4 Stocks to Buy Before They Rally Further

Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar Research Services chief US Market Strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead.

Well, good morning, Dave. We have a couple of important economic reports on radar this week, the March PCE and April payroll numbers. So let’s start with PCE.

What’s the market expecting, and what would you expect the market to do if the number is better than expected or worse than expected?

David Sekera: Hey, good morning, Susan. Well, first of all, let’s just start off with if it comes out worse than expected, I think that would actually be a very negative signal for the marketplace. Essentially, if it’s worse than expected, I think that would handcuff the Fed from being able to ease monetary policy anytime soon.

Now, if it’s either in line, or even if it’s better than expected, I don’t think it really matters to the marketplace at this point. It’s just near impossible to try and determine what future inflation is going to be over the next few months or even the next couple of quarters, because really, at the end of the day, it’s all just going to depend on what happens with tariffs and trade negotiations as we move forward.

Now, we also have jobs numbers coming out this week. And, you know, in the past, we’ve seen unexpected variances in these numbers can kind of jolt the markets.

Dziubinski: So what’s your take on what we’ll hear on the jobs front this week?

Sekera: Well, the payrolls number is always a very high profile economic metric, oftentimes depending on where it comes out. If it’s higher or lower than expected, you can see that move the market.

In this case, with all of these economic metrics that are coming out that are all backward looking, I think it’s very difficult to try and use these to try and gauge economic strength and weakness with everything that’s going on as far as the tariffs go.

Now, I’ve been listening to a number of different conference calls. I haven’t heard much anecdotal evidence yet of companies making large layoffs. But then, on the flip side of the coin, I also suspect companies are probably limiting the amount of hiring that they’re doing right now. I think they’re going to wait until they see how these trade agreements shape up, whether or not it impacts their businesses going forward.

So my focus really is just still going to be on average hourly earnings, as we’ve talked about before. That’s the area that I’m really looking for growth. I want to see that increase faster than the rate of inflation, just to help build repurchasing power among especially the lower income and middle income households.

Dziubinski: Now, we also have a full slate of tech earnings ahead. So Dave and I are bringing on a special guest to The Morning Filter this week. Eric Compton is the director of Morningstar team of tech analysts.

And I sat down with Eric last Thursday morning to talk about the toll that tariffs could take on tech companies and their guidance for the rest of the year. Here’s what he had to say.

So we have some Big Tech companies reporting this week, including, of course, Microsoft MSFT and Apple AAPL. And now, you and Morningstar’s team of tech analysts just published a new report about how the new risks are emerging from tariffs in the tech sector.

So talk at a very high level, Eric. What do you see as the highest tariff-related risk, and why?

Eric Compton: Yeah, absolutely. So, we use a framework for this. We’re looking through certain filters. Really, the key filters we’re focused on are, one, do you sell physical goods? Because that’s what’s being tariffed, right? Physical goods over services. Two, in our estimation, it seems a key focus of these tariffs is China, especially when you’ve seen the reverse of some of those reciprocal tariffs.

For now, with the 90-day pause, they’re still on China. So physical goods, supply chain, exposure to China, and then … You can add other filters on top of that, such as the demand elasticity. Or, said another way, you know, potential for demand destruction if your prices have to go up.

Dziubinski: How easy is it to change the supply chain?

Compton: Some are more complex than others. So those are different factors you can look at, but it’s really physical goods, exposure to China. And then maybe one final factor I would point to is another theme we’ve seen in a lot of the executive orders and some of the writing that has come out is a focus on items with potential national security significance. And so, I would say, technology actually fits squarely within that, particularly with semiconductors and hardware. So that’s really what we’re focused on.

So let’s unpack some of the implications on an industry-by-industry basis within tech, starting with hardware. Now, much of what falls in that hardware bucket as of right now, which are PCs and smartphones, are exempt from tariffs.

Dziubinski: But you do expect that to probably change, right?

Compton: Correct, yeah. So—like you said, for now, and it’s been quite a journey, so I’ll maybe walk through a little bit of that journey. So we started with the, I believe it was April 2, the original announcement at the start of all this, where you had country-specific tariffs. And under that executive order, semiconductors were exempt, but hardware was not. So you had tariffs on a wide range of countries, a wide range of levels, semiconductors technically not tariffed. And I’m talking about semiconductors in their raw form, like integrated circuits, electrical components, things like that.

But hardware, like a personal computer, would have still been tariffed. So from there, you had the 90-day pause, where tariffs were essentially dropped to 10% for all countries, except for China. And at that point, point, semiconductors still exempt, hardware still tariffed. After that, you had the, I’ll call it the “clarification of exemptions,” where at that point, they added hardware to the semiconductor category. And so, at that point, semiconductors and hardware, such as in PC servers, were both exempt.

