How to find a reasonably-priced and resilient stock amid the rush of earnings reports ahead
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Ahead of a shortened trading week, we will review how to find a new core holding for 2024 as updated earnings results hit Wall Street in the weeks ahead. And we’ll look at an alternative way to go long the stock we identify using options. Although the earnings season has kicked off in earnest with the earnings report of major financials on Friday such as JPMorgan, the upcoming trading week, shortened by the Martin Luther King holiday, has relatively few names reporting where the options markets are indicating big moves, which I’ve somewhat arbitrarily defined as greater than 5% higher or lower. For your consideration, among companies reporting this week with market capitalizations greater than $1 billion, fireworks are implied in only the following three: Naturally options traders, concerned as they are about volatility, when thinking about “what to watch” will tend to keep their eye on upcoming catalysts such as earnings, and unusual implied moves reflected by above average options prices. The markets suggest there isn’t much to watch this week, so our next question is what should we be looking for? What stocks might be good candidates as core holdings for 2024 and beyond and why? What to look for. Strong Balance Sheet: A strong balance sheet is often a primary indicator of a quality company. This includes low debt, high liquidity, and a solid capital structure. Consistent Earnings Growth: Quality companies usually exhibit steady and predictable earnings growth. High Profit Margins: A consistent track record of high profit margins can be a sign of competitive advantage. Note sometimes this is a relative thing, how are a company’s margins relative to others in their industry? Good Management: The quality of a company’s management is crucial. This might be assessed through the company’s strategic decisions, corporate governance, history of delivering on promises, and management’s alignment with shareholder interests. Competitive Advantage: A sustainable competitive advantage, or a moat, is important. Patents, unique technology, market dominance, or other factors that protect a company from being commoditized to such an extent that their business is no longer offering an attractive return on capital are important. Sustainable Business: What constitutes “sustainable” can be a fraught topic. In my case I am not focusing on environmental, social, and governance (ESG) practices necessarily, although these may be factors. Coal mining doesn’t strike me as sustainable for these reasons. However, obsolescence or other market trends are also factors. Typewriter manufacturing wasn’t a sustainable growth industry regardless of whether it adhered to ESG factors or not. So “sustainable”, in my estimation simply means prepared for future challenges whatever those might be. Valuation: While not a direct measure of quality, valuation metrics help ensure we are not overpaying for quality. Metrics like price-to-earnings, price-to-book, and free cash flow yield could be important. Bear in mind that finding a quality company cheap isn’t likely, but we would prefer to avoid crowded (i.e. potentially overpriced) investments! Resilience in Downturns: Quality companies often demonstrate resilience during economic downturns, maintaining performance while weaker companies struggle. Sector and Industry Position: Consider the broader industry dynamics and how the company is positioned within its sector. Historical Performance: While past performance is not indicative of future results, a history of outperforming peers and the market could be a sign of a quality company. So using these as guidelines let’s examine several sectors and see what we can find, this week looking at the communications sector. Who meets the criteria? The communications services sector (represented by sector ETF ‘XLC’ ) includes the following companies: AT & T, Alphabet, Charter Communications, Comcast, Electronic Arts, Fox Corp, Interpublic Group, Live Nation, Match Group, Meta Platforms, Netflix, News Corp, Omnicom Group, Paramount Global, T-Mobile, Take-Two Interactive, Verizon, Walt Disney and Warner Brothers. AT & T has more debt than equity. Revenues are stagnant (and declining on an inflation adjusted basis). Although profit margins are OK, the margins and net income have fallen in recent years. With a BBB rating (S & P/Fitch scale) it is one notch above the lowest investment grade bond rating and the company faces more legacy issues (South America wireline business for example) than competitors such as T-Mobile. While we may assume that consumers are loathe to give up their mobile phones, businesses are increasingly reducing their reliance on wireline phones. The valuation is, by some conventional metrics such as P-E ratio, very cheap at just 6.8. Even without delving into the quality of management and other factors it’s clear that AT & T is not a “quality” company as I defined it above. Nevertheless it is a “cheap” one, so I would view this to be a potential speculative long, but not a core holding. Alphabet trade Alphabet by contrast has a AA+ bond rating, has $90 billion in net cash on the balance sheet. This year’s net income margins are forecast to be 30%, up sequentially versus last year. The company has a meaningful footprint in industries experiencing secular growth, such as cloud computing, and an important toehold in artificial intelligence. Although I would argue Apple has a stickier platform in iOS than Alphabet does with Android, they have maintained meaningful marketshare. At 24 times 2024 EPS estimates of $5.92 a share share, the company isn’t “cheap” the way AT & T is, but given EPS is forecast to grow at 20% year-over-year in 2024 and 2025 it is very reasonably priced with a price-earnings to growth (PEG ratio) of just over 1. Better than that of the S & P overall. A strong management team has guided the company to excellent growth for an extended period. The company isn’t entirely immune from macroeconomic issues which can affect advertising and cloud spending, but it has an operating history through several sharp economic downturns including the GFC and 2020 that suggest a recession isn’t a huge concern. Alphabet therefore ticks the boxes I described above and therefore would represent a core holding, until such time as those metrics deteriorate. The only issue I see for Alphabet is that the stock is approaching it’s all time highs of just under $150 a share, a potential area of resistance. If the stock is likely to pause at that level before ultimately advancing higher it may represent an attractive level to sell covered calls against a core long position, however I don’t generally advocate selling covered calls ahead of earnings, which the company reports on January 30th. If you don’t already own the stock, but are leery of chasing after the recent rally, consider the following in-the-money call spread as an alternative to purchasing the underlying shares. The trade: Sold April $150 call for $5 Bought April $140 call for $9.75 DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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