CWS Market Review – March 2, 2018

“Your margin is my opportunity.” – Jeff Bezos

The S&P 500 went 94 straight days without a 1% day either up or down. Now it’s happened 15 times in the last 24 sessions including the last five in a row (first two, up; last three, not up).

I cautioned investors that the ruckus hasn’t yet passed. Three weeks ago, the S&P 500 bounced off its 200-day moving average, and it will likely “test” that support level again. Financial markets don’t walk away from a mess like we had so easily. Fear of the market gods is clean, enduring forever.

Let’s remember that the broad economic climate is quite good. This week’s initial jobless claims report showed figures at their lowest level since the 1960s. Thursday’s ISM Manufacturing report was the best one in 13 years, and consumer confidence is now at a 17-year high.

So what’s bugging Wall Street? This week, investors got a bit spooked by fears of a trade war. President Trump proposed steep tariffs on steel and aluminum. I thought it was interesting that on Thursday, stocks of big steel consumers like Ford and GM fell hard. Our own Snap-on (SNA) was down 3.3%.

Frankly, I’m skeptical that these plans will be implemented. Within the business community, the opposition to steep tariffs is nearly overwhelming. Also, a lot of the big steel exporters are good friends of the United States. Perhaps President Trump is sending a message to China. As usual, I’ll steer clear of the politics, but I’ll comment on the policy’s impact. Wall Street will not like a trade war.

I wanted to do something a bit different this issue. I recently asked readers for some feedback on the newsletter, and I got very constructive suggestions. A number of readers wanted to hear more in-depth reasons for why I like a particular stock.

Since there wasn’t a whole lot of news this week (Jay Powell made some hawkish comments on interest rates on Capitol Hill), instead I thought I would focus on one our favorite Buy List stocks: Ross Stores (ROST). This is a good time to highlight Ross because the deep discounter will report fiscal Q4 earnings after the close on Tuesday.

Why I Like Ross Stores

I like Ross Stores a lot. This is the sixth year the company has been on our Buy List. We added the stock at the beginning of 2013 when it was going for $27 per share (that’s adjusting for one 2-for-1 split in 2015). Now it’s at $78 per share. The stock is up 188% for us in a little over five years. It’s had a few nasty dips along the way, but I’m glad we’ve stuck with it.

Our return has been even better when we include dividends. When we added Ross, the quarterly dividend was 8.5 cents per share. Now it’s 16 cents per share, and they’ll probably raise it again on Tuesday.

The upcoming earnings report will be for ROST’s fiscal fourth quarter. I have to explain that many retailers, Ross included, like to use a January fiscal year so they don’t have to break up the holiday shopping season between quarters. Also like other retailers, Ross prefers to use a 13-week reporting period rather than a three-month one. Thanks to Pope Gregory XIII, this means that every so often Ross will have a 14-week quarter. As luck would have it, this past Q4 was a 14-weeker.

The important thing to understand about Ross’s business is that they’re a retailer. That means it’s a low-margin business. In fact, it’s even more so for Ross because they compete as a deep-discount alternative to other stores. There are several ways a business can implement its competitive advantage. Some companies offer something that no else does. In Ross’s case, they’re competitive on price. What Ross tries to do is squeeze every penny out of its costs and pass the savings to its customer base.

When we look at any business for an investment opportunity, we have to ask, “What makes you different? What’s so special about you?” What impresses me about Ross is how they’re able to maintain relatively high profit margins compared with similar businesses.

Let’s look at some financials. I promise not to get too mathy. Last fiscal year, Ross Stores had total sales of $12.7 billion. Major expenses fall into two categories: the cost of the stuff they sell and the cost of running the business. What’s left is the operating profit. For Ross, last year saw an operating profit of $1.9 billion with an operating profit margin of 14%. For a retailer in Ross’s business, that’s quite good. Think of it this way. For every $1 of sales, 71 cents went to the cost of the clothes, and 15 cents went to running the store. They’re left with 14 cents.

There are two items left. The company had interest expenses on their borrowing of $16.5 million. That’s tiny—about 0.13% of sales. Finally, there’s Uncle Sam. Last year, Ross paid about 37% of its pre-tax income to the government. This gives us a net income of $1.1 billion and a net margin of 8.7% which works out to $2.83 per share.

(As a side note, the recent tax reform helps domestic retailers more than other businesses. Large tech companies can use all sorts of fancy methods to shovel their cash around the world. With retailing, that option is very limited. )

Here’s an important reason why I like Ross. Their net profit margin is actually higher than most apparel retailers including The Gap, Nordstrom and Urban Outfitters. Ross’s margins are also higher than TJX’s, their closest rival. Strong relative margins tell us two key things. One is that there’s a good chance of superior management. Secondly, it means the company has pricing power. Even with Ross’s low prices, they can go lower if they need to. (Note this week’s epigraph, courtesy of Mr. Bezos.)

The thing about the retailing business is that it’s more accurately termed the inventory-management business. Next time you’re in a Walmart, try to find an empty shelf. You’ll probably find Bigfoot first. That’s what efficient retailing is all about—keeping the merchandise flowing in and quickly flowing out. Ross does it as well as anybody.