Now, that may seem more positive on the surface than I think it is. And the reason I say that is because there has been consistent commentary from the start that they are exploring semiconductor-specific tariffs. And so I would expect, based on that commentary, based on the national security themes, things like that, based on they actually launched an official investigation into semiconductor-specific supply chains, I think all that’s going to culminate with semiconductor-specific tariffs, eventually. And within that, that would include semiconductors plus hardware. So, yes, I do think they’re coming eventually.

Dziubinski: Got it. So then what pockets of hardware would you say are most at risk, and then which might be least at risk by being disrupted by all this tariff talk?

Compton: Sure, absolutely. And it is the key question, what products are going to be affected most? And so to answer this, we really dove pretty deep into the harmonized system import codes, trying to look at which products are imported from which countries and which quantities.

And after doing that research, some of the results actually surprised us on which products were maybe more insulated. So, for example, about 80% of servers are imported from a combination of Mexico and Taiwan. It’s about 40/40 each. So that’s actually not a lot of China exposure in server final assembly specifically. Networking gear was also pretty diversified across end markets that we imported from. Storage, particularly hard disk drives, primarily come from or imported from Thailand.

And again, this is all final assembly. And so, of course, there’s other parts of the supply chain before final assembly. But those, we’d say, are a little more insulated. The ones that we think are going to be most affected are going to be smartphones and PCs. We still import about, we estimate, 60% of smartphones and PCs directly from China. So we think those are most affected.

And then you add on top of that, obviously, demand elasticity. You’re always trying to estimate it, but we think those products are probably going to be a little more ripe for demand destruction if prices have to go up. People are more likely to delay a smartphone purchase rather than enterprises purchasing servers to keep the business running type of thing.

Dziubinski: Got it. So then, can you give sort of a ballpark, maybe in percentage terms, of what the impact could be on revenue, earnings, profits for some of these most at-risk companies in hardware?

Compton: Absolutely. So for the ones most at risk, you’re going to have companies where their primary revenue exposure is PCs or smartphones. One or the other, a combination of both. Companies that come to mind are companies like Hewlett-Packard HPQ. That’s HPQ, not HPE.

So Hewlett-Packard, the PC version, and then Dell would be another one. And so we estimate for companies like that, where they do get a lot of revenues from PCs, you could have, under certain assumptions, a hit to EPS in the short term of greater than 20%, just based on if you put draconian tariffs on China, and then it’s going to take some time for PC supply chains to shift. You have to raise prices so much to offset those tariffs. That could result in a lot of demand destruction, particularly in the short term. So we think EPS hits of over 20% for those firms is realistic under certain assumptions.

For Apple, it’s a little more complicated. They don’t have, really, iPhones is the bulk of their business. PCs a little bit less. And we think EPS exposure there may be more, like 10%, slightly less than 10%. Again, under certain assumptions, you have to throw a lot of assumptions in there, but we think a little more insulated, but still some potential for a hit there.

Dziubinski: OK. So then in hardware, are there any stocks we like right now?

Compton: Sure. So again, looking for which stocks are, I’ll call it the “cleanest” on a lot of those risk filters, one that stands out to us is Motorola Solutions MSI. And this is, a lot of times when people hear Motorola, they think of the flip phones, different company now, They sold off that business. And so their primary business is LMR, which stands for Land Mobile Radio. So think of the communication networks that public safety, like police, for example, or firefighters would use on their Motorola radios, like kind of those almost like push to talk, walkie talkie types of things. I’m not quite doing them full justice with that description, but that’s Motorola of today.

They also have some software offerings, but they’re one of the few companies to actually go on record and say they have zero China exposure in their supply chains and also minimal China exposure in the bill of materials. And the bill of materials part is actually pretty important because that gets beyond some of that final assembly. So you could have, in some scenarios, minimal China exposure in the supply chain on final assembly, but maybe 50% of the parts are still imported from China for that final assembly. And so I think that really derisks the supply chain. They’re very focused on kind of avoiding China in their supply chain. So I really like how they filter on that. Plus, they’ve got steady revenue. Public safety, which is usually based on government budgets, that’s not going to be affected as much in a tariff war.

And then another kind of even additional nuance I throw on top of that is one of the businesses they compete in is cameras, the security cameras. And in that market, you still have Chinese-made cameras. And so, to the extent that this escalates, and you start to see some of the Chinese cameras become less competitive, or maybe even in some cases, competitors have been banned, that’s more revenue opportunity for them.

So I think a lot of things actually go Motorola’s way in the current environment, even though they are technically, a large part of the business is still in hardware.

