The stock market is ending a remarkable year, with the S&P 500 index (.SPX) returning 17%, as investors see an end to the pandemic in 2021 and corporate earnings rapidly improving.
This year also featured one of the biggest disparities ever between growth and value strategies: Growth stocks in the S&P 500 have returned 31% including dividends, while value stocks are down 1%.
Barron’s has been publishing a list of 10 favorite stocks for the past 11 years, and the performance for the 2020 group was disappointing, reflecting a tilt toward value. The 10 have returned, on average, 9.9% since the list came out on Dec. 13, 2019, nine percentage points behind the S&P 500. In contrast, our 2019 roster topped the benchmark index.
Dell Technologies (DELL) and Alphabet (GOOGL) were notable winners in 2020, but the group was dragged down by a 34% negative return for energy giant Royal Dutch Shell (RDS/B) and declines in ViacomCBS (VIAC) and United Technologies, now Raytheon Technologies (RTX) after two spinoffs and a merger.
The list for 2021 again has a value bent and includes two returning companies, Berkshire Hathaway (BRK/B) and Alphabet. It has eight new ones, including Apple (AAPL), Coca-Cola (KO), Merck (MRK), Goldman Sachs Group (GS), and Newmont (NEM).
Many of these stocks have lagged behind the market this year and look inexpensive, based on earnings, dividends, and asset value.
The group offers good appreciation potential, while providing some downside protection if the stock market, now at a near-record valuation relative to earnings, falters in 2021.
Here are Barron’s 10 stock picks for next year:
Alphabet is recovering nicely from a pandemic-related hit to advertising earlier this year. Revenue was up 15% in the third quarter, and it stands to benefit in 2021 as ad categories like travel improve. The stock looks appealing even after a 31% rise in the stock so far this year, to $1,757 a share.
Alphabet is a technology conglomerate. It has a powerhouse group of businesses, including its lucrative core search operation, YouTube, cloud computing, Android, Waze, and Waymo, the leader in autonomous vehicle technology.
The stock trades for 28 times projected 2021 earnings of $62 a share. The price/earnings ratio is overstated because Alphabet’s less-mature and valuable Other Bets businesses, including Waymo, are losing about $4 a share annually and the company is sitting on about $118 billion of net cash, or $170 a share.
The adjusted 2021 P/E of about 24 is close to a market multiple. That is inexpensive for one of the great global franchises—one that RBC Capital Markets analyst Mark Mahaney sees capable of “sustainable mid- to high-teens” growth in annual earnings per share.” He has an Outperform rating and $1,900 price target.
Antitrust action is a potential danger, but Adam Seessel, the head of Gravity Capital Management, an Alphabet shareholder, isn’t worried. “Regulation and/or a breakup would actually improve share-price performance, just as it did with Rockefeller’s Standard Oil a century ago,” he tells Barron’s. “Forced to come out from behind Mother Search’s apron, undermonetized platforms like YouTube and Android would be forced to stand on their own, make money, and drive shareholder value.”
Apple has been a juggernaut in 2020. Its shares have climbed 74%, to a recent $128, on its way to a world-leading $2.2 trillion market value.
The stock, now trading for 32 times projected earnings of $3.95 a share in the fiscal year ending in September, is historically expensive. But Apple has never been stronger, thanks to concurrent product cycles, notably the current one, which includes the hot new iPhone 12. Apple is reportedly boosting production of that mobile phone by 30% in the first half of 2021.
The work-from-home trend and the new Apple-designed M1 chip have re-energized the Mac laptop franchise. Sales are surging for devices including watches and the new $549 AirPod Max over-the-ear headphones, which are sold out into the first quarter. Then there is a lucrative and annuity-like $60 billion services business, with new offerings like Fitness+.
J.P. Morgan analyst Samik Chatterjee argues that investors may have to temper their expectations after 2020, but he still sees upside to $150 a share, based in part on an above-consensus earnings estimate of $4.45 a share in the current year.
Berkshire Hathaway is coming off one of its worst periods of performance, relative to the S&P 500, during Warren Buffett’s 55 years at the helm. The stock’s total return is 44 percentage points behind the S&P 500’s since the start of 2019.
In the past, it has paid to buy Berkshire after bad stretches, even the 1974-75 bear market and the 1999 tech bubble. Berkshire, for instance, gained 129% in 1976. Investors now seem concerned about what happens when Buffett, who is 90, leaves the scene.
The conglomerate’s Class A shares, trading at $338,500, look like a bargain at 1.2 times Barron’s projected year-end book value of about $279,000 a share—against an average of 1.4 times over the past five years. Buffett has said that Berkshire’s intrinsic value is considerably above 1.2 times book. The Class B shares trade around $222.
Berkshire is both a defensive play, thanks to its cash hoard of $145 billion, and a reopening play, because of its many economically sensitive businesses like the Burlington Northern Santa Fe railroad.
