As we mentioned in our last email, valuations are amongst the most expensive in history. For instance, the S&P 500’s CAPE ratio is 38 for the only the 3rd time in history, along with 2000 and 2022. Those bubbles led to bear markets, although the 2000 one was far worse than 2022 of course, as the Nasdaq dropped 80% peak to trough. Another example is that the price to sales ratio has never been higher in history. Yes, AI is a transformational technology, akin to the internet’s impact, but clearly a great deal of optimism is priced in at this point. With that said, the beauty of the stock market is that there are almost always opportunities if you have the wherewithal and the temperament to find them.
TTCM has been opportunistically buying undervalued publicly traded real estate investment trusts the last two years. When we do so, we look for strong balance sheets and cash flows, growing dividends, and valuations that are at large discounts to intrinsic value. Overall, these investments have worked very well, but there is still a tremendous amount of room for growth over the next 3-5 years.
Healthcare stocks are also on sale after suffering the biggest crash in the last 20 years. There are a few things at play. For one, the market consensus tends to believe that the current administration is less favorable for big pharmaceutical companies. In addition, billing scandals and reduced compensation on Medicare and Medicaid are pressuring the large managed care providers, which had been on a massive long-term stock rally since the passing of Obamacare years ago. Now valuations are much more attractive in the sector, but the stocks do indeed have some hair on them. These tend to be businesses with pretty stable cash flows, good balance sheets, and high returns on equity, so the upside potential is substantial!
Another area of opportunity is in old-fashioned consumer staples companies, such as Pepsi, Kraft, General Mills, and Campbell Soup. These are companies that are indeed challenged due to changing diets, new medicines targeting reduced appetites, and a changing regulatory environment. With that said, these businesses still have products that are consumed weekly, if not daily by millions of people across the globe. They generally have good balance sheets, high returns on equity, and the key point is that now the valuations are hugely attractive. We saw Pepsi have a great rally after reporting earnings and guidance that were simply not nearly as bad as had been expected. When you are buying stocks that are so cheap relative to intrinsic value, you just need to avoid disaster to do well, which is the opposite of the perfectly priced stocks, where any earnings or guidance less than expected can result in catastrophic drops in share prices.
Now this email mentions a few sectors and specific stocks that we find cheap in general. I’d also throw in commodities stocks, such as miners and oil, where we have found some really good opportunities. It’s important to keep in mind that we use a multi-faceted approach into building positions. This can mean buying the stock, bonds, or selling cash-secured puts, or covered calls. We love for instance when between the dividend and the covered call, we get what we believe to be a relatively safe double-digit cash return, while also keeping upside on the stock. These tactics are most valuable in down, flat, or slightly up markets, which we think we will see a lot more of over the next decade giving the high valuations at the present time.