Dziubinski: That’s interesting. Let’s move on to semiconductors, which, again, they’re not subject to tariffs today. You expect them to be soon. And you also point out in your report that semiconductors are tariffed indirectly. So, you know, given that, which types of semiconductor companies might be more at high risk right now?

Compton: Sure. So the risk filters I think about for this are exposure to cyclical end markets. So you’ve got, as the cost of these supply chains goes up in a tariff scenario, it puts more pressure on the economy, and it tends to increase the odds of slow down demand or recession, things along those lines, and that’s going to impact cyclical end markets more. When I say cyclical end markets, I’m referring to things like automobiles or industrial end markets, things related to manufacturing, even smartphones a little bit, but typically, autos and industrials are the top two you tend to think about. So high exposure to that, high exposure to smartphones in case there’s a disruption there, just because a lot of those are still imported from China.

I would also think about geographical revenue exposures. So, for example, if there’s a tit-for-tat sort of reciprocal back and forth, it’s not just companies importing into the US, It’s going to be US companies selling into China. That revenue could also be at risk.

So those are really a lot of things we’re focused on while admitting, or maybe another thing to keep in mind is that semiconductor supply chains, a lot of it happens outside of the US. You might import silicon from a wafer manufacturer in China. You might fabricate the chip in South Korea. Then you might ship that to Taiwan for packaging. But all that’s happening outside of the US. And so to the extent that tariffs are just between something like China and the US, if all that’s happening outside of the US, and not between China and the US, in those cases, it can avoid the tariffs, at least up until, obviously, if you import the end product into the US, then the end product would be subject. But those are some of the factors I would think about.

Dziubinski: Interesting. Now, your report also suggests that there’s sort of a risk to fair value, which is our fair value estimate, on semiconductors at this point. You say it’s higher than other areas right now. So what suggestions would you have for an investor who is like, oh, but I see opportunity here, Eric. I might want to put some chips on the table for semiconductor stocks right now. How would you recommend investors be thinking about it specifically?

Compton: Yeah. So my first piece of advice would just be understand the risks and manage risk appropriately. And a lot of these semiconductor stocks have sold off. And we do think the pricing has gotten more attractive because it is starting to, I wouldn’t say it’s fully pricing in the most draconian scenarios yet, it could get worse, but it is pricing in some possibility of more negative scenarios post-April 2. So yeah, it is, you know, and price does matter.

Now, so first, a piece of advice would be think about your risks. Second piece of advice would be maybe try to avoid the ones with the most blatant cyclical exposure or China exposure. And some have more of that, some have less. Some of the analog names, particularly, are a little more cyclically exposed.

Another theme I would lean into is we still think the AI theme, while it has sold off a lot, we still think it has some structural demand trends that we still like. And we think both politically—it’s been something that’s been a focus of the administration for things like national security reasons and just maintaining competitiveness over the long term. So we think it’s got long-term political trends going in its favor, and also even commercially. We still see positive demand for AI, data center build outs, things like that. And so I think maybe focusing on the AI theme and then picking your spots within that.

Within that, I could potentially offer a couple of picks. But those are some themes I would think about.

Dziubinski: Well, give us the picks as well.

Comtpon: Oh, yeah. So, of course. So a couple names we like that are looking cheaper. I’ll start with Nvidia NVDA. It’s not the cheapest in the AI theme, but it has gotten cheaper, and it is really at the center of AI. So, to the extent that the AI theme holds up and is successful, Nvidia is going to benefit from that. So Nvidia is one to look at. Before it was trading in the $130-plus area. Last time I checked it. It was just over $100. And so it has sold off a bit. It’s, I think, in like, the mid-80s percent price/fare value. So again, not the cheapest name out there, but it’s at the center of the theme, one to think about. And it also, while it is still inextricably linked to the manufacturing side, it is a fabulous designer. And so it doesn’t have that manufacturing footprint.

Another one I would throw out would be Broadcom AVGO. So Broadcom is cheaper than Nvidia today. But it still has some of that exposure to the AI theme. And it doesn’t have a lot of that cyclical end market exposure that some of the other players might have. So that’d be another one I would consider if you’re trying to pick your spots within that AI theme.

Dziubinski: Got it. All right. So then you say that software and cybersecurity may be a little bit less risk than hardware and semiconductors. Let’s start with cybersecurity. Why aren’t tariffs as much of a risk here?

Compton: Yeah, so it really comes down to they’re tariffing physical goods and not services. And so the cybersecurity firms, they can still sell their services, they can still sell their subscriptions, and it’s just not going to be subject to tariffs. There may be some tail risk of … countries could try to target services with certain ways, but we still don’t expect that to happen. And so we think, one, the revenue stream is largely insulated just from the direct effect of it.

