Investors Alley

Howard Marks, the billionaire founder and chairman of Oaktree Capital, sends out his “Memos” several times a year. His December issue, titled Sea Change, offers food for thought about successful investment strategies to use in the new year.

Let’s take a look, and see how we can earn some nice cash returns next year with less risk…

Marks’ December memo opens with this:

sea change (idiom): a complete transformation, a radical change of direction in attitude, goals…(Grammarist)

In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes. I think we may be in the midst of a third one today.”

The first sea change Marks is referring to occurred in the mid-1970s when it became acceptable for corporations to issue non-investment grade bonds as a way to raise capital. Prior to that, there was no market for bonds that didn’t have an investment-grade credit rating. Non-investment grade or high-yield bonds opened up the potential for companies to issue this type of debt to fund growth or make acquisitions.

Marks, who made his fortune investing in high-yield securities, explains:

…The most important aspect of this change didn’t relate to high yield bonds, or to private equity, but rather to the adoption of a new investor mentality. Now risk wasn’t necessarily avoided, but rather considered relative to return and hopefully borne intelligently. This new risk/return mindset was critical in the development of many new types of investment, such as distressed debt, mortgage-backed securities, structured credit, and private lending.

The second sea change started when, in 1980, Fed Chairman Paul Volker ratcheted the federal funds rate up to 20% to kill the high inflation that had persisted since 1974. The move succeeded and ushered in four decades of falling interest rates, which were tremendously positive for investing and the economy. Bond prices go up when interest rates fall. As a result, bond funds posted year after year of positive returns.

Falling rates also fueled corporate investments that led to massive economic growth. Low interest rates reduce the cost of capital for businesses and increase the fair value of assets.

Per Marks:

It seems to me that a significant portion of all the money investors made over this period resulted from the tailwind generated by the massive drop in interest rates. I consider it nearly impossible to overstate the influence of declining rates over the last four decades.

The third sea change, now underway, is that inflation and high interest rates have produced investor uncertainty and pessimism. These are valid concerns, as growth-focused companies can no longer count on cheap money to fund their growth.

Marks closes the memo with this:

We’ve gone from the low-return world of 2009-21 to a full-return world, and it may become more so in the near term. Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets. Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21… if you grant that the environment is and may continue to be very different from what it was over the last 13 years—and most of the last 40 years—it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.I have already started making changes to my Dividend Hunter recommendations that should let subscribers earn attractive cash returns with less risk. Now in its ninth year, my strategy has continuously evolved, and the recommended strategy and investments will do very well in the new “sea-changed” world.
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While it’s been a rough year for the Ark Innovation ETF (ARKK), a large options trade may suggest a brighter 2023.  A strategist purchased what appears to be a 30,000-lot of covered calls on ARK that expire in February. The covered calls allow for over 10% upside potential in share appreciation before capping out, while

A special dividend announcement in my inbox reminded me it’s that time of year: special dividends season.

For certain types of stocks and funds, special dividends point to a high probability of future dividend increases. That’s a big help in a year when falling share prices made us wonder about the stability of our investment choices.

Here are a few special dividends I’m looking at that you still have time to get in on…

Last week, hotel real estate investment trust Apple Hospitality REIT (APLE) announced its regular $0.08 monthly dividend and a special cash distribution of $0.08 per share. The combined $0.16 per share dividend will be paid on January 17, and the ex-dividend will occur on December 29.

The special dividend indicates that APLE will likely return to the $0.10 monthly dividend the REIT paid before the pandemic-triggered economic shutdown.

As a real estate exchange trust (REIT), Apple Hospitality must pay out at least 90% of its net income as dividends. If an REIT has not paid at least 90% as the end of the year approaches, it can pay a special dividend can be paid to meet the legal requirements.

REITs and business development companies (BDCs) operate under the 90% payout rule. If you see one of these companies announce a special dividend payment between now and the end of the year, take a look at the stock. There may be a regular dividend increase coming soon.

Year-end special dividends also show if a company performed better than expectations. If you see a special dividend on a stock that has dropped this year, the stock price is wrong, and the business is doing well.

Investment funds, including mutual funds, closed-end funds (CEFs), and exchange-traded funds (ETFs), must pay out 100% of the net income and realized capital gains the fund received during the year. Many CEFs and ETFs employ a managed dividend policy, in which they pay level dividends based on the expected income for the year.

