Farr, Miller & Washington is a "buy-to-hold" investment manager, which means we make each investment with the intent to hold the position for a period of 3-5 years. Nevertheless, in each of the past twelve Decembers I have selected and invested personally in ten of the stocks we follow with the intention of holding for just one year.
These are companies that I find especially attractive in light of their valuations or their potential to benefit from economic developments. I hold an equal dollar amount in each of the positions for the following year, and then I reinvest in the new list.
The following is my "Top 10 for 2020," listed in alphabetical order.* This year's stock picks represent a nice combination of growth and defensiveness.
Results have been good in some years and not as good in others. I will sell my 2019 names on Tuesday, December 31st and buy the following names that afternoon.
(Prices as of Close on Dec. 19)
Disney is finishing up one of the most transformative years in the company's history after the closing of the 21st Century Fox (21CF) acquisition and the launch of its new direct-to-consumer (DTC) service, Disney+. The 21CF deal provides Disney with a deep library of content that will be included on its DTC products (Disney+ and Hulu), along with a strong international presence that will enable the company to broaden its global reach. Disney+ has blown away expectations in its initial launch with more than 10 million people signing up in the first 24 hours. The service will expand to Eastern Europe in early 2020, with Latin America to come on-line later in the year. The shift to DTC requires significant investment and will weigh on earnings over the next few years, but the move will lead to a reliable stream of recurring revenues. Additionally, the company will have access to important data on consumption that will allow Disney to interact with the consumers in ways it has not been able to prior. Disney's core businesses remain in good shape. In particular, the Parks & Resorts segment should benefit from the opening of Star Wars: Galaxy's Edge at both US parks, and the studio just set another record with more than $10 billion in global box office sales for 2019.
The stock trades at 26x the consensus for CY2020, which is well above historical averages. However, if we exclude the losses associated with its DTC investments, as well as the dilution from the Fox deal, the multiple is more in-line with historical levels. The dividend yield is 1.2%.
FedEx stock has been a disappointment over the past couple of years. We think the underperformance reflects a combination of weaker global economic growth, the trade war with China, a poorly timed acquisition of European delivery company TNT Express, and the perception of a competitive threat from Amazon.com. While the first three concerns are mostly valid, the Amazon threat is likely overblown. It has taken FedEx several decades to build a world-class distribution network, the likes of which cannot be replicated over a short period of time. Furthermore, we believe the rapid growth in e-commerce will create the opportunity for several different package delivery companies to flourish in the years to come. With regard to slower economic growth, it is true that the company's earnings power can be heavily affected by a deteriorating economic backdrop, to include reduced trade. The reason is that FedEx, along with other transportation companies, have high fixed costs that cannot be quickly and efficiently eliminated in the event of a widespread decrease in demand for its services. Somewhat offsetting the economic and trade risks are the ongoing restructuring of the company's Express segment and the potential for meaningful improvement at TNT Express, both of which serve as sources of profit growth that are not as heavily dependent on the underlying economy. Also providing some downside protection is the company's current valuation at just around 12.2x our expectation for CY20 EPS, which is a sizable discount to both UPS and the S&P 500. We believe this is a company that should reward the patient investor. The yield is 1.8%.
Valmont Industries is a relatively small company that manufactures engineered poles, towers and other structures for a number of different applications, including roads and highway safety, utilities, telecommunications, and access systems for construction sites. The company also produces mechanized irrigation systems and metal coatings for its own products as well as those of third-party customers. We view the company as an investment in infrastructure development that should benefit from the long-term global secular trends of population growth, urbanization and water scarcity. Over the nearer term, the company's performance stands to benefit from a possible large-scale infrastructure bill in the US, the ongoing buildout of the 4G and 5G telecommunications networks globally, efforts to harden the power grid in the US and beyond, and improved farmer incomes following several years of weakness. The company's performance has been spotty in recent years given global economic volatility and trade concerns. Still, at just 17x the consensus estimate for 2020 EPS, we believe that patient investors could be well rewarded over time as economic growth improves. The company also offers a strong balance sheet and cash flow, and a dividend yield of a bit over 1%.