Then another factor we think is going cybersecurity’s way is we do like the positive structural spending tailwinds for the space. In short, there’s only going to be more cyberattacks in the future. There’s only going to be more need to play defense against that. There’s only going to be more need to keep up with the latest advancements. So you’re going to see a structural tailwind to spend for the foreseeable future. So we like the structural support for revenue growth, plus the insulation against the direct effects of it.

Dziubinski: So does Morningstar have a cybersecurity pick we like best?

Compton: Yes, Palo Alto PANW is our top pick in the space. It’s a combination of wide-moat company. We like how they’re positioned competitively. Plus, they are also one of the, they are not the cheapest name, but they are one of the cheaper names under our cybersecurity coverage.

There are other names that are more expensive. For example, like CrowdStrike CRWD, we think is a little more expensive. So Palo Alto, we like the combination of just the competitive positioning plus the valuation. And it’s just, it’s a super quality franchise. So that’s our top pick in cyber.

Dziubinski: All right. Well, then let’s get to software. So why is Morningstar a little bit less concerned about tariffs here?

Compton: Sure. Same reason for cybersecurity as far as the risks, where you’ve got just no direct exposure to the effects of tariffs. Because they’re not physical goods. You still have maybe some second-level risks, where, for example, if you’re selling software subscriptions to the auto industry and the auto industry goes through a rough time, maybe you sell fewer seats to that. But the software just tends to be a little less cyclical than the actual cyclical sectors. The revenue is insulated from the direct effects. And so we do like how software is positioned in the current environment.

And then a couple of picks here. Sure. So, our top pick in software: Microsoft. And this is really, I say Microsoft fits the software theme. It also fits, we get questions on, hey, Mag Seven, which ones do you like? We really like just the overall position of Microsoft, plus the valuation. So Microsoft, obviously, wide-moat name. And it just doesn’t really have a lot of the risk exposures that we would see in other components of the Mag Seven. So, for example, it doesn’t have the cyclical exposure of something like a car manufacturer. It doesn’t have the retail exposure from companies that are selling goods or marketplaces for retail consumers. It doesn’t have really the semiconductor risk of like an Nvidia.

Even though we still like Nvidia with the AI theme, but Microsoft’s really just insulated from a lot of those risks, and it’s selling software to enterprises, and so it’s going to be real stable. It’s really well positioned, and it also, some of the benefits from the AI theme, you could say from just data center buildout, so yeah, Microsoft—top pick in software, top pick in Mag Seven.

Dziubinski: All right, so we do have a lot of tech earnings coming out next week and the week after. So are you expecting companies to be talking about their tariff risk? What should we be listening for?

Compton: Sure. Yeah. So last time we did this back in, I believe it was 2017, you really saw a lot of general commentary on supply chains. And sometimes executives would maybe say, hey, we’ve got some exposure here, not as much here. They would rank order it. But you often don’t see hard numbers, I would say. Some companies would do it, but most wouldn’t. They’d say, hey, we think tariffs, it’s going to be a 10% EPS impact. Or, hey, X percent of the supply chain is exposed to this. There’s not a lot of hard numbers. A lot of times, companies would also, instead of giving full-year guidance, they would kind of pull back and maybe only give guidance for the next quarter.

Some companies that were facing more uncertainty might pull guidance altogether. So we really expect probably a lot of those same techniques to be used this time around. We are just starting earnings. Companies like ServiceNow NOW, a software company, just reported last night, and they actually did really well and actually increased their guidance. And it fits within that theme of, hey, we think software is going to be OK. So a mix of those factors, depending on which industry the company’s in, but probably, I would say less clarity around hard numbers and super specific items like that, and more, just general color around supply chain potential effects, while emphasizing the uncertainty.

Dziubinski: Yes, it is uncertain. Yeah. Thank you so much, Eric.

Compton: Yeah, great to be here.

Dziubinski: Now, Dave, we have four tech heavyweights reporting this week, Microsoft, Meta META, Amazon AMZN, and Apple. How does each stock look from a valuation perspective heading into earnings?

Sekera: All right, let’s just start off with Microsoft. That’s a 4-star-rated stock. Trades at about a 20% discount to our fair value, but it has less than a 1% dividend yield. We assign the stock with a medium uncertainty and rate the company with a wide economic moat. That wide economic moat being based on its cost advantages, its network effect, and switching costs. In my opinion, I still think Microsoft is a core holding type of stock and, at a 20% discount, provides ample margin of safety to invest in.

Turning to Meta, also a 4-star-rated stock. A little bit more of a discount, almost a 30% discount to fair value, but even less of a dividend yield. I think that’s under a half a percent dividend yield. We assign a high uncertainty of that stock, and then we rate the company with a wide economic moat based on its network effect and intangible assets.