When a fund with a managed dividend policy earns more than the dividends paid, the fund must pay out any earnings above the dividends paid for the year by the end of the year, in the form of a special dividend.

The InfraCap MLP ETF (AMZA) provides a good example. This ETF owns an actively managed portfolio of master limited partnerships (MLPs) that provide energy midstream services. AMZA has paid a $0.22 per share monthly dividend for the last two years. MLPs have been aggressively increasing dividend rates this year—a big contrast to 2021, when dividends paid in the sector were relatively flat—so I will not be surprised if AMZA announces a special year-end dividend. And if it does, you can count on an increase in the monthly rate for next year.

To recap, when you see a pass-through business, an REIT or BDC, or an ETF announce a special year-end dividend, take a deeper look at the fundamentals. You may have found an excellent dividend growth investment.
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The stock market has proven to be very resilient in recent months. Even as Federal Reserve officials talk about the need for interest rates to be higher than expected for longer than anticipated, the markets have managed to hang on to the idea that if the pace of rate hikes slows, the eventual destination does not matter.

I suspect that the group of traders who believe this have never experienced rapidly rising interest rates or high levels of inflation, and will eventually be proven wrong.

Still, it will be a bumpy road for all of us before everything settles. We have already seen several sharp snapback bear market rallies this year, and I expect to see more before we find an ultimate bottom in stock prices.

The key to not taking it on the chin in markets like we are experiencing today is to avoid getting caught up in the enthusiasm surrounding these fast-and-furious rallies.

Often that is harder to do than it sounds. Here’s how to do it – and what stocks to avoid…

The talking head and financial media can get quite excited about these sudden moves, and you will hear many people trying to call the bottom. But in my experience, the bottom is only in once almost no one is trying to call the bottom anymore—and right now, with a P/E ratio of 21, it is hard for me to think an important bottom is in for stocks.

There needs to be more fear amongst most investors and traders. Everyone is far too complacent for stocks to have reached a significant turning point.

When we see rapid changes in the CBOE Volatility Index, or VIX, alongside soaring high-yield credit spreads begin to blow out, I will feel much more comfortable loading up on stocks.

But until we get an absolute bottom in the markets, the best way to avoid experiencing a devastating permanent loss of capital is to keep away from stocks with deteriorating fundamentals and heavy insider selling. These two factors can be a catastrophic combination even in a bull market, so they’re are far worse under the sort of market conditions we have seen in 2022.

A stock like Workday Inc. (WDAY), the enterprise software company, could hand investors some more ugly losses. The stock is currently down over 35% this year, and could decline further. The fundamentals of the business are getting worse, not better, and insiders have been selling a lot of stock in the open market recently.

Over the last few months, ten insiders have combined to sell over $20 million worth of Workday shares. Workday’s co-presidents, the CFO, and the co-CEOs have all been selling stock consistently in 2022. When the entire C-suite is selling shares of the company they run, it makes a statement—and not a good one.

The stock is rich at 7.3 times sales, and the company is not profitable. Analysts expect them to be profitable next year, but I doubt those estimates are factoring in a recession caused by the Fed’s inflation-fighting decisions.

Even if the analysts are on target, the stock would be trading at a P/E of more than 35, which is rich for a company where the most optimistic observers expect low-teens earnings growth over the next several years.

I also noticed heavy selling at Prothena Corp. plc (PRTA), an Irish biotech company that trades here in the United States. The stock soared higher in late September based on hopes that the FDA would eventually approve their Alzheimer’s drug. Other companies working on drugs for the dreaded disease have also seen abnormal buying activity based on hopes for a working treatment.

Prothena’s drug is still in Phase One trials, so approval—if it happens—is still months, if not years, away. Buying the stock now is a bet that Prothena gets approval before all the other companies working on an Alzheimer’s drug.

It is a big bet, and one insiders have not been making in 2022.

Since the huge price spike, 23 insiders have combined to sell more than $17 million of Prothena shares.

Most of us do not understand biotechnology enough to make intelligent biotech stock picks. In my opinion, no one without the word “Doctor” before their name and more degrees than a thermometer is, in my opinion. The only factors I’ve found that work for most mortals when picking biotech stocks are insider buying and profitability.

Six-figure insider buys at biotech stocks usually mean that good things will happen over the next thirty days for the stock price. Biotech companies with black ink bottom lines often beat the market for extended time frames.

