2024-01-08 08:00:00 ET
Summary
- Uncertainty about the direction of the economy in 2024 raises questions about investing strategies.
- I asked myself if I could find resilient stocks, no matter what happens.
- In this article, I share my three picks whose predictable operations, high profitability, and little leverage enhance the likelihood of success.
Introduction
Well, 2023 is over. It was rather funny: most of us expected a recession, but no recession happened. Most of us started 2023 with low sentiment and then we turned excited as a strong bull market unfolded. Most of us were worried about the geopolitical situation, and yet, the market seemed to shake off concern after concern. And then we had the big buzzword: AI. What a catalyst this has been.
Now we look back at 2023 and we can say: well, what an incredible investing year.
But then an issue arises: investing is not about the past but about the present and the future. So, the question then becomes: what are we expecting for 2024?
And here you may find yourself with no clue about the direction the economy is going to go.
Of course, we know 2024 is an election year and usually the market goes well during these years. Of course, we have heard about rate cuts by the FED and we all expect at least a couple of them. Of course, we know inflation is going down. Of course, we know commodities will be volatile because of geopolitical instability around the globe. Of course, of course, of course... but is this enough? What if none of these expectations take place, just like many forecasts about 2023 didn't prove true? Is there a way to invest with some insulation from the direction of the overall economy? Are there a few so-called "all-weather stocks" to pick?
In this article, I would like to share the mind frame to address this issue and three picks descending from it.
The investing mindframe
While many may feel ignorant if they don't have an idea about the prospects of the economy, I actually think this could be a rather important investing advantage. In fact, it would mean one is not biased towards a particular macroeconomic outcome. The consequence springs forth directly from here: an investor with no clue about the short-term development of the economy can focus on the stocks and their fundamentals. More in-depth, it means investors need to find stocks whose companies stand on their legs no matter what happens around them.
To make it clear, let me give an example. Fashion companies don't fit with what we are looking for. In fact, in just a second fashion can change and a brand up until then very popular can go out of favor. Remember what happened to Under Armour?
How do I choose companies that can withstand almost any economic condition? Here are a few criteria I use:
- They offer something unique, be it a service or a product, with strong and ever-growing demand
- Their operations and their results are highly predictable
- As a result, they almost have no competition or, if they do, they are the market leader in their specific sector
- They are highly profitable. I don't only look at margins, which need to be consistently high, but also at returns on invested capital, which must be well above the cost of capital
- They have little or no leverage and their earning power (pre-tax earnings/interest expense) is high
- They distribute back to the shareholders only the excess cash generated by their operations
After a company meets these criteria, I look at its price. Overpaying may cause issues and we have to be a little watchful about this, especially with the stock market so high right now. While I want to avoid overpaying, I have matured to be able to pay a reasonable price for very good business, without staying on the sidelines unless, for some unforeseeable reason, they start trading at a single-digit PE. Warren Buffett has taught us this after he learned it himself from Charlie Munger: "It is better to buy a wonderful business at a fair price, rather than buying a fair business at a wonderful price".
The three stocks that are part of the list are all currently in my portfolio. I don't like giving tips if my money is not where my mouth is.
Moreover, they are all down 10% or more from their ATHs. Being all of them usually strong stocks due to the strength of the underlying business, every time they pull back, I deem them worthy of a look.
Top 3 "all-weather" stocks
Here are my picks.
Pick number one is the Ferrari (RACE).
This is a cornerstone of my portfolio . No need to explain the value of the brand. The Italian iconic luxury sports vehicle manufacturer is the indisputable leader in the top tier of the automotive industry. As such, it showcases numbers no other automaker can even dream of. Its profitability sees gross margins at 50%, EBITDA margins targeting 40%, and net income margins well above 20%. Moreover, the company is compounding quickly , posting each year double-digit growth across all its main metrics. I have already explained why I would not be surprised if Ferrari will report €6 billion in revenues for FY 2023 compared to €5.1 billion in FY2022.
Ferrari IR webpage
What many may not know is that Ferrari is one of the easiest companies to predict. Its business model hinges on these words Enzo Ferrari, the company founder, used to say: "We will always sell one car less than the market demand". In other words, Ferrari is very restrictive with its order books and currently delivers around 13k vehicles per year. Demand for its cars is ever-growing due to the increase worldwide of ultra-high-net-worth individuals. Therefore, we already know Ferrari is sold out for 2024 and has orders extending well into 2025. To say the truth, Ferrari's Purosange, the first SUV (if so we may call it), is sold out until 2026 . Clearly, Ferrari has enormous pricing power. But its profitability doesn't only rely on the company's exclusivity policy. In fact, Ferrari has recently unveiled its new profit mastery . The company has discovered how profitable the personalization business is and is now seeing almost 20% of its total revenues coming from this business line.