Moving on here to Amazon. 4-star-rated stock, 21% discount, but they don’t pay any dividend at all. Rate this one with a medium uncertainty. And in this case, the company has a wide economic moat, based on four of the five moat sources. So that’s cost advantage, network effect, switching costs, and intangible assets.

Then, lastly, rounding it up here is going to be Apple. Now, Apple stock is down 16% year to date. It’s down more than a lot of these others. But it’s still a little bit above our $200 fair value. So, at this point, it is a 3-star-rated stock with a half a percent dividend yield.

Another stock we rate with a medium uncertainty. And in this case, its wide economic moat is based on switching costs, network effect, and intangible assets. We also have Berkshire Hathaway BRK.A BRK.B reporting earnings this week, actually on Saturday, just before the company’s annual shareholder meeting. So I’m certainly going to be listening to hear what Warren Buffett might have to say during the meeting about tariffs in the market, and also maybe if he’s been doing any buying during the market selloff. But as a programming note, we wanted viewers and listeners to know that Morningstar’s Berkshire Hathaway analyst Greg Warren will be joining us next Monday on The Morning Filter to talk about his key takeaways after the meeting.

Dziubinski: All right, so let’s move on to some new research from Morningstar. We’ll start with Tesla TSLA. Now, there was a lot of negative talk in the financial media after Tesla reported last week, but Morningstar maintained its fair value estimate on the stock. So, Dave, what were some of Morningstar takeaways from the report, and how does the stock look this morning from a valuation perspective?

Sekera: You know, in my opinion, I actually think there’s a lot more positive news here than negative news. So this is one of those cases where I think you really should read through the note here and get your own takeaway and opinion, as opposed to what you might hear in the mainstream media.

So, yes, first-quarter revenue and earnings were down. However, that was really largely as expected. Tesla had already announced a 13% decline in deliveries in the first quarter. But when you think about what really drives our long-term valuation on the company, I’d note that here, in the short term, the affordable vehicle production, that still remains on track. That is the key to our near-term forecast. We’re looking for that lower-priced vehicle to spur sales in the second half of this year and into 2026. I believe they also noted that robotaxi testing was also still progressing nicely. I believe management is planning on rolling that out in select markets in 2026. As that comes online, that just adds a very nice, strong revenue stream and earnings to the company going forward. And then, lastly, Elon Musk did say that he was going to start spending more time focusing on Tesla.

And then we also had some other news. Most recently, the US Department of Transportation announced plans to develop an autonomous vehicle framework. So, the goal here is to create a federal regulatory framework for autonomous vehicles, as opposed to each AV provider having to go to each individual 50 states in order to get that regulatory approval. Of course, each state would then have its own regulations that each company would have to meet. So I think that is very positive for the AV companies going forward. Having said all that, we did maintain our $250 fair value per share. So with where the stock is today, it does still put it in 3-star territory.

Dziubinski: Now, we also had the three main wireless providers, those being AT&T T, Verizon VZ, and T-Mobile TMUS, all report last week. So were there any surprises from them? And is Verizon’s still Morningstar top pick here?

Sekera: You know, there’s always going to be some give and take anytime companies report earnings, especially when you compare them to one another, especially when they’re in an industry where it’s going to be so tightly correlated.

In this case, our analyst noted that the churn rate was on the higher side. He has seen some increasing pricing competition. But overall, I think the takeaway here is that’s all still kind of the ordinary course of business for the wireless providers. There’s no change to our long-term investment thesis. That is, we expect that over time, the industry will continue to keep operating more like an oligopoly. We expect that they will compete less on price over time.

Taking a look at the individual stocks, now T-Mobile did fall, I believe, over 11%. So I think the big thing here was that the company disappointed the marketplace. T-Mobile didn’t raise its initial customer growth forecast, and our analyst noted—that’s the first time they haven’t done that in over the past decade. So I think just an indication here of how things are slowing. That was enough of a movement to the downside that T-mobile stock did move into 3-star territory from a 2-star. And at $232 per share last Friday, it’s still above our $220 fair value. Taking a look at AT&T, 3-star rated stock, trades very close to our fair value. Pretty attractive dividend yield at 4.1%. Company we rate with a narrow economic moat. But as you mentioned, Verizon is still our pick among the wireless providers. It also has a narrow economic moat, but at over a 20% discount, it is a 4-star-rated stock. It provides a very healthy dividend yield at 6.5%.

Dziubinski: Now, we had defense manufacturers Lockheed Martin LMT, RTX RTX, and Northrop Grumman NOC report earnings last week, and there was a good deal of stock-price movement there. So what were Morningstar thoughts, and are there any opportunities here today?