There is no insider buying at Prothena. Instead, insiders are using the unusual price action to take money off the table.

Prothena is not profitable, and there is no expectation of profits any time soon. One lousy report or failed FDA trial, and this stock will be down 50% before you can blink.

Now is the time to focus on avoiding mistakes. Stick to small banks and special situations to provide returns while emphasizing protecting capital.
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Founded in 1923, Novo Nordisk (NVO) is a global healthcare company headquartered in Denmark. Its focus is on diabetes and other serious chronic conditions, such as obesity, as well as rare blood and endocrine diseases.

The company is the global powerhouse in diabetes treatment, with about 30% of the $50+ billion global diabetes market and around half of the $20 billion insulin therapy market.

And now, Novo Nordisk is set to become a major force in the weight loss market, thanks to its drug, Wegovy (chemical name semaglutide).

The World Is Fat

For many decades, doctors approached obesity as an individual problem, best treated with lifestyle modifications like diet and exercise. But now, there is a growing body of scientific research that supports the use of pharmaceuticals in weight management.

This new way of treating obesity couldn’t come at a better time. Here’s why…

Over the past four decades, statistics show that obesity rates around the world have outpaced global population growth. That’s the main reason why analysts at Morgan Stanley forecast that these obesity treatments could soon be among the top-selling drugs globally, with sales soaring from just $2.4 billion in 2022 to as much as $54 billion by 2030.

This brings us to Novo Nordisk’s Wegovy. The drug works by mimicking a hormone known as GLP-1, which is made in the intestines when we eat and helps to regulate appetite. The drug also helps to slow down the movement of food from the stomach to the small intestine, meaning patients feel full more quickly and for a longer period of time.

Synthesized GLP-1 medicines were originally developed to help people with type 2 diabetes better manage the disease by increasing the release of insulin from the pancreas, which aids in the removal of excess sugar from the blood following a meal. One such leading drug is Novo’s Ozempic, which is a multi-billion-dollar seller.

When researchers studied patients on these drugs, they quickly noticed the weight loss and decreased appetite in diabetics taking GLP-1 drugs. So, they then began studying the potential of these drugs in the treatment of obesity.

In 2014, Novo’s Saxenda became the first GLP-1 drug to receive FDA approval for use in weight management. However, Wegovy is far superior because it’s given as a once-weekly injection, instead of being administered daily. And even more importantly, Wegovy produces more weight loss and comes with better cardiovascular outcomes for patients.

Novo’s Supply Chain Woes

It looked like Novo Nordisk would have the obesity treatment market to itself when supply chain issues struck. Late in 2021, a contract manufacturer filling syringes for Wegovy pens for the U.S. market had temporarily stopped deliveries and manufacturing following issues with “good manufacturing practices.”

In turn, Novo Nordisk paused the marketing and distribution of Wegovy. Production resumed by the second quarter of 2022, but manufacturers couldn’t keep up with surging demand, so the company was forced to restrict doses of Wegovy to patients who had already begun using it.

Wegovy has generated about $700 million in sales to date, far short of the $2 billion expected before those supply chain issues struck. However, during the October earnings call, Novo’s management reaffirmed plans to fully launch the drug by the end of the year.

That particular contract manufacturer is still experiencing some problems, so, it is good news for Novo Nordisk that another manufacturer is scheduled to begin producing Wegovy in the second half of 2023, taking the total number of filling sites to four.

The company’s supply chain woes opened the door to a possible rival GLP-1 drug from Eli Lilly (LLY), Mounjaro (tirzepatide). In October 2022, the FDA announced it had granted fast track designation to the medicine, meaning it will enjoy an expedited regulatory review process. Phase III clinical trials should conclude in the spring of 2023, so it’s possible that Lilly’s drug could be on the market around the start of 2024.

Novo Nordisk Is the Clear Leader

Despite the supply chain hiccups, Novo Nordisk remains the clear leader in the GLP-1 market.

Even a cursory glance at Novo Nordisk’s numbers confirm this. Constant-currency demand growth for the company’s GLP-1 products during the first nine months of 2022 showed a jump in diabetes treatments of 44% and in obesity treatments of 75%!

Management once again raised its outlook for 2022 on that news, and is now expecting 14% to 17% constant-currency sales growth (up from 12% to 16%), and with a 10-percentage-point additional boost from currency tailwinds.

