5 Stocks to Buy While They’re Still Cheap After Earnings
Susan Dziubinski: Hello and welcome to the Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning I talk with Morningstar Research Services chief US market strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead. Now, before we begin, a programming note for viewers, our show on Dec. 2 will be a viewer mailbag episode.
So send us your questions. Just remember, Dave cannot give individual investment or portfolio advice. Email your questions about companies and the markets to [email protected]. All right, Dave, let’s get started. Good morning. So finally, we have a week to breathe a little bit, the election and the Fed meeting are over. Earnings season is winding down, but we do have perhaps the most important company in the market reporting earnings this week, and that’s Nvidia. So should investors expect another blowout quarter?
David Sekera: Well, Susan, it’s always impossible to know beforehand, but yes, we would expect another strong quarter out of Nvidia where they should easily be able to beat their own guidance. You know, in fact, after talking to Brian [Colello], the equity analyst that covers that stock for us, I think Nvidia has actually alluded to the fact they’re already sold out of their new Blackwell products for at least the next 12 months.
Really, the only constraint on this company right now just seems to be their ability to supply as much demand as there is out there for their AI chip business. And I know within our own financial model, Brian assumes that the company is going to be able to build—sorry, is going to be able to sell pretty much everything that it can build for at least the next 12 months.
And of course, they can charge whatever price they want to at this point, and people are paying it.
Dziubinski: So what would you be interested to hear more about from Nvidia when it comes to AI in general?
Sekera: Well, whether or not you’re invested in Nvidia, I think it’s actually going to be very instructive to listen to their conference calls. I think they’re going to become increasingly more educational over time and really be able to help investors learn more about the evolution of AI. Now, in my opinion, when it comes to AI and investing, when I look at what’s happened over the past year and a half, it’s been all about the picks and shovels.
What I mean by that is they used to say that during the gold rush, the old adage was it wasn’t the miners that always got rich, but the people that sold them the picks and the shovels. And that’s really what we’ve seen here in AI for the past year and a half.
Looking forward, I think 2025 is really going to be all about who’s going to be able to utilize AI to drive revenue growth and/or use AI within their own business process to enhance productivity and expand their margins. So some of the topics, I’d like to learn more about, that I think in some cases Nvidia might touch upon in some of their calls, it’s just going to be more specificity and how are Nvidia GPUs being used, what are the specific use cases here? What percent of AI workloads are training versus inference? What is the firm seeing regarding development of large language models in the cloud versus at the edge? And what is it seeing from customers, doing what they’re calling moon shot projects: genetics, drug discovery, robotics, and autonomous driving.
Dziubinski: Now, Nvidia stock took a bit of a breather over the summer, but it’s been on the rise during the third quarter and it’s up nearly 200% this year. How overpriced is it today?
Sekera: Yeah, it’s interesting. It was for a couple of months in that $100-$125 trading range. But then we saw it recently break out to the upside. Once the market hit new highs in October, it still continued to rally to the upside from there. At this point, it trades at a 35% premium over our fair value of $105 a share, which puts it in that 2-star category.
Dziubinski: We also have a couple of big names in retail reporting this week: Walmart and Target. How do they each look heading into earnings? And does Morningstar prefer one stock over the other?
Sekera: Well, Walmart is a 1-star rated stock, trades at a 50% premium to our fair value—I mean, that in my mind is really a huge premium. Now, Target is a 3-star rated stock, but looking at where it’s trading at, it’s getting pretty close to that 2-star rating category. To be honest, I don’t have an interest in either one of these stocks.
You know, Walmart is the better company, wide economic moat. But at 33 times this year’s earnings, that’s just way too high of a valuation according to our model. Now, Target is less overvalued, but it is a company with no economic moat. So, again, at this point, from my point of view, I’d be a better seller than buyer.
Dziubinski: What do you want to hear about during their earnings calls?
Sekera: Fundamentally, Walmart has been doing great. They’re seeing an increase in the number of new shoppers, getting a lot of foot traffic coming in. And essentially a lot of people that are trading down from traditional supermarkets. Of course, the compound impact of inflation over the past two years, that has really taken its toll on low-income and middle-income consumers.