Lowe's is one of the two companies that dominate the home improvement retail sector in the United States. The other company, Home Depot, has greater market share than Lowe's and has consistently outperformed Lowe's over the past several years in term of sales growth and profitability. However, Lowe's hired industry veteran Marvin Ellison in mid-2018, and Mr. Ellison has implemented an aggressive transformation of the company that has just begun to pay dividends to shareholders. Ellison's efforts in such areas as merchandising, distribution and supply-chain management, labor management, customer service, marketing and the targeting of the professional customer should result in the potential for a long runway of improved performance relative to its rival Home Depot. We also expect that the company's significant investments to improve its e-commerce and Canadian operations will contribute to the turnaround story. Finally, we believe that following many years of subdued residential investment, the home improvement sub-sector of retail is relatively attractive compared to the industry at large. Despite strong performance in 2019, the stock still trades at just 18.2x the consensus estimate for 2020. The dividend yield is 1.8%.
Becton Dickinson is a global supplier of medical devices, hospital supplies, diagnostic equipment, and medication management systems to hospitals and labs. BDX's portfolio is diversified across a number of categories and geographies with high exposure to consumable products that produce recurring revenues. The company should continue to benefit from the following long-term secular trends: 1) Aging populations spending more on healthcare in developed nations; 2) Rising wealth in emerging economies leading to higher healthcare spending and a greater focus on safety; and 3) Movement in the U.S. health care market away from products and towards "solutions." Becton Dickinson has a strong track record of growing sales and earnings faster than the overall market. The company's earnings did not drop during the 2008/2009 financial crisis, and we believe that the long-term growth algorithm (e.g. 5-6% revenue growth and low- to mid-teens EPS growth) is reasonable and attractive in the current slow-growth environment. Questions about the future of the Affordable Care Act could weigh on the shares over the near term, but the long-term secular trends cited above should ultimately outweigh these concerns. The risk/reward appears positive with the stock trading at 20.7x estimated CY20 EPS. The dividend yield is 1.2%.
CVS Health provides health plans and services through its health insurance offerings, pharmacy benefit manager (PBM), and retail pharmacies. Last year, the big story around CVS was the acquisition and integration of Aetna. The focus in 2020 will be on the execution of its long-term initiatives, which were laid out at the June Investor Day and included a plan to return to sustainable double-digit EPS growth in 2022. We believe that the vertically-integrated model will allow CVS to achieve substantial cost savings while providing better outcomes and engagement for its members. CVS has enormous scale with about 70% of the US population living within three miles of a CVS retail location. This bodes well in the evolving healthcare landscape where trusted brands and a nationwide footprint are essential keys to success. CVS's businesses are stable and generate strong cash flows, thus enabling the company to de-lever the balance sheet to its long-term target of 3x debt-to-EBTIDA within two years. The stock currently trades at 10.4x estimated CY20 EPS and offers investors a 2.7% dividend. The depressed valuation reflects a combination of industrywide headwinds and concerns around the health of the legacy businesses, but we believe the risk/reward tradeoff is attractive for long-term investors.
Johnson & Johnson is one of the world's largest and most diversified healthcare companies with revenue divided between the Pharmaceutical, Medical Device, and Consumer segments. The company should continue to benefit from an aging global population and rising standards of living in the world's emerging economies. JNJ's Pharmaceutical segment is well positioned to achieve industry-leading growth over the next few years thanks to ten blockbuster drugs that are in the early stages of growth. The Medical Device segment has underperformed the market over the past decade, but recent investments in innovation have rejuvenated the growth outlook for this business. The stock will likely trade in reaction to litigation headlines over the near-term, but the underlying strength in its core businesses should lead to market share gains over the long term. JNJ sports a rare AAA-rated balance sheet, produces ample free cash flow, and generates above-average returns on equity. The stock trades at 15.9x estimated CY2020 EPS, which reflects a 12% discount to the S&P 500. This reasonable multiple, the 2.6% dividend yield, and our expectation that JNJ should continue to grow faster and in a more stable fashion than the overall market over the next five years, underpins our positive view of the stock at current levels.