While insulin accounts for roughly 50% of Novo’s top line, its GLP-1 franchise (Rybelsus, Victoza, Saxenda, Ozempic, Wegovy) is where the growth lies—it now makes up roughly 40% of sales.

Morningstar analyst Karen Andersen believes Novo Nordisk will have a more than a 60% share—$25 billion of the nearly $40 billion global GLP-1 market—across indications by 2026.

The prevalence of diabetes is expected to soar in the coming decades, as a result of an increasingly

overweight and aging global population. That will only benefit Novo Nordisk as it continues to dominate in diabetes and obesity treatments. And keep in mind, the company is only beginning to feel the impact of soaring demand for Wegovy.

While Novo trades at about 31 times next year’s forecast earnings (far cheaper than rival Eli Lilly at 41 times), I believe NVO stock will be a big winner, outperforming its peer group by a large margin—as it did during the past decade. The stock is trading around $132 a share, up 21%% year-to-date. It’s a buy in the $120 to $140 range.
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A recent Wall Street Journal article stated that Americans missed out on $42 billion of interest income because of where they keep their money.

The culprits are the low-yielding savings accounts offered by America’s big banks.

As luck would have it, there are much better places to put your money. Places that will generate much more yield, without much added risk.

Let me show you where I put my savings to earn more…

Before I discuss how to earn more from your cash holdings, let’s look at an excerpt from the article:

The $42 Billion Question: Why Aren’t Americans Ditching Big Banks?

Americans are missing out on billions of dollars in interest by keeping their savings at the biggest U.S. banks… In theory, savers could have earned $42 billion more in interest in the third quarter if they moved their money out of the five largest U.S. banks by deposits to the five highest-yield savings accounts—none of which are offered by the big banks—according to a Wall Street Journal analysis of S&P Global Market Intelligence data.

The five banks—Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., U.S. Bancorp and Wells Fargo & Co.—paid an average of 0.4% interest on consumer deposits in savings and money-market accounts during the quarter, according to S&P Global.

The Journal highlighted the $42 billion number for its shock value. The five listed banks didn’t have that much profit for the quarter. The article points out that in this new era of higher interest rates, you can earn much more on your savings.

The article also discusses how banks can set rates at whatever they think they can get away with. The listed banks have billions of dollars of customer deposits earning very little. Going to another bank account that offers a higher rate may not be the solution. The new bank could lower the rates it pays as soon as it has enough deposits.

I suggest looking at money market mutual funds to earn higher yields on your cash savings. These funds hold a stable $1.00 share value and pay interest based on the yields of short-term securities like Treasury bills. For example, I am using the Schwab Treasury Obligations Money Fund, which currently yields 3.52%. That means on $100,000, the fund would pay almost $300 per month in earnings. That same amount at a 0.40% yield would pay just $33.33 per month.

If you have funds you don’t want to comingle with your investments, it is easy to set up a new brokerage account. I have four accounts with Schwab, so I can see in dollars the results of the different investment strategies I recommend to my subscribers.

For my next Dividend Hunter newsletter, out January 1, I will show subscribers how to earn even higher yields with investments that secure the principal invested. This strategy lets investors earn 6% to 7% annual yields.
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Several times in recent months, I recommended that you consider purchasing the major European oil stocks: BP (BP), Shell (SHEL), TotalEnergies (TTE), and Equinor (EQNR)… so I was gratified to see that many of the large U.S. fund managers are jumping into these stocks. For example, the second-largest holding of the Blackrock Equity Dividend Fund is now BP.

The Financial Times recently reported: “European oil companies are attracting U.S. investors who view them as cheap compared with the likes of ExxonMobil and Chevron, after a furious rally in American energy stocks.”

The Financial Times article also revealed that “shares in European supermajors are trading at less than half the value of their U.S. rivals, when measured as a multiple of their expected profits over the next 12 months.” U.S. oil firms have price-to-earnings ratio of around 8, while European oil stocks have a P/E of around 4!

Both groups are dirt cheap, but analysts at JPMorgan Chase say the spread between the two groups has become “extreme.”

That’s in large part due to recent stock performances. As of early December, the S&P 500 energy sub-index is up 53% year-to-date, nearly triple the 18% rise of Europe’s Stoxx 600 energy sub-index.

Why the Valuation Gap?

There has always been a valuation gap between American and European energy companies. but it is unusually wide at this moment. Even though the major European oil companies are moving into renewable energy in a big way, the current valuations look as if they are no longer huge oil and gas producers, nor big money makers.