“Berkshire shares represent a solid opportunity for investors looking for stocks to own in an economic recovery,” says James Shanahan, an Edward Jones analyst who has a Buy rating on the stock.
Shanahan has no price target, but if book value grows 8% in 2021, the stock could approach $400,000 a share, assuming an expansion of its multiple of 1.3 times book.
It is encouraging that Buffett decided to buy back a record $9 billion of stock in the third quarter, or nearly 2% of the shares outstanding. That pace may continue in the current quarter, as the stock continues to trade cheaply.
With half of its sales coming from restaurants, stadiums, and other out-of-home locations, Coca-Cola was slammed by the pandemic. Yet as the world normalizes in 2021, it stands to benefit.
Coke shares, which are off 4% this year to $53, offer an underappreciated reopening play along with a safe, bond-like 3% dividend yield.
Coke also offers exposure to developing economies and a weaker dollar; 75% of its profits come from outside the U.S.
It is also a restructuring story, as CEO James Quincey has sold bottling businesses to create a capital-light company that is more focused than ever on beverage innovations.
The company remains dependent on carbonated soft drinks, which account for about 70% of sales, but contrary to popular perception, that category is expanding globally.
“The beverage industry is a growth industry, and we are the market share leader not just in soft drinks, but also in other major categories, and we are gaining share,” Quincey told Barron’s in October. Coke expects to “recover faster than the broader economic recovery.”
The stock isn’t cheap, trading for 25 times estimated 2021 earnings of $2.11 a share, and the earnings recovery is slowing with Covid-19 lockdowns and other restrictions around the world. But Coke could generate double-digit profit growth when global economies recover and become a must-own consumer stock.
Eaton (ETN) could be one of the biggest winners among industrial conglomerates from the growth of renewable power, the expansion of data centers, and the electrification of the U.S. economy.
Eaton is a leading maker of electrical equipment, including transformers, circuit breakers, uninterruptible power systems, and software. Electrical equipment accounts for over 40% of its sales. It takes more equipment and software to get electricity from a wind farm to a home than from a traditional power plant.
The shares, around $115, trade for 23 times projected 2021 earnings of $4.98 a share and yield 2.5%. The company is targeting 8% to 9% growth in earnings per share.
Gordon Haskett analyst John Inch rates Eaton shares a Buy. He says that Eaton is in the “catbird seat” moving into 2021 after a recent pruning of its portfolio.
Goldman Sachs doesn’t get much credit from investors for its blockbuster earnings in the past two quarters, rising returns, and ongoing transformation under CEO David Solomon.
The shares trade cheaply at just 1.1 times tangible book value of $215 a share and for about 10 times projected 2021 earnings. Industry leader JPMorgan Chase (JPM) fetches 1.9 times tangible book and 13 times forward earnings.
Rising book value should put a floor underneath Goldman stock. Given the past two blowout quarters, it’s a reasonable bet that the company’s 2021 earnings will top the current consensus of $23 a share. Goldman’s shares could approach $300 next year as a result.
Goldman and other big banks got some good news late Friday, when the Federal Reserve allowed them to restart share repurchases in the first quarter—earlier than many analysts and investors anticipated. Bank stocks rose in after-hours trading, with Goldman up about 5%, to $254.
The Wall Street bank’s traditional strengths in trading and investment banking helped produce a record third quarter, earnings $9.68 a share. Unlike arch rival Morgan Stanley, Goldman has been focused on building, rather than buying—Morgan Stanley purchased E*Trade Financial earlier this year and has a deal for asset manager Eaton Vance (EV).
Goldman has created an impressive online consumer banking platform under the Marcus banner with nearly $100 billion in deposits and a credit-card relationship with Apple.
Goldman is seeking to boost more-durable revenue streams and garner a higher valuation on its stock. Evercore ISI analyst Glenn Schorr is looking for a strong fourth quarter.
Graham Holdings (GHC) is a miniature version of Berkshire Hathaway controlled by the Graham family, which has a long relationship with Buffett.
The low-profile Graham Holdings used to be known as the Washington Post Co., but it sold the flagship newspaper to Amazon.com (AMZN) CEO Jeff Bezos for $250 million in 2013. The CEO of Graham Holdings is Tim O’Shaughnessy, the son-in-law of former boss Don Graham, son of the famed Post publisher Katharine Graham, who died in 2001.
The conglomerate now holds a valuable group of TV stations, a sizable education business under the Kaplan banner, and a grab bag of other assets, including auto dealerships and several Washington, D.C., area restaurants, including the well-known Old Ebbitt Grill near the White House.
The shares, which are off over 25% this year to $464, trade for about half of their estimated asset value of $910 a share, according to Craig Huber of Huber Research Partners, one of the few analysts covering the company. Graham Holdings has a market value of just $2.3 billion.