Sekera: Yeah, they all sold off last Wednesday. Now, Northrop was the worst hit of the three. When I look at the stock price action over the second half of the week, I’d note that Northrop is still down, but both Lockheed as well as RTX do appear like they’ve been bouncing back relatively nicely.

Taking a look at Lockheed, that’s a 4-star rated stock, 11% discount, 2.8% dividend yield. Now, in this case, we did make a small increase to our fair value, up to $539 per share. I think the takeaway here is overall, we thought the earnings were in line. They’re on pace to meet their guidance for the full year. And they also downplayed the impact of tariffs on their own business. They said that most of their US defense supply chain is either made here domestically, or in countries with no tariffs or low tariffs, and that they’ve also been long prohibitive from using rare earth metals from China.

Taking a look at RTX, our takeaway here—Now, we thought the quarter was actually quite robust. They had pretty strong commercial aftermarket sales. I think what sent the stock down here was that. The company did provide an estimate of $850 million in additional costs if the proposed tariffs were to remain in place through 2025. And the big difference here between LMT and RTX is that RTX is half commercial business, as opposed to being pretty much all defense.

Next, RTX is a 3-star-rated stock. So the one really to talk about here is going to be Northrop. That stock is down 12% following its earnings announcement. Sales were down 7% year over year. And that’s due to slower work on the B-21 bombers, as well as winding down a few programs in their space division. And then they also booked additional costs of $477 million to increase their B-21 production. So I think the differential between how we’re looking at the company and how it’s being priced in the marketplace is that. We expect that those additional costs will end up adding economic value over time. So, we currently expect that between 2026 and 2028. That the Air Force will take delivery of 100 bombers faster than expected. And that they may also end up adding to fleet size as well. So both of those would add to the value of the company over the next couple of years. At this point, that stock trades at a 24% discount to our fair value, putting it pretty firmly in a 4-star territory.

Dziubinski: All right. Well, we’ll move on to our viewer question this week, which is about Alphabet GOOGL. But before we get to that question, quickly go through Alphabet’s results that came out last week, Dave. What stood out, and any changes to our fair value estimate on the stock?

Sekera: Well, even before we talk about Google itself or Alphabet, I’d say the read-through here, which really kind of allayed a lot of my concerns about AI in particular, was that the company reiterated its plan to spend $75 billion on capex. You know, a big concern I had coming into earnings this quarter was that, with the bear market that we’ve seen and all of the AI stocks, that that could lead to a reduction in capex spending by the big mega-cap stocks. So at least at this point, we’re not seeing that evidence thus far. Now, as far as the company’s individual results—looked very good. Twelve percent top line growth, operating margin expansion by an additional 230 basis points.

Our analysts noted that the company is making clear progress on monetizing generative AI. AI overviews is helping increase engagement. They’re getting improved ad-targeting tools. And we’re also seeing 28% growth in Google Cloud, the part of the business which actually supports artificial intelligence. And we think that part of the business actually is going to accelerate and have faster growth in the second half of this year. It has been capacity-constrained over the past couple of quarters. So as they spent more money building that business out, I think that’s gping to help generate faster growth there. Overall, we maintained our fair value at $237 a share.

We think generally the market is overly discounting the company for two different reasons. One being the DOJ antitrust case. And then, secondly, the market really discounting the company, with concerns that potential economic slowdown here could pressure their digital ad growth. We think both of those are more than already incorporated in the stock price. It’s a 5-star-rated stock, trades at a 32% discount to our fair value.

Dziubinski: All right, so let’s get to our viewer’s specific question. Najmi asked, if we could share what Morningstar’s worst-case scenario would be for Alphabet, what would happen if Alphabet was required to break up? Does the sum-of-the-parts thesis continue to hold?

Sekera: It does. So I took a quick review through our model over the weekend. We do have a sum-of-the-parts analysis in that model. And really, when I take a look at it, it just bolsters our case that we think that Alphabet is undervalued overall.

So, in this case, a sum-of-the-parts analysis prices the company at $250 a share, which is actually slightly higher than the DCF fair value of $237 per share. Now, like anything else with a company this large, with all of these different moving parts, it’s pretty hard to break the company down into its component parts, but we did our sum-of-the-parts analysis based on really its three main businesses. That’s going to be Google Search, Cloud, and then its YouTube ads business.

And then we had a couple of other line items for other businesses and other bets that the company has. So, to do the sum of the parts, our analyst used a revenue estimate for each and then applied a revenue multiple to each, an enterprise value to revenue multiple. And he looked at a lot of competitive companies for each of these different business lines in order to come up what he thought the proper EV/revenue multiple was going to be, looked at kind of the average as well as the median in order to price each of these different business lines.