But in reality, they are…and they are also paying out nice dividends to shareholders. The current yields are of the European oil majors are: BP: 4.28%; Equinor: 4.72%; TotalEnergies: 4.77%; and Shell: 4.42%.

Morningstar summed up the current sentiment around these companies this way:

“European [oil and gas] firms are investing a relatively greater portion of capital into low carbon businesses (renewable power generation, EV charging, etc.) that will reduce their relative oil and gas exposure over time. The market seems to be assigning a greater uncertainty to these transition strategies and a preference for Chevron and Exxon’s primarily hydrocarbon-focused strategies.… Regardless, the transition plans will take time to play out and hydrocarbons remain the primary driver of earnings and cash flow—and they will continue to be during the next five years, at least. As such, European integrated oils are reporting record earnings as well and directing surplus cash flow back toward shareholder returns like their American peers. However, with the lower valuation comes much higher total expected yields (dividends and repurchases). Investors are thus paid to wait for a potential valuation convergence.”

I completely agree, so let’s take a closer at the company in this category with the highest current yield, TotalEnergies.

TotalEnergies (TTE)

Total is an interesting company, to say the least. On the one hand, it is pursuing some of the energy industry’s most contentious developments, like its $20 billion liquefied natural gas play in Mozambique and a $10 billion oil project and pipeline in Uganda.

But on the other hand, Total is investing billions of dollars in clean energy projects from wind farms in the UK’s North Sea to solar plants in Iraq, to hydrogen installations spanning the U.S. to India.

In fact, the investment bank RBC Capital Markets values Total’s low-carbon business at $35 billion, making it far larger than that of any of its big competitors. The low-carbon business got a lot bigger in May with the acquisition of 50% of Clearway Energy Group, a developer of renewable energy projects. It also controls and owns a 42 % of economic interest of its listed subsidiary, Clearway Energy, into which projects are dropped when they reach commercial operation.

Total is similar to Equinor, and not BP and Shell, in that it does not plan a quick retreat from hydrocarbons. Instead, it plans to grow oil and gas production near term while delivering a reduction in emissions over time by expanding its ownership of renewable power and low carbon assets.

Total management is only investing in oil projects with less than a $30 per barrel after-tax breakeven. Oil production will grow by 1.5% per year (thanks to projects in Brazil and Africa) through 2027. Meanwhile LNG production should grow 40% by 2030, with various projects in the U.S., Qatar and Papua New Guinea.

On the dividend front, Total—like its peers—has profited from rising prices for oil and natural gas in 2022, and set aside funds for bigger shareholder payouts.

Investors in the company got an extra €1 ($1.06) per share special dividend in 2022, on top of regular quarterly payouts of €0.69 ($0.73) per share (up 5% from the year prior). The company also buys back its shares to the tune of a few billion dollars per quarter.

I expect the dividend will rise again in 2023, with another special dividend as well. TotalEnergies stock (up 17% year-to-date) is a buy anywhere in the mid-to-upper $50s.
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In recent years, whenever there has been hype in the computing sector in recent years, the GPUs (graphic processing units) produced by Nvidia Corp. (NVDA) have been involved. GPUs underpin almost all of the most exciting computing developments, from artificial intelligence (AI) to data centers to autonomous driving to video gaming graphics.

No wonder then that, in 2021, near-zero interest rates, coupled with pandemic lockdown tailwinds, saw the stock bid up by 130%, to a peak valuation of 71 times forward earnings.

However, 2022 has been a completely different story for stocks, particularly technology stocks. Rising inflation and interest rates, as well as the war in Ukraine, sent technology stocks plunging.

Nvidia’s stock has fallen nearly 50% year-to-date and is now trading on a saner forward price/earnings ratio of around 50. Given the company’s explosive growth potential in the years ahead, this is an entry point worth looking into. So let’s look at where Nvidia stands.

Nvidia Today

Before the turn of the century, computers ran on central processing units (CPUs) that were first made commercially available by Intel in 1971. Although the power of CPUs improved rapidly in the first few decades after their widespread adoption, this progress had started to slow by the end of the century.

Then, in 1999, Nvidia invented the GPU, which allows for faster computing because it uses matrix calculations (parallel computing) rather than linear calculations. Nvidia began by designing GPUs for PCs to improve gaming graphics, but since then has expanded into data centers, professional visualization, and the automotive industry.

