Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. So good morning, Dave. It doesn’t look like you have many economic reports on your radar this week, just some earnings you’re watching. So before we get to that, let’s talk a little bit about last week’s Fed meeting. The Fed left rates unchanged as expected. But then Fed Chair Jerome Powell made some pointed comments about interest-rate cuts after the meeting. Recap what he said, for viewers.
David Sekera: Hey, good morning, Susan. I hope everyone’s got their morning cup of coffee going on here. A lot to talk about. So, first of all, Chair Powell, I got to say, I was shocked. I mean, I was really surprised that he came out and he was that specific, stating that he thought the committee would not have enough confidence that inflation was remaining low enough for long enough, that they would not be in a position to be able to cut rates in March.
You know, in fact, in the middle of that meeting was listening to it actually pinged Preston Caldwell, our chief U.S. economist, on Teams and was like, “Did he actually really just say that?” You know, to the best of my memory and, you know, viewers, you know, correct me to below if I’m wrong in the comment section, but I’ve never heard him be so specific as far as giving an opinion on an upcoming policy meeting. Now, he did give a “but we’ll see” qualifier at the end of the response. But I think he was quite clear that he just does not see a cut coming out at that March meeting. And also note that Chair Powell was on 60 Minutes last night. So I’d recommend viewers go and watch that interview as well.
Dziubinski: So now, as a result of what Chair Powell said, did Morningstar make any changes to its interest-rate forecast for 2024?
Sekera: So he didn’t make any changes to our interest-rate forecast, but we did make a change in the timing. Now, our base case, coming into the meeting was for that first cut to come up here in March. With inflation as low as it’s been, if it still stays on that trajectory, that is still certainly a possibility, albeit, much lower probability at this point. So based on Powell’s commentary, economics team did change their forecasts in that they changed the language such that we now expect the Fed to cut either in March or May. But we do remain confident that the Fed will cut in the first half of the year here.
Dziubinski: So the market sold off a bit after Powell’s comments. Do you expect that to linger into this week?
Sekera: As you mentioned, the markets did sell off right after he made those comments. But then the market rallied right back on Thursday and Friday. And I think this is a good lesson for investors. There’s so many different competing forces acting on the market at any one point in time, they’re really trying to attribute, you know, market movement over a couple of days to just any one individual aspect of it is really kind of a fool’s errand at the end of the day.
So as far as this week goes, I mean, it’s always impossible to know. But I’d say I think the more important thing is what the market is going to be focused on this week as really shifting away from the virtual world, shifting away from the “Mag Seven” stocks and really looking more at the real economy stocks. And I think when I’m looking at what’s coming up this week, there’s McDonald’s, Chipotle, Yum Brands, I think those are all going to be good indications of consumer strength.
We have Estee Lauder coming up. It’s a 5-star-rated stock. It’s been a top pick of our analyst team. Looks like that stock is trading pretty well before market opened today. And then lastly, for the consumer stocks, I’d also watch Uber. I think that’s just a good indication of the continued reopening of the economy on the manufacturing side.
A lot of different companies coming out there. We’ve got Caterpillar, Air Products, Cummins, DuPont, Emerson. So again, all will give us, you know, good views as far as what’s going on with the real economy. And then lastly, a number of different healthcare stocks, Amazon, Gilead, and AstraZeneca being among those.
Dziubinski: So let’s talk some specifics about a few earnings reports you’ll be watching this week. You mentioned healthcare right at the end there. And drugmaker Eli Lilly also reports this week. Now, Lilly has become quite a story stock. The market’s anticipation anticipating some stunning growth from its weight loss and diabetes drugs. So what will you be listening for, and what do we think of the stock today heading into earnings?
Sekera: Well, we think the stock is overvalued. It currently trades at over a 40% premium to our fair value, puts it well into 2-star territory. Now, as you mentioned, it is becoming a story stock based on their weight-loss drugs. And we do incorporate those drugs, you know, into our forecasts. But we think the market is just applying way too high of a valuation for the long term potential that we see for earnings growth.
