Where To Find Attractive Growth Opportunities Amidst The “Profit Recession!”
Note: Two week free trials to the Biotech Forum are in effect for new subscribers only until the end of Friday April 15th. Come try the #2 most subscribed to service on SeekingAlpha’s Marketplace and see why our portfolio has far surpassed the performance of the overall biotech sector since its launch in April of 2015. Also check out our reviews!
Equities have staged a remarkable comeback after their deep early declines to begin 2016. I think is quite amazing the S&P 500 has been able to sprint back to breakeven levels after being down slightly more than 10% in early February. This is especially true as the world economy is seeing its lowest economic activity levels since 2009, first quarter domestic GDP growth looks like it will come in just above flat line, and most importantly there is no earnings growth in the overall market.
The current consensus has profits falling nine percent within the S&P 500 when first quarter earnings reports are tallied. Given analysts always set a pretty low bar for companies to step over, I would expect earnings will “only” be down five to seven percent when things are all said and done. Out of the ten sectors in the S&P 500, only Healthcare, Telecommunications and Consumer Discretionary are expected to produce year-over-year profit growth. Financials, Materials and Energy are projected to see the biggest earnings declines this quarter.
This is hardly a new challenge for stocks as it will be the fourth quarter in a row that profits have declined and if that nine percent downturn as projected turns out to be accurate, it will be the worst quarterly decline in profits since 2009. Revenues have declined year-over-year in the S&P 500 for five straight quarters as a strong dollar and tepid global demand have been very challenging headwinds to overcome.
Goldman also noted to start the week that more than 75% of S&P 500 firms will be unable to execute discretionary buybacks until early May which will dampen what has been one of few consistent sources of demand in the market. For these reasons, I am very cautious on the market at this point in time after the recent buoyancy in equities.
Given this, I have slowly started to build my cash allocation back up in my portfolio in recent weeks. In addition, the bulk of my holdings are in sectors and stocks that can actually deliver both earnings and revenue growth in a very challenged global environment. One of primary sectors that can accomplish this at the moment is biotech. It is also a key reason the sector seems to have bottomed and has been moving up off its deepest and longest bear market since the financial crisis in recent weeks. I expect this outperformance to continue throughout the second quarter and beyond.
There are myriad good values in the large cap portion of this sector which until its recent rally was selling at its lowest overall valuation levels in five years. Typical of the bargains still available in this space is AbbVie (ABBV), a stock that I have profile repeatedly on these pages and is finally moving up. Basic attractive attributes are earnings growing at 15% to 20% annually, an almost four percent dividend yield and a valuation of under 12 times forward earnings.
Homebuilders also look like good values after a recent decline since summer despite the best year for housing starts in 2015 in eight years. There are myriad firms in this space that warrant consideration here. Starting with Toll Brothers (NYSE:TOL) which was the subject of a positive article in Barron’s this week which predicted the shares had 40% upside potential. Earnings should be up 30% this year and 10% to 15% in FY2017. The shares are a solid value at just under 11 times this year’s profit consensus.
My favorite homebuilder and one I have given a “shout out” to many times on these pages, LGI Homes (NASDAQ:LGIH); jumped last week in trading. The company reported very strong first quarter home closing figures which showed closings had jumped over 20% from the same period a year ago. This homebuilder is still cheap as investors continue to believe it is much more linked to the energy industry given its headquarters in Texas than it is in reality. Most of this homebuilder’s communities are not in the energy intensive parts of the Lone Star State like Houston, and 50% of its homes are now built outside of Texas as well. Profits should be up some 35% this year on a 30% jump in revenue. Even with this week’s rally the shares go for just over eight times earnings.
Finally, Alphabet (NASDAQ:GOOGL) is one of the few large cap technology stocks that should be able to deliver solid earnings and revenue growth in 2016. The company continues to dominate the search market, basically splits the online advertising market with Facebook (FB) and its YouTube business is growing faster than Netflix (NASDAQ:NFLX). You are basically getting its venture capital like arm (Driverless cars, global internet, web services, etc..) as an equity kicker and this is wise investment in future growth opportunities. You are paying a decent premium to the overall market multiple. However, for a company that continues to see earnings and revenue growth in the mid-teens, it is worth anteing up a bit for quality especially in a market that is in the midst of a severe growth recession at the moment.
Thank You & Happy Hunting
Founder, Biotech Forum
Disclosure: I am/we are long ABBV, GOOGL, LGIH.
For more information on Bret’s core investing strategy that is hugely successful in the lucrative biotech sector, consider Bret Jensen’s exclusive investment service, The Biotech Forum on Seeking Alpha.
Originally published at seekingalpha.com.