In the third quarter of 2021, data centers made up 65% of Nvidia’s sales, with gaming accounting for a further 26%, followed by automotive and professional visualization with around 4% and 3% respectively.

It is interesting to note that automotive revenue of $251 million rose 15% sequentially and 86% annually in the third quarter. Nvidia believes that the middle of the 2023 fiscal year was an “inflection point” for automotive, as its DRIVE Orin—the central computer for autonomous driving—has “great momentum.”

In fact, Morningstar said the following: “The firm has a first-mover advantage in the autonomous driving market that could lead to widespread adoption of its Drive PX self-driving platform.”

Data Center Dominance

Data centers have only recently surpassed gaming to become the dominant division in the business. It’s easy to see why…

The consumer-facing internet and cloud giants—Alphabet, Meta, Amazon, and Microsoft—have found GPUs to be very useful at accelerating cloud workloads that use deep learning techniques to achieve speech recognition (Siri, Alexa, etc.), photo recognition (identifying faces in pictures on Facebook, cat videos on YouTube), and recommendation engines on Netflix and Amazon.

In the third quarter of 2022, Nvidia’s data center revenue soared 31% from a year ago, to $3.83 billion. This was thanks in part to Amazon Web Services’ (AWS) growing use of the NVIDIA A100 Tensor Core processor in its servers.

Along these lines, Nvidia recently announced new two-year partnerships with Oracle Corp. (ORCL) and Microsoft Corp. (MSFT) during the quarter. The Microsoft deal consisted of a contract to “build an advanced cloud-based AI supercomputer to help enterprises train, deploy, and scale AI state-of-the art models.”

Nvidia is also developing HPC (high performance computing)-as-a-service offerings, including simulation and engineering software used across industries. The company’s GPUs are deployed in 72% of the top 500 supercomputers globally, and in 90% of the new computers on that list.

Perhaps the most important characteristic of Nvidia is that it is fabless: it outsources its GPU, mostly to Taiwan Semiconductor (TSM). While this business model does leave the company dependent on TSM, it also makes Nvidia a capital light, high margin, and highly cash generative business. In 2021, its operating margin stood at 40% and its free cash flow hit an impressive $8.13 billion from just $10.7 billion of operating profit.

Nvidia Outlook

Nvidia is sitting in the proverbial catbird seat.

The company has little competition in the GPU market. Intel Corp. (INTC) and Advanced Micro Devices Inc. (AMD) make CPUs for the cloud servers, but neither can yet challenge Nvidia in designing GPUs used for machine learning and AI. For instance, Intel only launched its first GPU for data centers in 2021.

I agree with Morningstar’s assessment that Nvidia’s the data center division will enjoy at a 25% compound annual growth rate (CAGR) through fiscal 2027. And its CAGR during the same period for the automotive segment could be around 50%.

However, there is more to the future of the GPU market than just greater corporate use of the cloud. Nvidia management has said that consumer-oriented AI applications—such as “large language models, recommendation systems and generative AI”—are already driving growth, alongside the major cloud players.

This could be huge. New technology is often first adopted by companies, but demand doesn’t really grow quickly until consumer applications appear. Go back a few decades and think about how computing didn’t really take off until the personal computer for consumers appeared.

The one big cloud on Nvidia’s horizon is geopolitics and the de-linking of the American and Chinese economies. During the third-quarter results conference call, Nvidia management said: “…sequential growth was impacted by softness in China,” although no direct link to the recently passed CHIPS and Science Act legislation in the U.S. was mentioned.

Keep in mind that in 2021, 26% of Nvidia’s revenue came from China, another 32% from Taiwan, and only 16% was from the U.S. To get around the current U.S. sanctions, Nvidia has already designed a less powerful GPU that can be sold to Chinese data center businesses, but that cannot be used in supercomputing. But it is always possible the U.S. could change the law again to prevent any GPUs designed in the U.S. from being shipped to China.

That is why we are seeing a multi-year discount in the market valuation for Nvidia, a business with seemingly endless potential.

NVDA stock will not be a huge upward mover until the macroeconomic environment is more settled. However, you can begin building your position now in Nvidia, anywhere in the low-to-mid $100s.
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Unilever plc (UL) is a leading international consumer goods company, and one of the largest providers of personal care products. Some of its well-known leading brands include Dove, Lifebuoy, Hellman’s, Knorr, Axe, and Magnum.

