Readers who followed this series on my 20 highest-rated stocks may be a bit flummoxed. The top four stocks have not garnered the highest scores among my top twenty names. My response is that although I have confidence in my rating system, the system alone does not drill down into every aspect of a company as an investment. I compare it to a coach placing a pinch hitter into a game: the rating system puts you into the batter’s box. You must assess each pitch.
Three of the four companies featured in this article earned their way into my portfolio due to the safety provided by these firms as investments. Microsoft (MSFT), Kroger (KR), and Discover Financial Services (DFS) each possess competitive moats. All three companies boast exceptional, shareholder-friendly management teams. In the case of Kroger and Discover, I believe both trade below fair value.
Microsoft’s growth story, provided it continues, should offer investors market-beating returns far into the future.
The case of Expedia (EXPE) is, in my estimation, an example of market mania. Here is an opportunity to invest in a solid company at an artificially low entry point.
Microsoft is an anomaly among the stocks I’ve highlighted. Unlike the other 19 names, my rating system provides a score indicating Microsoft is trading at fair value. However, I have stated on more than one occasion that my rating system has an Achilles’ Heel: companies growing at a rapid pace never appear undervalued. Consequently, it is remarkable that my rating system grades MSFT as trading at fair value. All other companies with growth rates matching Microsoft’s score very low on the valuation scale.
Moat, Management, Growth, and Financial Stability… Microsoft Has It All
Microsoft boasts a wide moat, and Satya Nadella ranks among the best of CEOs. When the company won the Department of Defense $10 billion Joint Enterprise Defense Infrastructure (JEDI) contract, it served to highlight the progress Microsoft has made with Azure.
JEDI is only one of the many large fish the company landed. Azure also netted Microsoft contracts with Walgreens (WBA) for $500 million, AT&T (T) for $2 billion and an unrelated DOD contract for $1.8 billion. While discussing contracts of this nature and scope, Satya Nadella recently stated that Microsoft, “has line of sight to many more such deals.”
Despite Microsoft’s enormous size, I believe Azure will continue to drive share value for the foreseeable future. I also have high hopes for the firm’s initiative with Augmented Reality-related products and services.
My recent investigation into Microsoft leads me to believe the company has an investment profile that is likely to provide steady, safe returns over the long haul. I am in the process of completing an in-depth article on the firm that should be published on SA by the end of this week. If you are skeptical regarding Microsoft’s growth potential, I recommend you read my upcoming article.
Arguably the greatest concern for investors is that the company currently trades for a premium. Should Microsoft fail to execute, the shares could suffer a significant decline. The size of the company means the sums required to move the growth needle are enormous.
As I type these words, MSFT shares sell for $149.33.
My Valuation Score for MSFT is 67, and my Overall Score is 79. (My rating system is outlined below.) Morningstar has an FV of $155 and CFRA of $138.57. Argus has a target price of $173, and Credit Suisse provides a target price of $155.
My rating system indicates MSFT has a fair value that is likely near the lower range of the figures cited above.
For my recent article on this company, see “Kroger: A New Initiative That Could Be A Game Changer.”
This will come as a surprise to many: Kroger is the third-largest retailer in the world! Even so, the company only operates in 35 states. I contend that the number of players in the low-margin grocery space are likely to decline, and that translates into a solid future for this firm.
The company’s E-commerce sales are growing, and Kroger’s private-label products are driving margins. I believe the company possesses a narrow moat, and I have a great deal of faith in the Kroger’s management team.
I have the good fortune of having two members of my extended family that hold a business relationship with Kroger. One is a serial entrepreneur that supplies produce to grocery chains. The other is a former executive with a company that supplies major retailers, including Kroger and Target (TGT). Both have high opinions of Kroger. The former executive describes Kroger as “a juggernaut” that other grocery chains “seek to emulate.”
Margins are thin, and competition is fierce in this space.
As I compose this article, KR shares sell for $27.34.
My Valuation Score for KR is 83, and my Overall Score is 68. (My rating system is outlined below.) Morningstar has an FV of $27, CFRA of $34.92, Argus has a target price of $32 and Credit Suisse provides a target price of $30.
My rating system indicates KR has a fair value that is likely near the lower end of the figures cited above.
Discover Financial Services #2
For my recent article on Discover see “Discover Financial Services: Give This Company Credit Where Credit Is Due.”
On the basis of ROE, Discover consistently ranks among the highest performing banks. The company possesses a narrow moat, has exceptional management and rewards shareholders with a long-term, robust, stock buyback program. The company’s credit card offerings operate in a sort of sweet spot (credit scores of 700-749) that results in a reasonable risk profile, while at the same time resulting in a relatively large pool of customers with balances at the end of each month.
If rates inch higher, this would eat into profits.
The evolution of new paying systems could disrupt credit card models.
As I compose these lines, DFS shares sell for $84.87
My Valuation Score for DFS is 83 and my Overall Score is 75. (My rating system is outlined below.) Morningstar has an FV of $89, CFRA of $93.53, Argus has a target price of $105 and Credit Suisse provides a target price of $99.
My rating system indicates DFS has a fair value that is likely near the lower end of the figures cited above.