Like Berkshire, the company has a great balance sheet and is expected to have about $500 million in net cash following the sale of a podcast business to Spotify Technology (SPOT) and a pension plan that is overfunded by about $1.5 billion. The free-cash-flow yield on the stock is nearly 10%, and the company bought back 6% of its shares this year.
While the Graham family is unlikely to sell the company, its “valuation metrics are too attractive to ignore,” Huber wrote recently. He has a price target of $610 on its stock. One potential catalyst: a spinoff of the TV stations.
This is a cheap play on the reopening of Las Vegas and New York, two cities hard hit by the pandemic.
Madison Square Garden Entertainment (MSGE), which owns the Madison Square Garden arena in Manhattan, is one of two companies formed from the April split of Madison Square Garden. The other is Madison Square Garden Sports (MSGS), which owns the New York Knicks and the New York Rangers.
MSG Entertainment shares, at about $80, have badly lagged behind those of leading concert operator Live Nation Entertainment (LYV) in the past six months. MSG Entertainment is valued at less than $2 billion and has net cash of nearly $1 billion.
The cash will largely go toward construction of a state-of-the-art concert venue in Las Vegas called the Sphere, due to be completed in 2023. The Sphere is expected to cost close to $1.7 billion and about $500 million already has been spent on it.
Investors worry about the ultimate returns on the Sphere and the current cash burn at the company, given that Madison Square Garden is shuttered to sports fans and concertgoers. But the company has adequate liquidity, says Jonathan Boyar of Boyar Value Group, whose firm holds the stock.
“When the virus passes, MSG Entertainment should be poised to capitalize on robust pent-up demand from consumers and artists with its strong pipeline,” Boyar observes.
Prepandemic, Madison Square Garden was the world’s top-grossing arena, and bookings for 2021 are running 50% ahead of what had been reserved for 2020.
Boyar values the company at $115 a share, while John Tinker of G.Research sees it climbing to about $145, citing its “unique entertainment assets” including the Christmas Spectacular with the Rockettes at Radio City Music Hall in New York.
Boyar says that Chairman and CEO James Dolan, whose family controls the company, might be interested in taking it private.
Major drug stocks have rarely been so inexpensive relative to the S&P 500 in the past 15 years, and Merck (MRK) is a prime example.
Shares of the pharmaceutical giant are down 12% this year to $80. They trade for 13 times projected 2021 earnings of $6.29 a share, against a market multiple of about 23. Merck has a secure 3.3% dividend yield, double that of the S&P 500.
Merck was slow in developing a Covid-19 vaccine—it is months behind Pfizer (PFE) and Moderna (MRNA)—but it has one of the industry’s best overall vaccine franchises, led by Gardasil for cervical cancer. That franchise could be worth half of its current market value of about $200 billion.
Analysts see high-single digit earnings growth in the coming years, adjusted for the pending 2021 spinoff of a unit that will be called Organon, which will include the slower-growth women’s health business and off-patent drugs. One of the more promising drugs in Merck’s pipeline is an oral antiviral for Covid-19.
The company’s top drug is Keytruda, which harnesses the immune system to fight lung cancer and other malignancies. It may generate over $14 billion in sales this year—30% of Merck’s total revenue. Keytruda’s patent expires in 2028, but Merck has plenty of time to deal with that.
J.P. Morgan analyst Chris Schott, who has an Overweight rating and a $105 price target on Merck, sees an “attractive upside case for the stock” based on margin improvement, 7% annualized revenue growth through 2025, and potential acquisitions enabled by the pharmaceutical maker’s strong balance sheet.
Gold remains a good hedge against ultraloose monetary policies worldwide and possible higher inflation. The metal has risen 24% this year to $1,880 an ounce, but it is way behind Bitcoin, a digital alternative, which is up 220% to more than $23,000.
One of the better ways to play gold is through mining industry leader Newmont. At $60, its stock isn’t expensive, fetching 14 times estimated 2021 earnings of $4.15 a share and yielding 2.7%, against 1.6% for the S&P 500. Its shares have pulled back lately, along with gold, which peaked at over $2,000 an ounce in August. The shares would gain over 20% if they merely got back to their August high of $72.
Newmont boosted its payout by 60% in October under a policy tying the dividend to gold prices. The company sees annual free cash flow of more than $3 billion annually at current prices, for a 6% free-cash-flow yield.
“Our portfolio is hitting its stride,” Newmont CEO Tom Palmer told Barron’s in October. Investors worry about mines being wasting assets, but Newmont expects to maintain annual gold production of six million ounces or better for a decade—and beyond.
Joe Foster, portfolio manager of the VanEck International Investors Gold fund (INIVX), sees gold and gold stocks as alternatives to low-yielding bonds. Among alternative assets, none have gold’s “established history of a store of wealth,” he recently wrote.
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