Because of the business it’s in—consumer staples—Unilever’s stock is often thought of as a “bond proxy.” This status helped propel its shares forward during the 2010s, although that became a much less attractive characteristic at a time of rising interest rates.

Like its peers, Unilever is in a tough fight to maintain its profit margins in the face of significant and persistent food price inflation. But the company has put in a creditable performance year-to-date, with its stock down less than five percent—far outperforming the broader market.

The outperformance partly reflects the price hikes Unilever has handed to consumers.

For example, in the third quarter, the company increased its prices by 12.5% from a year earlier, its highest-ever quarterly rise! Underlying sales accelerated to 10.6% growth year over year—from 8.1% in the first half—driven entirely by price/mix. Nutrition and ice cream led the way, with an acceleration to low-double-digit growth. By geography, emerging markets were strong: year-over-year growth in Latin America was 17.6%.

Unilever achieved higher price growth than analysts had expected, with a smaller volume decline, enabling it to raise its full-year forecast for underlying sales growth to more than 8% from the previous range of 4.5% to 6.5%.

This reinforces the idea that many of the company’s core characteristics work well over the longer term for shareholders. Cementing its pricing power and providing its highly reliable cash flows is the aforementioned portfolio of products for which consumers are willing to pay up.

Change Is Coming

However, many of Unilever’s shareholders are frustrated by the company’s growth rate.

That’s why change at the top is imminent at Unilever. CEO Alan Jope is set to retire next year, having been in the job since 2018.

Jope presided over a period where there was little growth. Going back to 2016—even before he took the reins—annual net income growth at Unilever has averaged a mere 4% per year.

Keep in mind, though, that Unilever is not owned for its growth prospects, but for its reliable cash flows and consistent dividends. Over the past decade, the compound annual growth rate in the company’s dividend per share payouts stands at 6.5%. That is ahead of its peer group, thanks to a succession of above-average increases in the past five years.

Of course, no company can merit the “quality share” name if it cannot show good earnings growth. Unilever still does produce plenty of cash: its current free cash flow yield (the ratio of cash generation to a company’s share price, favored by value investors) is 5.3%. That figure is line with the company’s five-year average and looks reasonable for a quality growth stock.

But shareholders believe it is important that free cash flow per share grows in the years ahead.

To this end, Unilever says that the company’s growth prospects are about to improve. It contends that a reorganization announced in the aftermath of the botched deal for GSK’s consumer health unit, Haleon plc (HLN) will soon start to bear fruit. The company reorganized its business into five segments: Beauty & Wellbeing, Personal Care, Home Care, Nutrition, and Ice Cream.

Activist pressure in the form of Nelson Peltz’s Trian Fund will help as well. Peltz became a board member in May.

Progress seems to have begun already: Unilever’s results have started to exceed analysts’ expectations in recent quarters. And according to Jefferies’ Martin Deboo: “One of the big changes from the first half was that volumes no longer beat expectations across the board in Q3. Unilever was the only company that outperformed consensus.”

What’s Ahead for Unilever

The pressure on consumers the world over will worsen before it gets better. Management teams must balance their intent to pass on cost increases with the risk that shoppers tighten their belts by turning to private-label goods instead. And as interest rates continue to rise, the relative attraction of consumer staples’ own growth rates—already pretty meager in some cases—will continue to dwindle.

But even within the relatively defensive consumer staples space, Unilever has delivered some of the most consistent organic growth of its peer group in recent years. The breadth of the firm’s portfolio across both geographies and product categories limits risk and is a huge positive.

I expect Unilever to benefit from new products, further expansion in emerging markets, and ongoing efforts to improve productivity (cost cutting).

With 58% of reported sales coming from emerging markets in 2021, the company has one of the largest emerging markets footprints of all the global consumer staples manufacturers. This should be a long-term volume driver and profits center for the business.

Unilever is currently less profitable than many of its peers, with an operating margin of 17.0%, which is below the peer average of 22.3%. However, as management reaches its operating margin goals over time, I look for earnings and dividends to grow faster than the industry average and for multiples to expand.

Dividends (current yield is 3.52%) have been the preferred vehicle for returning capital to shareholders, with Unilever having delivered slightly above-industry-average payout ratios of at least 60% since 2012. I expect the company to maintain (and perhaps bump up) its high dividend payout ratio.

Unilever is a buy anywhere around the $50 a share level.
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