And in fact, I think this is just a good example of how there are certain stocks out there, specifically story stocks, that we think you can get overvalued and in fact can even just get more and more overvalued. However, I would just caution investors with the stock, I mean, if they miss expectations or give any guidance below what the market is expecting, I’d say a look out below on this one.
Dziubinski: Now, you’re also watching a stock this week that you like that is should benefit from advances in AI. It’s Cognizant Technology Solutions.
Sekera: Yeah, it’s a 4-star stock. Trades at a 18% discount to fair value. And we’ve talked about AI a number of times. You know, at this point, all of the kind of obvious AI plays, I think, are already either fully to overvalued at this point. So if you want to play artificial intelligence, I think you really need to try and identify those companies that are really more of a second derivative play on AI. So in our opinion, you know, Cognizant kind of fits the bill. It’s one of those few ways that we still think is undervalued. So the investment thesis here is that many companies either just don’t have the expertise or the financial wherewithal to build out their own artificial intelligence. They’re going to need to hire outside consultants with that expertise to do that. And I think Cognizant is well positioned to meet those needs.
Dziubinski: Now, we have a few other stocks that you’ve recommended on the show in the past reporting this week. Give viewers a quick round up on those and what you think of them heading into earnings.
Sekera: Sure. So we’ve got Simon Property Group. They report after market close today. As you mentioned, it’s a stock we’ve discussed a number of times and had recommended in the past, but that stock has moved up enough recently that it’s now in 3-star territory. Still trades at a slight discount of 9% to our fair value. Does pay a healthy 5.5% dividend yield. So it’s still a good one to watch. We have Gilead. That reports after market close tomorrow, Another stock we’ve recommended. Now, I would note there was some disappointing news out on this one. I think about two weeks ago some of the data on one of their cancer drugs was disappointing. That sent the stock down a little bit. But that didn’t impact our fair value. Four-star-rated stock, 19% discount, 3.9% dividend yield. And then last thing going to be watching Alibaba. I think I mentioned last week that it was supposed to report last week. I was wrong about that. It actually reports this week. So I think what’s really interesting here is when you look at the Chinese indexes for Chinese stocks now, depending on which Chinese index you look at, you know, the Chinese stocks are all the way down, too, and in some cases even below prepandemic levels. So I think this is a good one to watch for insight as to the state of the Chinese consumer and China outlook.
Dziubinski: So let’s move on to some new research. We have two things to discuss on that front this week. We’ll start out with what Morningstar analysts think about some of the big companies that reported last week. And we kind of have to start with Meta. The stock really soared after earnings. The company announced that it was going to begin paying a dividend. And Morningstar’s analyst raised his fair value on the stock pretty significantly too.
Sekera: Yeah, he raised his fair value all the way up to $400 a share. Essentially, he updated the model, incorporated some stronger margin expansion than what he was originally expecting. Now, that stock right now, though, and it’s trading at about a 20% premium even to that upside fair value, you know, that we recently moved to.
And so I really kind of dug into the model here, and I just don’t think we’re being overly conservative. When I look at our assumptions, we’re looking for 16% revenue growth this year. We’re looking for a five-year compound annual growth of revenue of 11%. Our operating margin this year, the assumption is 37%, and that increases all the way to 41% over the next five years.
And if you look at that and compare that to historical averages, you know, the operating margin’s only been 33% over the past three years. I’d also say, be careful with the stock, too. I know our team does expect digital ad growth will start slowing over the next three quarters as the economy slows as well. And I’d also note that companies are going to be up against some pretty tough comps in the second half of this year.
Dziubinski: So on to Apple, Dave, the market didn’t seem too excited about what it heard from Apple. And Morningstar held its fair value estimate after earnings at $160 per share. So, recap what our analysts thought of earnings here and whether there’s an opportunity in Apple stock today.
Sekera: Yeah, Apple stock was down a little bit after earnings. Really not as much as I kind of would have thought it would have been myself. As you mentioned, our fair value is unchanged at $160 a share. So that puts it in 2-star territory as it’s trading at about a 16% premium here. And I think what our analysts note is that really there’s, you know, two offsetting forces going on in his view.
