went from over $40 per share to about $5. As you can see, earnings collapsed with it. However since the GFC earnings have steadily increased and it has managed to turn itself around.
One thing to keep in mind during the Covid-19 crisis: expect a hit to earnings on the horizon as we get to see the full effects of the lockdown. That might be a good entry-point.
Valuation
One of the largest shareholders in Bank of America is none other than Warren Buffett, whose Berkshire Hathaway owns 10.6% of the company (his second largest holding). The first wave of selling hit Bank of America shares hard and took it to a close of $18.08. At the current levels we’ve got a 34% margin of safety, so ideally look to get as close to $18-20 per share as you can and comfortably hold onto it. Trading at 60% of intrinsic value and with a 3.51% dividend yield, from a market leader, this is a pretty enticing entry point. At the moment the Fed is looking to allow banks to continue to pay dividends.
Leadership Position
Bank of America is the second largest bank in the US next to JP Morgan Chase, based on market capitalisation. On the worldwide scale it sits 8th based on total assets and 3rd based on market cap.
American Express
American Express is a unique business because it makes money on in two distinct categories: (1) interest income in the form of APR charged to customers for outstanding balances along with other fees for the service; and (2) payment processing fees and discount revenue charged to payment merchants. American Express card holders charged $1.2 trillion in 2018, so business is thriving!
EPS Record: 10 years
DPS Record: 5 years (previous: 25)
Product Line-up
The initial assumption when Apple Pay came out was that it would be disastrous for the credit card companies and established banks. As it happens, far from it! American Express has embraced the digital transformation and it is offered through Apple Pay, Google Pay, Mobile HCE, NFC and Samsung Pay. Amex draws on its experience as an issuer, acquirer, and payments network to give customers quick and seamless access to payments.
Earnings
Up to January 2020 American Express was kicking it out of the park: after all, following colossal tax cuts and a culture of excess, the American consumer was alive and kicking up until February 2020. That means profits for financial services companies like Amex were hitting record highs, with Q4 EPS $2.03 beating analyst expectations and Revenue of $11.4 billion. The long term record is very sound and although it suffered during the 2008-2009 credit crunch, as you can see below, it quickly recovered in 2010 and has been marching higher since then:
Valuation
There is no denying that this time could be different and may lead to a drastic reduction in revenue and profit for 2020. After all, if the consumer is banned from going outdoors, then you would expect charging things to their Amex card and engaging in payment services to be the last thing that they would be doing from the privacy of their local couch. At $73.60 today (5th April) the company continues to trade at a 42% discount to intrinsic value.
Concluding Thoughts for Frugal Investors
Buy the best of the best.
What you should take from this is that there’s a logical way to approach investing in businesses (through stocks). That doesn’t mean just following tips and then acting on them, either. It means taking a careful and research-oriented approach to investing where you wait patiently until the business that you are after comes into the target range for you to buy.
In fact any of the businesses on the list above are worth researching further and giving consideration towards an investment. Berkshire Hathaway, the conglomerate that owns many of the businesses on this list, currently trades at a discount of 25%.
About the Author: David began Frugal Investors in order to help others learn about smarter money management – today. He has spent nine years working as a senior process improvement professional and has extensive experience helping FTSE 100 and Fortune 500 businesses to improve their efficiency, quality and speed of delivery.
Over that same timeframe he has built up a £1mn+ portfolio of stocks and bonds through self-directed investment. Follow David as he uses thorough, detailed investment research aimed towards accruing £2,000,000 in investable assets within the next ten years.
