2019’s (Midyear) Stocks To Watch

I am quoted in this Smith Brain Trust (Robert H. Smith School of Business, University of Maryland) article: “2019’s (Midyear) Stocks To Watch”.

Professor David Kass’s six stocks to watch in 2019 have been on something of a winning streak. Now, as we approach the midway point of the year, he recommends keeping your eye on four others, as well.

On an equally weighted basis, six equities he recommended back in December have gained 20.9%, easily outpacing the broader S&P, which added just 8.7%. “I’m flexing my muscles now. Since my six stocks did so well, I’m now going to recommend 10 stocks,” he says.

His macroeconomic outlook is pretty rosy. He says he’s confident the U.S. economy will continue to grow at around 2% for the remainder of the year, and he sees the risk of recession being at least a year in the distance. “The main risk to the U.S. economy right now is the trade war with China,” he says. “If that escalates, it could substantially slow down our economy.”

But the Federal Reserve appears poised to cut its key interest rate by 25 basis points, and that, he says, “is, of course, is very positive.” And it means the U.S. economy is likely to remain resilient, and likely to continue to outmuscle other advanced economies.

“I expect the market for the rest of this year to be mildly positive if the trade war is resolved with China, adding maybe 10%,” he says.

Kass, a clinical professor of finance with the University of Maryland’s Robert H. Smith School of Business, is keeping his original six stocks on the list – ”I don’t see any reason to drop any of them,” he says – while adding four new ones.

The Additional 2019 Midyear Stocks To Watch

Progressive Corp (PGR): At the Berkshire Hathaway annual meeting in May, CEO Warren Buffett and vice chairman Charlie Munger said some pretty positive things about automobile insurer, Progressive Corp. It was somewhat unexpected, says Kass, since Progressive rival Geico is a wholly owned subsidiary of Berkshire Hathaway. Buffett has said several times, including to Kass and a group of his Maryland Smith students during a 2005 visit to Omaha, that Geico was his favorite company. “Now that may have changed. But certainly Geico remains one of his favorite companies.”

It’s interesting, Kass says, that Buffett’s favorite child “is being outperformed by someone else’s child.” And that means it must be doing some things very right.

Geico has the significant advantage over Progressive when it comes to the expense ratio, to the extent of about 7 points or so, Kass notes. On the loss ratio side, Progressive does a much better job than Geico does; boasting a 12 point advantage over Geico. “So net-net, Progressive is ahead by 5 points.” It’s price-to-earnings ratio is around 16.

Kass has studied Buffett’s investments and philosophy for more than 35 years. He notes that the insurance sector held favor for Buffett’s mentor, economist and famed investor Benjamin Graham. “Anything Graham liked, Buffett liked. It’s a little like myself with Warren Buffett. Anything Warren Buffett likes, I like as well.” he says.

Amazon (AMZN): One of Berkshire’s portfolio managers made an initial investment in Amazon this year. The e-commerce giant is obviously very popular and has been growing by leaps and bounds, and in the foreseeable future is expected to continue growing rapidly. Kass notes that Buffett has described Amazon CEO Jeff Bezos as “the best manager he’s ever met.”

However, a visible risk overhanging Amazon is the potential for antitrust oversight.

Kass, who was an antitrust economist at the Federal Trade Commission before coming to Maryland Smith, notes that the agency typically exercises oversight when consumers are being harmed, when higher prices are being charged as a result of market power, for example. He quotes the commission’s Guide to Antitrust Laws, saying, “Obtaining a monopoly by superior products, innovation, or business acumen is legal; however, the same result achieved by exclusionary or predatory acts may raise antitrust concerns.”

“Right now, I’m not aware of any illegal conduct that would justify any kind of antitrust concerns,” Kass says. “I believe that Amazon is achieving its monopoly because of its superior products, innovation and business acumen, which the FTC says is legal. Nonetheless, there is this cloud overhanging Amazon.”

Amazon has a high PE ratio, around 78.

JPMorgan Chase (JPM): “JPMorgan Chase is considered the best managed bank, and its CEO, Jamie Dimon, is considered the best bank manager,” says Kass. And in the past three quarters Buffett and Berkshire Hathaway have added $6 billion in stock to its stake. That represents the largest investment in a single stock that the company has made in the past nine months.

The bank has shown solid earnings growth, good prospects for future growth, and is well managed, Kass notes. “Plus, Jamie Dimon has a large stock buyback program, which Warren Buffett loves.”

JP Morgan has a PE ratio of approximately 12.

Danaher (DHR): Kass has known about the D.C.-based manufacturing conglomerate for many years. But it really captured his attention last fall, when General Electric tapped Danaher’s former CEO, Larry Culp, to be its new chief executive. As the highly celebrated chief executive for the Danaher conglomerate, Culp was credited with turning that company around. He’s being tasked with a similar mission at GE, though he recently cautioned that the turnaround wasn’t going to come at whiplash speed. It will be a multiyear turnaround, he recently told an industry conference. “I don’t want to sugarcoat that in any way, shape or form. There’s a lot of work. It’s a game of inches.”

Danaher’s earnings per share have been growing rapidly, thanks in large part to Culp’s turnaround and the strong management team he left in place.

Earnings are projected to grow about 15% over the next year. The price-to-earnings ratio on 2019 operating earnings is 28. “That’s a little high, but you have above-average growth potential,” Kass says. “I think it’s a well managed company in good areas. The fact that GE brought in its former CEO to run a much-larger company, that certainly says good things about the job that Larry Culp did.

Adding it up

Kass’ sentiments on his original six stock picks largely mirror what he said six months ago.

With five of his six stock picks outperforming the broader market, Kass says he sees no need to make a change. He brushes off the underperformance of his portfolio’s only laggard, Berkshire Hathaway. “It was a six-month period in which growth stocks outperformed value stocks,” Kass says, helped by improving growth prospects and strong corporate earnings.

“Buffett is still Buffett,” Kass says. “And Berkshire Hathaway is therefore still solid, with little downside risk.”

At current share prices, Berkshire Hathaway is trading below the level that Buffett has recently bought back shares. If it should fall much further, Buffett would buy even more. So there’s some limit to the risk that those shares will decline.

Berkshire (BRK) was up just 1.1% over the six months through June 13.

Here is a look at his other five original stock picks and their six month performance since the recommendations were published:

StoneCo +51.9%

Microsoft +21.1%

Stanley Black & Decker +20.9%

Bank of America +15.7%

Apple +14.5%

For more on those stock picks, read more…