So he did lower his revenue growth assumption. We’re seeing just a softer adoption cycle for iPhones. You know, the replacement cycle for phones is lasting longer. And he’s also seeing more aggressive domestic alternatives for cellphones in China. But that was offset. He did increase his margin assumption slightly. It looks like in the model here, he’s just making a mix shift to higher margin services, you know, in like some of their app business and their online stores.
Dziubinski: So moving on to Microsoft, our analyst raised his fair value estimate on that stock quite a bit after earnings. Why, and what do we think of the stock today?
Sekera: As our fair value was increased by 13% to $420 a share. That’s still puts the stock in the 3-star territory. I think it’s trading at just a couple percent discount to that fair value. Essentially with Microsoft, we’re just still seeing a strong performance out everywhere in its business. But I think the fair value increase was really mainly on the strength of Azure.
That’s its cloud business. We’re seeing artificial intelligence booster its growth rate there. So as such, you know, we did increase our assumptions by 1 point for both the top line and as well as for margins over the next five years.
Dziubinski: So next there’s Alphabet. Now here ad revenue growth disappointed, yet our analyst raised his fair value by a hair. What happened here?
Sekera: Yeah I think this is a good example of a lot of times the initial stock reaction after earnings isn’t really necessarily indicative of the results. So as you mentioned, the other stock initially, it did sell off here after earnings on that disappointment. But I think it appears that it looks like a lot of that might have just been profit-taking. The stock then traded pretty well in the next couple of days thereafter and similar to Microsoft, you know, that fair value increase was based on growth and margin expansion in its cloud business. So net net we did increase our fair value by 6% to $171 a share. And what I’d note here at this point, Alphabet is actually the last of the “Magnificent Seven” stocks. You know, in our view, that was still meaningfully undervalued. Four-star-rated stock at a 17% discount to our fair value.
Dziubinski: Now, our analyst thought Amazon’s fourth-quarter results were strong and Morningstar raised its fair value estimate on the stock to $185, which is about a 19% increase. What triggered that boost in fair value? And is the stock a buy?
Sekera: Yeah, I mean, Amazon still just hitting on all cylinders across its entire business line. I think the fair value increase here is really mostly from positive results in the ad business. Again, the ad business being a very high margin business. And so as we updated our model, that led to a good amount of that fair value increase. So the stock is trading at about a 7% discount to fair value, so slightly undervalued, but that does put it in that 3-star territory. So essentially that just means the stock is within the range that we consider to be fairly valued.
Dziubinski: And then finally, we have ExxonMobil. It looks like results were solid, and our analysts didn’t make any changes to the stock’s fair value estimate. So recap what our take was on earnings and whether the stock is undervalued today.
Sekera: Yeah, not a lot to say here. I mean, there was no need to make changes to our forecast. The results did come in line with our expectation. And so the stock is currently rated 4 stars. Trades at a 17% discount pace, a nice healthy yield of 3.7%.
Dziubinski: So we have another new piece of research to talk about aside from all those earnings reports, and that’s your February stock market outlook. There’s a link to your outlook below this video for viewers to access. So first, Dave, recap January for viewers. How did the market perform, and what styles and sectors drove those returns?
Sekera: Yeah, I mean, January was actually just a very solid month. The Morningstar US Market Index was up 1.3% for the month. Now, interestingly, when we look at the performance here, driven by a category, is really driven by, you know, core stocks. So when you take a look at our core segment of the index, it includes Meta, Broadcam—Broadcom, excuse me—Procter & Gamble and a couple of other large-cap stocks that did very well during the month.
So, for example, Meta was up 10% in January, Broadcom up 6%. Procter & Gamble up 7%. So those, because of the size of their market cap, did skew the core sector higher. When I look at value stocks are up a quarter percent, nothing stellar. But again, at least, you know, to the upside. And interestingly, growth stocks, I don’t think a lot of people would expect, were actually down a half a percent in January.