Regarding its financial health, let me spend a word: the company has almost no industrial debt and sports a net industrial debt/adj. EBITDA ratio of just 0.1.
Looking for a dividend growth pick? Ferrari will reward you, as well. Being able to generate almost €1 billion in FCF, the company has committed to paying increasing dividends, keeping its payout ratio below 35%. On top of this, the company is running a €2 billion buyback program.
Ferrari IR webpage
While the starting yield may be very low, the compounding machine Ferrari is may deliver over the long-term very pleasant returns coupled with strong price appreciation. Yet, investors should know Ferrari pays its dividend once a year, usually in May.
Regarding its valuation, the stock, just like the cars, isn't cheap. After Ferrari reported its Q3 earnings, investors pushed the stock up from $300 to over $370. Now the stock is 10% below its latest high and it has also formed a double-top which shows some weakness in the short term. Ferrari's quality has a price, but I have found that taking advantage of any dip in this stock can pay off very interesting results.
Pick number 2 is S&P Global (SPGI).
This one is the latest significant addition to my portfolio. I added it in October for the simple reason I came across it while I was researching Warren Buffett's investment in S&P Global's main competitor Moody's. What makes me really confident about this company is that it has 5 different sources of revenue: Market Intelligence (provider of financial data); Ratings (provider of credit ratings); Commodity Insights (provider of information and prices for the commodity markets); Global Mobility (provider of data for the automotive value chain); Dow Jones Indices (index provider). This is a truly profitable company. Take a look at the picture above and you will see no division has margins below 30%, with Ratings and Indices hitting, respectively, 55% and 59% operating profit margins.
S&P Global Investor Factbook
The company has almost no capex because it runs capital-light services. Therefore, it generates tons of FCF. Dividend investors, take note that 85% of the company's FCF will be redistributed back to you.
Now, S&P Global is subject to a little cyclicality. For example, this past year it performed a bit worse. But, zooming out and looking at the overall picture, it is part of an oligopoly almost any other company has to pay a toll to. This gives the company huge pricing power and almost no risk of seeing new competitors coming in unless the overall financial system we live in changes. In fact, this company is simply able to make gold out of debt.
You will find that S&P Global carries some debt due to recent acquisitions.
Pick number 3 is Hershey ( HSY ).
We change completely sector here and we look at a chocolate producer. While the market went up in 2023, Hershey's investors had no part in the rally, with the stock falling and falling $100 from its $273 peak in May 2023. Concerns about weight loss drugs were the major issue here. In addition, investors were worried about Hershey's ability to keep on passing on to its customers its exposure to high cocoa prices. Pricing power must come to an end, this was what investors thought. True, but chocolate is also a treat many consumers won't go without. Moreover, Hershey's is not only about chocolate. It owns brands such as Reese's and Almond Joy and it is also building a salty snacks business that is rapidly (and profitably) growing.
While here we are not before a true moat, we are before one of the undiscussed market leaders. In the snacks business, this means one word: scale. And scale means higher profits. Higher profits mean the company can protect itself from newcomers by using its balance sheet when needed. In the past few months, I added to my Hershey position quite a bit, starting once the stock dipped below $200.
Hershey is highly profitable, just like my other two picks, with gross profit margins well above 40% and very high returns on capital employed (between 18% and 20%). Considering it is a slower-growing business than the other two, it is still able to grow its EPS by 7-8% per year thanks to top-line growth, operating efficiency, and buybacks. Surely, it rewards its shareholders with a higher starting yield compared to the other two picks, so, in a certain way, it makes up for its slower growth.
No matter where the economy goes, chocolate and snacks are so entrenched into our habits that Hershey won't go out of business. Currently, the stock trades below a 20 fwd PE, which is very rare for such a defensive and profitable stock. This is why I took advantage and am monitoring it closely to add more shares as 2024 kicks off.
Conclusion
In a snapshot, let's take a look at my three picks' grades. Obviously, the one I consider most important is profitability.
Seeking Alpha
Here we have three nice As. At the same time, they are supported by nice growth grades while their momentum is, to different degrees, fading a bit off.
No matter where the economy goes, Ferrari will sell its cars in 2024 and beyond, S&P Global will keep on powering the markets with its services, and Hershey will keep on delivering nice treats to us all. And they all take advantage of their position and couple it with excellent management, lean execution, and rewarding policies for long-term shareholders.
For further details see:
No Clue About 2024 Economy? Seizing Three (Dividend) Stocks On A Dip