Investing for the Long Run: Looking Beyond the Obvious

I have separated my long-running Investor section from Weighing the Week Ahead. My hope is to highlight ideas for the long-term investor. In my last investment post I applied the key concepts of the matrix to the deeply bifurcated market – FAANG and everything else. The Great Reset research has moved on. Here are the key points:

  1. How long until the recession ends?
  2. What pandemic developments can facilitate the return to a normal economy?
  3. What are the best stocks for the “other side?”

For now, and for as long as the pandemic weighs on the market, that is the necessary context for each stock idea. To provide a starting point, I created The Great Reset Matrix. The Matrix is a conceptual guide, which I use in evaluating every new stock idea. The current version draws upon results from the Great Reset Project, where readers have joined in to help with my Wisdom of Crowds approach. Their help has led us to some important findings about what will help an economic recovery and what will not. We studied two areas.

Social Distancing — Testing and Tracing

The social distancing approach requires fairly widespread cooperation. Asking people what they will do is far less reliable than drawing upon the wisdom of crowds. Here is what our panel expects in terms of cooperation for the next three months.

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I hoped for improvement by using a nine-month interval, but the results were almost identical. Moving cooperation beyond 50% is a major challenge. When we get to tracing or encouraging others, we can forget it.

Vaccine

Everyone’s big hope is for a vaccine. The market has a knee-jerk reaction to any positive vaccine news. Many seem to believe that once we have a vaccine, everything will be back to normal. I focused on the simple question of how many people would take a vaccine. As I noted in the report:

The goal of achieving “herd immunity” requires 60% of the population to be immune. But vaccines are not 100% effective. A 75% rate is an optimistic target. This means that 80% of the population must take the vaccine to reach the 60% level.

Here was the poll result.

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I asked about government agencies and the president to see if certain pockets of resistance might be reassured by this support.

Survey Conclusion

Despite current optimism it is clear that neither the medical treatment nor social distancing methods will work alone. As I have suggested in past posts, this will require a combination of methods – perhaps several.

The corollary is that it will take time, with some disappointments along the way. This result is crucial for stock investors, who are tempted to plunge into what is working right now.

Please Join and Help

You can see past research and become a part of the project by signing up for a free membership.  I will continue to disseminate results in post like this one, and you can help.

The current matrix version is moving to analysis of individual stocks. Here is the sector matrix, but we currently have a discussion room for stocks in each cell.

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This Week’s Ideas

Each idea I include comes from a respected source that I have often cited in the past. In each case I offer a comment about how I might use the stock in client portfolios. I also assign a matrix classification. Comments are most welcome. Please join me in a discussion of the classification as well as contributing other ideas. I hope that authors will soon include some of the matrix thinking in their work.

My Criteria

I am looking for high-conviction calls that fit the matrix. Many do not. Here are some examples. D.M Martins Research, a frequently quoted source, posted a nice article on Big Lots (BIG), but what should we conclude? The author cites strong momentum and good quarterly numbers.

That is not enough for me. Classification within the matrix, along with some reasoning, would be very helpful to investors. Without it we are rooted in the recent past. This is B2 at best, and maybe C2.

Stone Fox Capital, another favorite source, evaluates the rebound in Five Below (FIVE). The basic argument is that retail was decimated by the shutdown, but some stocks have rebounded. This one has lagged. The author concludes:

The key investor takeaway is that Five Below is now attractively priced for a recovery in retail demand. The company serves a consumer base likely to recover quicker. The stock faces some short-term risk with volatile sales numbers, but ultimately, Five Below will recover. The stock is a bargain here, with investors ideally holding some capital in order to buy more shares on any dip following FQ2 numbers. If the specialty retailer actually reports positive total sales in FQ2, the stock won’t look back.

A more convincing argument would consider the Matrix and why retail should be seen as a rebound sector. It still looks like A1 or B1.

Office REITs

Hoya Capital Real Estate considers the trend to work from home. The authors track 26 office REITs accounting for $75 billion in market value. There is a realistic, data-driven attitude about the upcoming “hybrid” workforce.