For my recent article on this company, see “Expedia: Manic Market Reaction Or Moribund Money.”
Expedia shareholders suffered the largest one-day decline of the shares in company history. While the headwinds that prompted the selloff are real, the company is still growing at a high rate. Furthermore, forecasts for all forms of travel are robust; future trends in the industry are promising.
Expedia is steadily gaining market share in the US. The concerns that prompted the selloff will likely require the company to increase marketing costs by a sum equal to 2% of sales. While this is a considerable cost, it is not a death knell event.
My position is that the size of the recent selloff was unwarranted. From the time my article recommended buying the shares until today, a period of less than two weeks, the stock has rebounded more than 5%.
Google (GOOG) and other competitors moving into this space will result in significant headwinds.
As I type these words, Expedia shares sell for $101.66.
My Valuation Score for EXPE is 93 and my Overall Score is 83. (My rating system is outlined below.) Morningstar has an FV of $170, CFRA of $99.38, Argus has a target price of $130 and Credit Suisse provides a target price of $159.
My rating system indicates EXPE has a fair value that is likely near the middle of the figures cited above.
I have a full position in Kroger that I have held for an extended period. I am confident in the long-term prospects of this company.
I recently initiated a small position in Discover. I’ve also sold puts in hopes of obtaining additional shares at lower cost.
I recently initiated a full position in Expedia. I intend to treat this stock as an opportunistic trade. Although the shares have appreciated markedly since my related article debuted, I believe the stock has room to run.
I am adding incrementally to my position in MSFT. My most recent share purchase was on 12/02/19.
Understanding The Rating System
I follow approximately 180 dividend-bearing companies. In the middle of each month, I review each company and provide an updated score.
For example, my Valuation Score for EXPE is 93 and my Overall Score is 83.
The first number represents the Fair Value of the company and measures six valuation metrics. The highest FV score possible is 100. A company is considered significantly undervalued with a score of 83 or higher. A company trading near fair value would score a 67.
The second number represents the overall score of the company. This takes into account the moat, management, past and projected growth rates, financial strength, historical ROIC and valuation of the company. The highest score possible is a 100. A score of 83 or higher is rare.
The rating system is far from foolproof; however, my initial testing (it has been in use for a year) indicates a Valuation Score of 83 combined with an Overall Score of 63 provides investment targets that often outperform the market. The overwhelming majority of companies score far below 83 for valuation and 63 overall.
In this article, you may note the highest-rated stock may be ranked below a company with a lower rating. That is because I weigh other factors when ranking the company in question. Nonetheless, the rating score plays a large role in how I assess a company’s likelihood of performing well over the long term.
A List Of Additional Companies The Rating System Ranks As Trading Below Fair Value
For a variety of reasons, the following companies failed to rank among my top twenty. In some cases, the company’s future is too opaque for me to rank it higher without reservation. In other instances, I ranked a company rated higher due to my having previously conducted due diligence of one and not the other. When two companies appear nearly equal according to my rating system, I will always opt for the company I have researched (provided the research led me to have above-average confidence in the company’s future).
The following is a list of companies that score as undervalued by my rating system (score of 83 or better) and also have an overall score of 63 or higher. The companies are not listed in a particular order. Most provide regular dividends.
Abbott (ABT), Analog Devices (ADI), Best Buy (BBY), BP plc (BP), The Greenbrier Companies (GBX), Gilead (GILD), General Motors (GM), IBM Corp. (IBM), j2 Global (JCOM), Kohl’s (KSS), ManpowerGroup (MAN), Medtronic (MDT), Morgan Stanley (MS), PACCAR Inc. (PCAR), Polaris (PII), Raytheon (RTN), Seagate Technology (STX), United Technologies Corp. (UTX), Ventas Inc. (VTR), Walgreens, Xerox (XRX), Berkshire Hathaway (BRK.B) and Micron Technology (MU).
It is important to note that I re-rate each company in the middle of each month. An event between re-rating periods can cause a marked change in a company’s valuation score. This is particularly true when quarterly results are provided between re-rating periods and the company misses projections by a wide margin.
My list of twenty stocks constitutes the best-scoring firms among the 180 companies I follow. The overall market is trading at a high valuation. Consequently, most companies’ shares are also trading at high levels. Therefore, the companies listed are those that I believe are trading at the best valuations among those I follow. This does not mean that I advocate investing at these levels. You may note that I am often selling puts in the listed companies at a share price significantly below the current value rather than buying at these levels.
One Last Word
I hope to continue providing my articles without cost to SA readers. If you found this article of value, I would greatly appreciate your following me (above near the title) and/or pressing “Like this article” just below. This will aid me greatly in continuing to write for SA. Best of luck in your investing endeavors.
Disclosure: I am/we are long MSFT, KR, DFS, EXPE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Additional Information
I have no formal training in investing. All articles are my personal perspective on a given prospective investment and should not be considered as investment advice. Due diligence should be exercised, and readers should engage in additional research and analysis before making their own investment decision. All relevant risks are not covered in this article. Readers should consider their own unique investment profile and consider seeking advice from an investment professional before making an investment decision.