Microsoft is one of the largest technology companies in the world. It has successfully pivoted from a Windows PC-first world to the cloud. The company has become a strategic partner in enterprise digital transformations through its cloud, app and infrastructure, and artificial intelligence offerings. There is a lot of runway left for cloud growth as companies slowly deal with legacy investments that still drive value but are not cloud-based. MSFT is uniquely positioned to grow its wallet share of corporate IT budgets in this hybrid world. It is also encountering new opportunities in security, compliance, and workflow, and the transition to subscription-based sales is no longer a headwind to free cash flow growth. Shares trade at 27.2x the CY20 EPS estimate. We think the premium valuation is justified given the above-trend growth, exposure to secular trends and strong balance sheet. Compared to software peers, the valuation is quite reasonable. The dividend yield is 1.3%.
Chevron is a US-based integrated oil and gas company with global operations. Unfortunately for the company, the price of oil continues to suffer from oversupply fears. On the demand side, the picture has not been much better. Overall, demand is still growing very slowly as consumption has likely peaked in the developed world but continues to grow in emerging markets. With regard to production, oil fields have natural decline rates of roughly 5-7% globally. However, decline rates for US shale wells are far more rapid, with initial production rates falling 70% over the first 12-18 months of operation. While overall production from the fracking of shale rock is rising domestically, few are able to achieve sufficient returns on capital. Consequently, US production growth continues to decelerate. After massive spending several years back, Chevron has been devoting more focus to its cost structure, and we believe the company would generate cash sufficient to cover capital spending and dividends at a price of $50 per barrel of Brent. We see production volumes increasing 3-4% per year through 2022 without an increase in capital spending. We believe this discipline should serve the company well in this new era of shorter oil cycles. The stock is trading at 17.0x CY20 estimated EPS with a 4.0% dividend yield. Including share repurchases, we think cash returned to shareholders next year should be north of 6%.
Truist is the company that was formed by the recent merger of banks BB&T and SunTrust. The merger created the sixth-largest bank holding company in the US (by assets and deposits) while also forming a banking powerhouse in the high-growth Southeastern states.We are supporters of the merger as it will yield a large amount of expense synergies and provide the resources to accelerate investments in transformative technologies.The merger should also lead to some revenue synergies and enhanced diversification as each legacy bank cross-sells its respective products and services. Once integrated, we expect Truist to generate industry-leading expense efficiency and returns on equity, allowing for a higher valuation multiple on a price-to-book (P/B) basis. Because the integration is being managed by highly regarded BB&T Chief Executive Kelly King, we expect a disciplined and conservative approach. And finally, the earnings accretion from the integration should act as an engine for earnings growth even as the operating backdrop remains difficult (low interest rates, subdued economic growth). At around 12.3x our current expectation for EPS in 2020, the stock is reasonably priced. However, we believe earnings growth should handily outpace the peer group over the next several years as the integration is completed.
Source: Thomson Reuters, Bloomberg, and Yahoo Finance. Long-term growth rates are an average of FirstCall, Bloomberg, and FMW estimates, depending on availability.
Michael K. Farr is president and CEO of Farr, Miller & Washington, LLC, a Washington, DC-based wealth management firm. He is chairman of the investment committee and is responsible for overseeing the day to day activities of the firm. Prior to founding Farr, Miller & Washington in 1996, he was a Principal with Alex, Brown & Sons.
* The reader should not assume that an investment in the securities identified was or will be profitable. These are not recommendations to buy or sell securities. There is risk of losing principal. Past performance is no indication of future results. If you are interested in any of these names, please call us or your financial advisor to discuss.