So, for Google Search, he used 5.9 times enterprise value/revenue. That equates to 42% of the overall sum-of-the-parts valuation. So the biggest part of the valuation is still coming from Google Search. Our cloud business, he applied at 12 times enterprise value/revenue. That equates to 23% of the valuation of the company. In this case, I think a lot of people might think that 12 times is very high, but I would just note that the cloud business not only has the fastest growth, but it also has some of the best attractive margins over time. So we’re actually very comfortable with that 12 times multiple.

Taking a look at the YouTube ads, we applied a 5.8 times EV/revenue multiple. That ends up being 8% of the valuation of the company. Then the other business lines, we have 3 to 4 times EV/revenue multiples. That equates to about 10% of the valuation of the company. And then another 5% of the valuation is going to be based on other bets. That would be like Waymo and some of these other side businesses that they have.

Now, like anything else with the sum-of-the-parts analysis, it’s very difficult, but you also do need to take into consideration some of the other aspects. So oftentimes, a conglomerate like Alphabet, the market ends up applying a conglomerate discount to it. But in this case, I think a lot of that is also going to be offset because you do have negative leverage here. So if the company was broken up, you’d have to recreate a lot of the shared services at each one of those entities. You’d need its own accounting, its own HR, its own executive suite, and so forth. But even after you incorporate all of those, we still think that that stock is trading at a pretty wide margin of safety.

So, lastly, as far as kind of the worst-case scenario here, if the DOJ is able to enforce Alphabet to sell or spin off. both Chrome and Android, which is, I think, what their intention is, we do think that would be value-destructive to the Google Search business line. So we would lower that valuation specifically by 30%. And that would take our sum-of-the-parts valuation down to $190 per share.

Dziubsinki: All right. Well, we’d like to ask our audience to keep on sending us your questions. You can reach us at TheMorningFilter@morningstar.com. And Dave and I hope to meet some of you in person at the Morningstar Investment Conference in Chicago on June 24 and 25. Dave and I will be taping a special episode of The Morning Filter at the Podcast Stage on Wednesday at 10.50. And you can find out more about the conference in the show notes.

All right, so it is time for the picks portion of The Morning Filter this week. This week’s picks are all companies whose stocks rose after earnings, but that we still think look undervalued. So, Dave, your first pick this week is Danaher DHR. Tell us about it.

Sekera: 4-star-rated stock, 27% discount, only like 0.65%, so less than a 1% dividend yield. Personally, I like stocks that have a little bit more dividend yield than that. But in this case, it still looks pretty attractive. Medium uncertainty, wide economic moat based on switching costs and intangible assets. Now, Danaher’s first-quarter results were good, and the company announced that it expects a net-neutral tariff impact on 2025 profits.

Dziubinski: Yet the stock still looks really undervalued. So what’s the market missing here, Dave?

Sekera: Well, as you mentioned, first-quarter results did exceed guidance. And I was actually very comforted by the discussion that they had about tariffs and how that would be net-neutral on their business. They have a lot of different ways, a lot of potential changes that they can make to their manufacturing footprint, their supply chain, make some surcharges, and use some other cost controls. So that actually allayed a lot of my concerns there.

Overall, I would say this is a similar story as what we’ve seen in a lot of other companies that we’ve found a lot of value in following the pandemic. There was a very significant pull forward of demand in 2021. And then in 2022, you had a lot of customers that bought a lot of excess inventory because of all the shipping bottlenecks. So that pulled forward a lot of additional business. In those two years that artificially bolstered both the revenue and their margins. The stock probably rose too far. People were applying too high of a multiple on those artificially high revenue and operating margins. Of course, you then saw the company suffer from customer destocking, the margin deleveraging in 2023 and 2024. Stock price sold off as customers used up all of that excess inventory.

So, looking forward at this point, we’re seeing a lot more normalization going on in our model. We expect the five-year compound annual growth rate to be 5.7%. That’s essentially equal to our long-term demand trends that we expect in the company’s end markets. And then we expect operating margins to normalize and rebound as sales growth comes back after having fallen for the past two years. So, our results in our compound annual growth rate for net income is 13.4% over the next five years. So we think it’s pretty attractive at the current levels.

Dziubinski: Now, your second pick this week is ServiceNow. Walk us through the key metrics.

Sekera: Yeah, that stock has actually grown quite a bit here since it announced earnings. It’s up, I think, about 15%. So at this point, it’s only at a 7% discount to fair value. It puts it in 3-star territory. However, I still think it’s a very attractive company, very attractive stock. Rarely does this company trade at much of a discount to its fair value. Now, I would note we do assign a High Uncertainty Rating here, as are most names in the technology sector. But it is a company with a wide economic moat, based on its switching costs.