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The authors break down the REIT sectors into categories of sensitivity. This is very useful.

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The entire post is worthy of your analysis. It includes data and reasoning that help us think about what is happening now and also what to expect at the end of the recession. Here is the key element of the conclusion:

While we think that the pace of dividend cuts will slow – and even reverse – in the months ahead across most of the REIT sector, we think that there may be a few more office REITs that will be forced to scale back distributions in the quarters ahead. With a 43% Debt Ratio according to NAREIT data, the office REIT sector operates with leverage ratios that are above the REIT sector average of around 31%. Twelve office REITs currently have debt ratios above 50% while seven REITs are above 60% which we view as the “danger zone” for potential dividend cuts or other means of deleveraging. That said, while access to capital may be an issue for some of the smaller, more highly-levered office REITs, thirteen office REITs command investment-grade bond ratings.

I like the honest recognition of problems and the future. I’ll call this an A2, an idea worth watching.

Stable, with Upside

Blue Harbinger highlights the rebound and potential in Verizon (VZ). As always, he does a comprehensive data analysis, highlighting the 14 consecutive years of dividend increases. Here are the key points:

  • Stable during the pandemic. High exposure to the “more resilient wireless business.”
  • High free cash flow. Nice data provided
  • 5G opportunity. Verizon has invested heavily in building this out.
  • Valuation. A current multiple of 8.4.

As always, Blue Harbinger does a nice job in discussing risks – delays in 5G and competition in wireless.

Verizon’s relative strength comes from the scale of its wireless business, which has positioned it on strong footing as compared to its rivals. We believe that because of a largely resilient business model with a recurring revenue stream, the company should be able to generate robust free cash flows in the future, thereby strengthening regular dividend payouts. Also, there is plenty of room for dividend growth given that Verizon currently pays just over half of its free cash flows in dividends. Accordingly, we believe the stock is worth considering if you are a long-term income-focused investor (we own shares).

However, if you are concerned with near-term frothiness (the debt and valuation are on the high side, and the shares have rallied quite a bit from the pandemic low), you might consider selling covered call options.

I chuckled at this conclusion, since selling calls against my Verizon stock is the approach I have chosen. It is the right approach when you are confident of the downside but do not expect explosive upside. It is indeed a little out of my price range, so I have substituted T in the Yield Boosting Corner.

Closed-end Funds

KMF: Strategic Policy Shift Provides A Potentially Brighter Future is a nice analysis from Nick Ackerman and the Stanford Chemist.

This is a midstream energy fund that is switch emphasis to an ESG approach. Naturally, the name of the fund will change as well. The key thing for investors to monitor will be the change in holdings, which are currently all midstream.

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I like the focus on the future. This is a fund mired in group A1 but struggling to become A3. It I worth watching.

Watch Out For

Consolidated Water (CWCO). Ian Bezek explains the risks. Hint: tourist season and their bottled water. Oh, and they operate with a license from the Cayman Islands, where water sales also fell.

It is important to look beyond the name of a company. Do not join in just because the price seems low or other stocks in the same (apparent) sector might rebound. This looks like a stock that might be stuck in group A1.

General Equity ETFs. Juan de la Hoz explains the advantages and disadvantages of this approach.

CEFs are one of the few ways investors can receive strong distributions from equity investments, and with strong discounts to boot. Unfortunately, with general equity CEFs, the potential advantages of steady distributions and wide discounts need to be balanced against the high fees and potential for underperformance versus the benchmark.

And his conclusion—most in this class lag the benchmark.

CEFs are one of the few ways investors can receive strong distributions from equity investments, and with strong discounts to boot. Unfortunately, with general equity CEFs, the potential advantages of steady distributions and wide discounts need to be balanced against the high fees and potential for underperformance versus the benchmark.

Conclusion

The current market makes it all seem easy to many investors. It is actually a big challenge for anyone looking ahead for a few months. I do not expect stocks that are currently leaders to be the best of breed a year from now. It is a real challenge to think ahead, but this is a case where foresight will be rewarded.

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