CWS Market Review – June 19, 2020

“The expectation of an event creates a much deeper impression on the exchange than the event itself.” – Jose de la Vega, 1688

After last Thursday’s unpleasantness, when the S&P 500 plunged nearly 6%, the stock market has been much more relaxed this week. At one point on Monday, the S&P 500 was down 2.5% during the day. Yet by the closing bell, the index had eked out a small gain. That was only the third time in the last ten years that a 2.5% drop wound up being a day in the black.

So the bulls haven’t all been scared off. In this week’s issue, I want to cover some of the recent economic data, which hasn’t been good; it just hasn’t been quite as terrible as previous data. I’ll also preview next week’s earnings report from FactSet. The stock is having a good year for us. I also have some updated Buy Below prices for you. But first, let’s review some recent economic data.

Where the Economy Can Improve, It’s Improving

On Tuesday, the Census Bureau said that retail sales rose an amazing 17.7% last month. It’s not often you see a retail-sales report beat Wall Street’s consensus by 10%. Last month’s result was the best on record, by far.

Get used to seeing a lot of that. We saw lots of economic data recently that was among the worst on record. Now that some sectors have reopened, it’s only natural that we’re seeing a pronounced snap back.

So is the economy back on track? Not exactly. While the retail-sales report is good news, the government’s stimulus checks clearly played a role. We still have a long way to go till the economy is fully back on its feet. Much of that will be due to the course the coronavirus ends up taking. Gradually, more companies are getting back to normal.

Here’s the retail-sales chart. Sometimes the chart really does tell the story.

Disney World looks to start reopening on July 11. Disney World Hong Kong just reopened, and Shanghai Disneyland opened up in May. Speaking of Disney World, the NBA looks to finish off its regular season starting in late July. All games will be played at the ESPN Wide World of Sports Complex in Disney World.

Also on Tuesday, we learned that industrial production rose by 1.4% in May. Some factories are coming back online, albeit only partially. The economy is a long way from full capacity. Industrial production is still 15.4% below where it was in February.

In last week’s issue, I mentioned that the recession-dating committee officially declared that the recession had started. There’s a good chance that this could be one of the quickest recessions on record. There was a brief recession in 1980 that only lasted six months. We could see something like that. The difference is that this recession is much steeper.

This week, we learned that homebuilder confidence rose sharply in June. That’s a good sign. On Wednesday, the Commerce Department said that housing starts rose 4.3% in May. This was the first increase since January. Housing starts are still bad, but the increase is off the lowest reading in five years. This aligns with the previous report which tells us that the economy is in rough shape, but where it’s allowed to improve, it’s improving.

On Thursday, the jobless-claims report fell to 1.508 million. It’s odd to say that’s a good number, but it’s the tenth-straight improvement in a row. Continuing claims decreased slightly, from 20.606 million to 20.544 million.

Finding a Competitive Advantage

Since this is a fairly short issue, I wanted to talk a little more about proper stock selection and how to find superior investments. I’m often asked about this, and it’s an interesting but complex topic.

I’ll try to keep it simple. My basic plan is to find companies with a distinct competitive advantage. Here’s a good way to think about this (I’m heavily borrowing from our friends at Investopedia for this example).

Let’s say you have a lemonade stand and business is going well. You suddenly have an idea. Normally, your stand buys lemons each morning. Instead of doing that, you decide to buy a bunch of lemons at the beginning of the week. Your supplier gives you a bulk discount.

Let’s say, this cuts your cost of goods sold by 20%. In terms of economics, this is a huge deal. This means you can cut your prices by 20%, thereby gaining market share, and it will have zero impact on your gross profit margins. This is great news for you and your business.

As much as we love this, there’s one small problem. While it’s a great idea, it’s just an idea—and one that can be easily copied by your competitors. Once they discover the secret, your advantage is gone.

Now let’s say you come up with a second idea. You invent a revolutionary new lemon squeezer that’s so good, you get 20% more juice out of each lemon. Once again, this is a huge deal in terms of business economics. You’re effectively cutting your costs of goods sold by 20%, and again, you can pass those savings on to your customers with no impact on your gross margins.

But there’s a crucial difference between the first example and the second. In the second case, you can patent your lemon squeezer. That means you can line up state power to enforce your invention monopoly. The idea in the first example isn’t protected the same way.

The second example shows the kind of company I look for. I look for firms that do things that no one else can do. Several stocks on our Buy List have strong competitive advantages. In particular, I think of companies like Moody’s (MOC) or Fiserv (FISV).

With that said, how do you know if a company has a strong competitive advantage? There are a few characteristics that typically show up.

Oftentimes, the company we’re looking at has a consistent operating history. Sales and earnings edge higher nearly every year. There may be bad years, but the positive trend is clear.