Dziubinski: Now, you did mention that the stock rallied after earnings, and Morningstar did raise its fair value estimate on the stock, but just by a hair. So why is this one a pick this week?

Sekera: Yeah, I mean, typically, I really like 4- and 5-star-rated stocks to use as picks for the week. And in fact, I believe this was a 4-star-rated stock at the end of last week. But, you know, it’s now moved into that 3-star territory. And it’s just one of these ones where you got to be quick. You know, the stock doesn’t stay in 4-star territory very long.

Taking a look at the results here, you know, first-quarter results were better than expected. Second-quarter guidance also better than expected. They raised their full-year guidance. At this point, neither tariffs nor potential trade issues are weighing down the company’s demand.

As far as AI goes, they said their AI deal sizes grew by 33% as compared to the year-over-year period. Overall, just the general takeaway that we’ve talked about on this stock a couple of times. Dan Romanoff, he’s the analyst that covers this stock. He’s just noted he thought that the company is just one of the most attractive stocks in the tech sector. He thinks it just has the best combination of growth, valuation, and a strong balance sheet.

Dziubinski: Now, your third pick this week is a name we’ve talked about before. It’s NextEra Energy NEE. Give us the headlines.

Sekera: So NextEra—it’s a 4-star-rated stock, trades at a 12% discount, 3.4% dividend yield. As most of the utility companies, the regulated utilities, a medium uncertainty and a narrow economic moat. Now, utility stocks as a group are slightly overvalued, but Nextera is still undervalued. So with this one, what’s the market missing? You know, first-quarter results were in line, no problems there. Management reaffirmed its 2025 EPS guidance, which was in line with our estimate for the year as well. Longer term, we continue to assume the company’s got kind of that 6%-8% earnings as far as its long-term growth targets. So we maintained our fair value. That’s just a matter of I think some of the market might be a little bit concerned about its renewable energy business. Now, that is only 20% of the company’s overall business.

The other 80% is a regulated utility in Florida, and we believe Florida has a very favorable regulatory environment for stockholders. But that renewable energy business just might be a concern to some investors about the economic viability of renewables. But in this case, our analysts have noted that they were an early mover into the renewable space. They’ve already locked down some of the best locations to put those renewables in. In fact, they still have additional area that they can expand in renewables if they want to, if the economics make sense going forward.

As far as their existing business, they’ve already got long-term power contracts in place. So they’ve already got the ability to sell the electricity that those renewables will produce and essentially lock in the economics of those current assets.

Dziubinski: All right. And your final pick this week is Hasbro HAS. Tell us about it.

Sekera: Yeah, I mean, we had a big spike in that stock after earnings. In fact, it spiked enough to push it into 4-star territory from 5-star. But even there, it’s still a 27% discount. Nice, attractive dividend yield at 4.6%. Company we rate with a narrow economic moat based on its intangible assets.

Now, as you said, here’s another stock that had a really nice rally after earnings but still looks significantly undervalued. So why has Hasbro Stock been so depressed? Well, in the short term, the shares have been under a lot of pressure. Just because of concerns about how much it does source from overseas and how the tariffs would impact that. I think a lot of also concerns just that you can have a negative or softer economic environment in the second half of this year. So I think both of those combined really push that stock price down here in the short term. And in fact, we’re going to increase our Uncertainty Rating to High from Medium on this one based on those two factors as well.

But, you know, we think that that’s going to already take into account the heightened uncertainty by the tariffs. 50% of the company’s products are manufactured in China. So with Hasbro’s case, I think the market just needed to see the evidence that the company is bolstering its digital gaming efforts. It’s really starting to work. This past quarter, they reported a 17% increase in revenue. And that is driven by really two things. One, Wizards of the Coast, but also its digital gaming businesses.

Now, digital gaming has a much higher business margin structure. So as that increases as a part of the total revenue of the company, you’re going to get that natural mix shift, which then increases the operating margin of the company overall. So, our 2025 forecast is for $4.2 billion in sales. Looking for a 21.1% operating margin. Company reiterated its outlook for slightly positive sales growth and an increase in operating margin to that 21% to 22% range. So we maintained our long-term forecast. We’re looking for average sales growth, about 4% top line, long-term operating margin to increase some more, up to 23%. When I look at the stock, it only trades at 14 and a half times our earnings estimate for 2025 and only 12.8 times our 2026 earnings estimate.

Dziubinski: All right. Well, thank you for your time this morning, Dave. Those who’d like more information about any of the stocks Dave talked about today can visit Morningstar for more details. We hope you’ll join us next week for The Morning Filter on Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this episode and subscribe. Have a great week.

Got a question for Dave? Send it to themorningfilter@morningstar.com.