Ross Stores Doesn’t Compete Directly with Amazon

Whenever we talk about retailing, the discussion always turns to Amazon. This is a key point about Ross Stores, and it’s something many critics don’t get: Ross doesn’t compete against Amazon. Ross is not at all like Borders or Barnes & Noble.

Let me explain the difference. Ross’s customers enjoy going to the physical stores. Many of their devoted fans go more than once a week. They enjoy the “treasure hunt” experience of shopping in the store, and you can’t easily recreate that online.

Another benefit of Ross’s business is what’s called “packaway.” This means the company can buy off-season stuff for cheap and lock it away for later. Other retailers can’t do that so easily. Let’s say the winter is unusually warm. That’s no big deal for Ross. They’ll just save their inventory for a later day. Other retailers are expected to always have current fashions. Ross can play by different rules because they’re playing a different game.

TJX is a good business, but I happen to like Ross more. They’re similar in many ways, but TJX has some stores outside the U.S. while Ross does not. TJX also sells some upscale items that you won’t find at Ross.

By the way, I should touch on an important point. Some investors are skittish about investing in a business that caters to lower-income consumers. Please, don’t let that bother you at all. Lower-income consumers are often one of the best, and most loyal, customer groups. Ross’s fans love the company, and there’s nothing wrong with giving the people what they want at a fair price. Sure, Tiffany draws some first-class shoppers, but around here, we care about stocks, and ROST has creamed TIF.

What to Expect on Tuesday

For the first three quarters of this fiscal year, Ross’s sales are up 7.6% while net income is up 11.6%. The higher net margin was helped by lower interest expenses. Thanks to fewer shares outstanding, Ross’s earnings-per-share is up by 14.6% so far this year. The company is gobbling up its own shares at an impressive rate.

In November, Ross said they expect Q4 earnings (remember this is for 14 weeks) of 88 to 92 cents per share. For the entire year, that works out to $3.24 to $3.28 per share. Ross estimates that the extra week works out to an extra eight cents per share. Here’s my take: The Q4 estimate is probably a little low, but not by much. I’ll say they made about 95 cents per share, give or take.

More importantly, on Tuesday, Ross will probably give a forecast for the coming fiscal year. I’ll caution you that Ross loves to lowball its initial estimates. That means they can raise it later on. Their first estimate for last year was $3.02 to $3.15 per share, which they later raised three times. Realistically, Ross should be able to earn around $4 per share this year. However, I expect them to go on the record with something like $3.75 to $3.85 per share. I’ll also be curious to hear about the impact of tax reform.

What about the quarterly dividend? It’s currently at 16 cents per share. I think they’ll raise it to 20 cents per share. That will give them an even 80 cents for the year which is around 20% of their profits.

Last August, when it was at $55 per share, I said Ross was “a good value.” Now it’s at $78 per share. It’s not the bargain it was, but it’s still worth owning. Ross is going for 19.5 times forward earnings which isn’t unreasonable especially considering tax reform, a higher dividend and the improved economy. Ross Stores is a buy up to $81 per share.

That’s all for now. There are some key economic reports coming next week. On Monday, we’ll get the ISM non-manufacturing report. Wednesday is the ADP payroll report. Then Friday is jobs day. The Labor Department will release the employment report for February. Wall Street estimates that 200,000 new jobs were created. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

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How to Profit from the Death of Oil

In the latest annual energy outlook from BP PLC (NYSE: BP), it was the first time the company forecast oil demand would eventually peak and then steadily decline. BP put the date for peak oil demand in the late 2030s.

And the cause is one I’ve told you about quite often in my articles – the rise of electric vehicles. BP said there would be 300 million electric vehicles on the road by 2040, up from about 3 million today. BP says electric vehicles will account for only 15% of the roughly 3 billion cars on the road in 2040. But they will account for 30% of all passenger car transportation, as measured by distance traveled, because so many of them will be shared vehicles, à la Uber.

BP’s outlook also envisaged renewable power growing from just 4% of global energy consumption today to 14% in 2040.

Add all of that up and you can surmise that a lot of changes are ahead for the oil industry. Yet only some of the world’s major oil companies are preparing for what the future will hold.

How to Get Your Cut of Apple’s Money Coming Back to the US

Financial risks can seemingly come out of nowhere. Think about how many on Wall Street were caught off guard by the 2008-09 financial crisis or even the volatility of a few weeks ago. Yet the potential risk emanating from the packaging of bad mortgages was in plain sight, but ignored.

Today, there is another financial risk lurking in plain sight. It lies in the vast overseas holdings of technology giants like Apple, Alphabet, Microsoft and many others. I discussed this topic to my subscribers in the October issue of Growth Stock Advisor. But since there is so much misunderstanding about the roughly $1 trillion (or possibly as high as $2 trillion) in funds held overseas by U.S. multinationals, I wanted to clear it up for you.

I know there is much misunderstanding about this subject just from gleaning the comments section on several recent articles published by The Wall Street Journal. Apparently, Americans are under the impression that this $1 trillion is just sitting in bank accounts overseas and that both the overseas banks and host countries don’t want to lose control of this money. Nothing could be further from the truth. Let me explain…

Posted by on March 2nd, 2018 at 7:05 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.