This tells me a few things about the business. First and most obviously, it’s a growing enterprise with a steady demand for its products. It also tells me that management is probably on the ball. That’s because in a dynamic marketplace, you need to make a lot of small corrections to keep the ship moving.

A company with a consistent operating history also probably has a loyal customer base. Never overthink a business. You can make a lot of money selling the same thing to the same people. Ask Starbucks (SBUX).

Lastly, investing in companies with a consistent track record is an easy way of reducing risk. I’m not a fan of “oil well” stocks. These are companies that appear flat broke but are pinning all their hopes on some deal that may never come. There are too many of these stocks around. When in doubt, I always prefer a stock that grows its business each year.

A company should also have the ability to raise prices. This is a subtle rule, so let me explain what I mean.

You’ll notice that I didn’t say I look for companies that do raise their prices. Rather, the key is finding ones that, if the need arises, can raise their prices.

Think about the items in your home or office. Now imagine which ones you would still buy even if they raised their price by 10% or 15%. Some items you’d simply stop buying. But not all.

Why? Maybe you’re attached to it. Or maybe it’s an integral part of your day. I have friends who would make their daily Starbucks run no matter what.

Also, a company that has the ability to raise its prices most likely has a firm handle on its costs. That way, it can pass savings along to its customers, which builds customer loyalty

There’s a risk component as well. No company wants to raise prices, but it’s nice to be in a position where they can do so if need be.

Ability to raise prices is often a sign that a company has a dominant position in its market. I often think of Harley-Davidson (HOG), the legendary hog stock and former Buy List member.

I also like to see a company that is the dominant player in a niche market. A company doesn’t have to own the world to be successful. Owning the best autobody shop in town, or the best Thai restaurant in town, can be a great business.

Why? Because the firm is doing something no else can do. In business, there’s a term called “switching costs.” This refers to the cost for a consumer to change his or her preference. With toothpaste, folks aren’t so picky. With eating habits, people can be very picky.

For a business, you want to be the dominant player, even if it’s in a very narrowly-defined market. Think of the ratings agencies. If you want to float a bond, you pretty much have to deal with Moody’s or S&P.

Warren Buffett often tells the story that the perfect business to own is an unregulated toll road. The fixed costs are low, and drivers need to use it.

On our Buy List, we have Broadridge Financial Solutions (BR). This is the dominant player in share-voting proxies. This is the kind of business not one person in 20 ever thinks about, but it fills a concrete need.

You can spot a dominant player because it often has modest debt levels, wide operating margins and strong cash flow.

I hope that gives you a better idea of what I look for when selecting our Buy List stocks. I’ll have more details in upcoming issues. Now let’s look at next week’s earnings report.

FactSet Earnings Preview

FactSet (FDS) is due to report its earnings on Thursday, June 25, before the stock market opens. This will be for FactSet’s fiscal Q3 earnings, which ended on May 31.

I like this company a lot, and it’s one of the stocks that has a strong “moat,” meaning a strong position in its market. Three months ago, FactSet reported solid results from its fiscal Q2. The company earned $2.55 per share which beat consensus by six cents per share. Quarterly revenue rose 4.2% to $369.8 million. This was for the quarter that ended on February 29, so coronavirus didn’t have a noticeable impact on its operations.

For FactSet, the key stat to watch is Annual Subscription Value, or ASV. For Q2, that stood at $1.44 billion. ASV is growing at more than 4%. At the end of Q2, FactSet’s client count reached 5,699, and the user count is up to 128,896. Annual ASV retention is over 95%.

At the time of the Q2 report, FactSet stood by its full-year earnings estimate of $9.85 per share to $10.15 per share. Like nearly everybody else, FDS rallied nicely off its low, although the stock recently pulled back over 10% in four trading days.

Wall Street currently expects Q3 earnings of $2.43 per share. That sounds about right.

Updated Buy Below Prices

Before I go, I want to update a few of our Buy Below prices.

Ansys (ANSS), a new stock for us this year, has been doing well lately. The May earnings report was quite good. This week, I’m raising our Buy Below on Ansys to $300 per share.

Church & Dwight (CHD) has rallied for the last four days in a row. It’s now up 10.6% this year. The shares just hit a nine-month high on Thursday. I’m raising my Buy Below on CHD to $80 per share.

Danaher (DHR) has also been acting well lately. The stock hit another new high this week. It’s now a 14.7% winner for us this year. I’m lifting our Buy Below to $185 per share.

That’s all for now. Next week, we’ll get the existing-home sales report on Monday and the new-home sales report on Tuesday. Thursday morning will be busy, as the jobless claims report is due out. At the same time, the Q1 GDP revision comes out. This will be the second revision to Q1 GDP growth. As if that weren’t enough, we’ll also get the report on durable goods at the same time. 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

Posted by on June 19th, 2020 at 7:08 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.