Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Last week was a bumpy ride in the markets. I'm here with Matt Coffina--he is the editor of Morningstar StockInvestor newsletter--for his take and also to see if he made any changes or buys in his portfolio.
Matt, thanks for joining me today.
Matt Coffina: Thanks for having me, Jeremy.
Glaser: Let's start by looking at the volatility last week. What do you think was the big driver behind this? Changes in fundamentals or just fear-driven selling? What's your take?
Coffina: My sense is that it's more investor fear than a real change in the fundamentals. We did see some negative economic news, particularly out of Europe and in certain developing markets, especially China, which is really leading the way there. There are some follow-on effects in other developing markets. But these concerns have been out there for a while that China's growth is slowing and that they could be headed for a hard landing at some point. There is this ongoing deflation risk in Europe as their recovery has been very slow.
So, I don't think there was really any fundamental change last week. It's just that investors have started to pay attention to some of these risks a little more. And I think that the relatively elevated levels of valuations for stocks, particularly going into last week or into the last couple of weeks, maybe set the stage for investors to be a little more on edge, a little less willing to absorb some negative economic news when it arises, because stock prices, especially as of a few weeks ago, weren't baking in much margin of error. Or, in other words, they were baking in a pretty optimistic outlook for future economic growth, which if some news comes out that's not as positive as people are expecting, creates some downside risk.
Glaser: You mentioned valuations there. After the sell-off, after things are off their highs, do you have a big change in your view of valuation or do you see the market still as being fundamentally fully valued?
Coffina: As we stand today, the S&P 500 is only down a high single-digit percentage versus the all-time high of mid-September, and we still think that stocks are trading pretty close to fair value. We now have the median stock in our coverage universe trading at about a 4% discount to fair value versus before the most recent sell-off we were maybe at a 3% or 4% premium to fair value. So, it's still not a huge difference. We are still kind of circling fair value in the market as a whole.
Another indicator I look at is the number of 5-star stocks. As of today, there are only about 18 U.S.-listed 5-star stocks out there. So, really, we went from a situation where the market was fairly valued to moderately overvalued to a situation where now the market is fairly valued to maybe very slightly undervalued.
Glaser: If you look into the situation where stocks are selling off over 450 points on the Dow at one point last Wednesday, how do you evaluate if this is a good time to be buying on the dip? Or how do you know if you might just be catching falling knives?
Coffina: Well, I think after the last couple of years where the market has just gone straight up, investors are anxious to jump on any dip that they see and they want to see that as a buying opportunity. But I would say that this dip is certainly not a buying opportunity on the scale of, say, the financial crisis in 2008-09. We had more than 800 5-star stocks at that time. The average stock in our coverage universe was trading 45% below fair value. So, the market will give you some very serious disruptions sometimes, which are really great buying opportunities, and I don't think this is one of those times.
That said, stocks still look relatively fairly valued, and we think that stocks still are one of the best places to be and probably the best asset class to be in over the very long run. So, if you have a 10-, 20-, or 30-year time horizon, I think you're almost certain to do better in common stocks than you are in bonds or cash or even commodities and other alternatives that are out there.
Glaser: In the portfolios that you manage then, did you make any changes over the last week? Did you find any more things to buy?
Coffina: Last week, I made two small add-on purchases with cash on hand of existing StockInvestor holdings--both in our Hare portfolio. I added about 1% each to our weightings in Schlumberger (SLB) and MasterCard (MA).
In the former case, energy has been selling off especially hard in the last few weeks as oil prices have a taken a dip on concerns about oversupply as well as weakening demand with a deteriorating economic outlook. Schlumberger, we think, is a very high-quality company; it has the widest moat in oilfield services, but it is very commodity price sensitive. So, it's reasonable to expect that if commodity prices stay depressed and the price of oil in particular, that that's going to hurt demand for the services that Schlumberger offers--[namely, helping] companies drill for oil and gas.
Schlumberger could certainly be headed for a cyclical downturn in the short term, but that's just really the nature of this business. There are always going to be cyclical ups and downs in oilfield services, and we think at the current price you're getting a pretty good risk/reward trade-off. The valuation isn't baking in very optimistic assumptions.
The company is looking for high-teens earnings per share growth if oil stays around $100. But even with oil prices where they are today, I think it's still a company that could grow earnings per share perhaps in the neighborhood of 10% or even a little better than that and only trading for a mid-teens multiple on earnings. So, I think the risk/reward trade-off is decent, and I think our fundamental investment thesis is still intact, which is that over the long run it's only going to become harder to find incremental oil and gas reserves. And that means that companies are increasingly going to rely on Schlumberger for their technologically advanced drilling solutions, whether to maximize production, to minimize costs, to extend the life of reserves, and so on.
Now, MasterCard is a little bit of a different story--not nearly as cyclical of a business as Schlumberger is. There is some economic sensitivity in that they are exposed to the overall level of global personal-consumption expenditures. But really, this is just a very, very high-quality company.
I think MasterCard is one of the widest moats around, and it's a company that I thought we could have a very high weighting in or a relatively weighting in in the Hare portfolio. I wouldn't mind making this one of our largest positions, or even our largest position, in the long run because of their very wide moat. Really, there are three sources of moat here. Network effect: So, consumers want to use payment cards that are widely accepted; merchants have to accept cards that are widely used. Intangible assets, which would be MasterCard's brand name, which is well known around the world. As well as cost advantages: So, the incremental cost of processing a few more transactions is close to zero, which gives MasterCard very healthy operating margins that have tended to expand over time.
And then besides the wide moat, this is a company with very strong secular-growth tailwinds behind it--growth in personal-consumption expenditure being only one part of that. We are also seeing the secular shift away from cash and checks toward digital forms of payment. Then, you add to that the operating leverage, the tremendous free cash flows that the company generates. This is just a very, very high-quality business that's going to see robust double-digit earnings growth through the foreseeable future.
It's not trading at that cheap of the multiple. Even as I was purchasing the stock last week, it was trading for 23 or 24 times earnings. But I think that multiple is justified, and it makes sense relative to the growth prospects of the company and the quality of the company. So, in that case, I just saw it as an opportunity to add to what's been a core long-term holding for us for quite a while and, I think, for quite a while to come.
Glaser: Matt, I certainly appreciate your take on the sell-off and for that information on what you've added.
Coffina: Thanks for having me, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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