So the two biggest drawdowns here were Apple and Tesla. Apple down 4%, Tesla down 25%. So those two stocks, did skew that part of the market down. And when we look by market cap, you know, large caps were the winner. They’re up 2.5. Mid-cap stocks are up 1.2% and small-cap stocks down 3%.
Dziubinski: So now that we’re we’ve headed into February, does the market look fairly valued?
Sekera: It does. In fact, if you look at a composite of where the market is trading, all of the stocks that we cover versus the, market-weighted value of our intrinsic valuations market right now trading almost actually it’s exactly right at one. So right our price/fair value metric.
Dziubinski: So which sectors in particular look overpriced today, Dave?
Sekera: So the one first I got to go over is going to be the tech sector that’s now trading in the 9% premium to our fair value. So they’re getting pretty far, you know, well into overvalued territory in our view, not necessarily the most overvalued it’s ever been in the past could certainly get more overvalued in the short term, but is an area that’s probably getting to be overextended at this point. Industrials also slightly overvalued at a 4% premium to fair value and consumer defensive, also a little overvalued at a 2% premium.
Dziubinski: And then let’s look at the opposite side of the coin. Which sectors look undervalued?
Sekera: So the first two are going to be communications and real estate. Those are both trading at a 12% discount. A lot of different opportunities that we see for investors in both of those areas. Basic materials has been struggling as well. That’s now at a 11% discount to fair value. A lot of interesting ideas that we’ve got there. And then lastly, energy and utility is both trading in the 9% discount.
Dziubinski: And then let’s pivot over and look at the market by market cap. Small caps versus large caps. Do small caps still look like the better value today?
Sekera: They do. And with the drawdown in January, they’re getting to look even more attractive than they were, you know, coming into the month. So, yes, at the end of the day, small caps do remain the most undervalued part of the market. They traded an 19% discount to fair value. And for a number of different reasons, I do think that they’re still set up well to do well over the course of this year and into next year.
Dziubinski: And then let’s look at the market through value stocks versus core stocks versus growth stocks. How do valuations look?
Sekera: Yeah, so value stocks still remain the most undervalued according to our valuations. They trade at an 11% discount to fair value. You know, of course, stocks getting a little overextended now, trading at a 4% premium, and then core stocks at a 1% premium.
Dziubinski: So given where valuations are at the start of February, how should investors be thinking about their stock portfolios today?
Sekera: So based on our valuations, I would say your overall equity weighting should be right at your targeted allocation. So whatever your allocation is based on your risk profile between equity and fixed income, I’d be right at what those targets are. You know, right now I don’t think there’s a reason to be either overweight or underweight equities at this point in time.
But I do think the opportunities really are to be able to manage within those different allocations and try and take advantage of where we do see some value today. So by category, you know, I think being overweight value would be the right way to go. I’d probably underweight growth in order to be able to pay for it. And with core stocks being only a 1% premium, I think you could probably just market-weight that.
And then by capitalization, I would overweight small-cap stocks, probably have a slight modest overweight in mid-cap. And then to pay for that, I think you need to be a little underweight in the large-cap stocks. And then by sector, I would look to overweight, I’m sorry, underweight tech and industrials, maybe a little underweight in consumer defensive as well, and use that to be able to overweight communications, real estate, basic materials, energy, and utilities.
Dziubinski: So let’s move on to the picks portion of our program. As you noted, Dave, the tech sector looks overvalued. However, there are some opportunities to be found. So this week you’ve brought viewers three overvalued technology stocks to sell and three undervalued technology stocks to buy instead. So first, let’s talk about the stocks to sell. You say that Dell is a sell. Why?
Sekera: Yeah, so and I’m sorry, I kind of lost my train of thought there for a second. Yes. Dell is definitely one of the more overvalued stocks. You know, amongst our coverage trades that are 80% premium to our fair value. Puts it well into 1-star territory. You know it’s a company that we rate with no economic moat. Yeah. And I actually just pulled up the stock chart here. It looks like the stock has doubled in the past eight months. You know, you might ask why? I have no idea.
Dziubinski: So another tech stock to avoid and this is when you’ve panned on the show before, Dave, is IBM.
Sekera: Yeah. So IBM did already report earnings. I would note we did bump up our fair value, but it only by a couple of percent. The stock did pop after earnings. I think they probably surprised a little bit to the upside, but it does look like that stock is now giving back much of those gains. I think about IBM, I really think of IBM as really just being somewhat of a melting ice cube for the long term. You know, revenue there has been on a multiyear, you know, downward trend. Now, we do forecast a little bit of revenue growth over the next couple of years, but really very modest margin and very modest earnings growth. So this one is a 1-star-rated stock, trades at well over 30% premium to our fair value. So again, just the stock I think is it’s a good time if you’re involved in that one, kind of revisit whatever your long-term investment thesis is and maybe start scaling out of that one and look for some other tech stocks at least that we think have some discount to fair value today.
Dziubinski: And then your final tech stock to sell is actually a name that you recommended on the show about a year ago. It’s CrowdStrike. Why is this one now a sell?
Sekera: Yeah, I mean, we recommended that one. I think it was Feb. 6, 2023. That stock is up 175% since then. So fundamentally, I still like the cybersecurity industry. I think it’s got a lot of good positive tailwinds behind it. I like the fundamentals of the industry in and of itself, but at this point, you know, in our view, the stock has just gotten to be too expensive. It’s now in the 2-star territory. Trades at a 37% premium to fair value. So again, while the stock, you know, is one that we do rate with the narrow economic moat, it just comes down to valuation being too high on this one today.
Dziubinski: So let’s move on to the three stocks you like in the tech sector. Your first pick is a stock you talked about earlier in the program today. It’s Cognizant Technology Solutions. Reiterate why you like it.
Sekera: Yeah. And first I’ll just note this one does report this week on Feb. 6, I believe. So the stock is rated 4 stars. Trades at about a 17% discount to our fair value, pays about a 1.5% dividend yield. And it is a company that we rate with a narrow economic moat. So I do like this one as being kind of that second derivative play on artificial intelligence. The investment thesis here is essentially, you know, most companies aren’t going to have either the expertise or the financial wherewithal to be able to build and train their own artificial intelligence models. So we do think that Cognizant Technology is well positioned with their consulting business to be able to do that. So we do see some good long-term tailwinds behind this company’s revenue.
Dziubinski: So your next tech stock pick is another example of what you’re calling a second derivative AI play. The stock is Snowflake. Tell us about it.
Sekera: Yeah. So they don’t report until toward the end of this month on the 27th, I believe now it is only a 3-star-rated stock. It trades at a 15% discount to fair value. So that does put it within the range that we consider to be fairly valued based on its uncertainty rating. But as you mention, I do still like this one as a derivative play on AI. Yeah, the companies are provider of a data lake and data warehousing and when I think about AI, it’s just going to require, you know, greater and greater amounts of both. The company also does provide some AI tools for their customers. So we think that’s going to help build some switching costs in their business over time.
Dziubinski: And then your last stock pick this week is F5. Tell us about it.
Sekera: Yeah, so F5 actually already reported. We did increase our fair value estimate here after earnings up to $205 a share from $180 a share. Again, it’s a 3-star-rated stock, but it does trade at a 10% discount to that upsized, you know, fair value estimate. When I look at F5, you know, we do think that they are a leader in the application and application delivery controllers. You know, it does have a narrow economic moat based on its switching costs. So really when I look through our note here, the reason for the fair value increase is, one, the other companies just very materially outperformed our expectations and our team does think that they are well positioned to start, you know, generating some additional revenue growth over the next year or two.
Dziubinski: So then one last question for you, Dave. Chiefs or 49ers?
Sekera: Well, you know, as the chief U.S. market chief U.S. strategist, I do have to say I’m going to go for the Chiefs.
Dziubinski: Fair enough. Thanks for your time this morning, Dave. Viewers interested in researching any of the stocks that Dave talked about today can visit morningstar.com for more analysis. We hope you’ll join us again next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.