So a lot of people trading down to Walmart with its everyday low price. Now, Target kind of seems lackluster in our view. That’s not necessarily surprising. We don’t think Target has the same value proposition as Walmart. They’re not picking up the same amount of foot traffic, not doing as well as Walmart. And I’d say additionally, Target is seeing a lot of pressure on their sales, specifically for discretionary goods, which of course is a high percent of their business and a high-margin part of their business.
Dziubinski: All right. So let’s move on to some new company-specific research from Morningstar. Home Depot reported earnings last week. Report was solid, our Morningstar analyst raised her fair value a bit. So what are the key takeaways on this one for investors?
Sekera: Now, the results were slightly better than expected, but Jamie [Katz] did notify in her note that a significant portion of that was due to hurricane-related sales. So those are going to be more one-off in nature. Yeah, away from the hurricane, she noted that high interest rates, macroeconomic uncertainty, those continue to pressure and maybe even stall a lot of home projects for renovation by do-it-yourself customers.
Specifically, she evidenced a 6.8% decline in big-ticket sales. And then also, more interestingly, she did write here about the potential impact of tariffs. She noted that barring that worst-case scenario of a 60% tariff on Chinese products, she doesn’t think the implementation of those tariffs would necessarily have a material impact on the results.
Dziubinski: So then how does Home Depot stock look from a valuation perspective?
Sekera: This is a similar story as to what I’m seeing across a lot of the stocks in today’s marketplace. You know, it’s a high-quality company, wide economic moat, low uncertainty, all the things that you’d be looking for. Earnings, doing well enough, although I wouldn’t say anything necessarily spectacular. Looking forward when I take a look at the modeling, we are forecasting a five-year revenue compound annual growth rate of about 4%.
So essentially inflation plus some organic growth over time. But that only leads to a five-year compound annual growth rate of earnings of 5%. The stock’s trading at 27 times this year’s earnings; in my view, that’s probably too high based on our long-term outlook. So a 1-star rated stock, trades at a 39% premium to our fair value.
Dziubinski: All right. Well, Cisco reported earnings last week. The company beat on earnings and revenue, but the stock was down a bit after the report. So what did Morningstar think of the results and were there any changes to our fair value estimate on the stock?
Sekera: Yeah, Cisco is a 2-star rated stock, trades at a 15% premium. So we do think it’s a bit higher than what we would like to see. And again, similar to Home Depot, it’s just another story where we think the company is doing just fine, but the market is just way overestimating its long-term growth.
Now, Cisco did raise their fiscal year 2025 guidance, but that just puts that in line with our forecast for 4% sales growth. Our analysts noted that the sales outlook for the quarter ending in January is $13.8 billion at the midpoint, but again also in line with what we already had in our model. Now that growth does equate to an 8% year-over-year growth rate, but we think that’s over depressed demand last year.
Results have been really pretty choppy over the past years just due to overordering and inventory destocking. So again, nothing here that really changes our view on the long-term outlook for that stock.
Dziubinski: All right. Let’s talk a little bit about Bristol-Myers, which was a pick of yours on last week’s show. Shares popped after competitor AbbVie reported disappointing results for the trial of its new schizophrenia drug. So what was Morningstar’s take on the news? And after that price pop, is Bristol-Myers still a buy today?
Sekera: And this is just kind of one of those instances. Oftentimes in finance, you’re just better to be lucky than be smart. We didn’t necessarily know that any of those results were going to be coming out here in the short term. So AbbVie’s drug would have been a competitor to Bristol-Myers schizophrenia drug, Cobenfy.
So after the news, we did increase our sales estimate for Cobenfy to $5 billion by 2033 from $3.6 billion. Just because we’re now assuming less competition from that drug, and our analysts noted that it also helps to solidify Bristol-Myers’ wide economic moat. Slight bump up in our fair value on Bristol-Myers to $66 from $63. Our fair value on AbbVie is unchanged.
It does leave Bristol-Myers stock still rated 4-stars trading at a 15% discount. So it’s still attractive in our view. AbbVie still remains in that 3-star territory.
Dziubinski: Now, a viewer of last week’s show asked for Morningstar’s updated take on Huntington Ingalls Industries, which was a pick back in July. The stock plunged 26% after reporting earnings a couple of weeks ago. What happened?
Sekera: Yeah, well, I wanted to wait to talk about this one just because I did want to talk to Nic [Owens], our analyst on the stock, before we talked about it. And, to some degree, just like our mea culpa on Estee Lauder this week, I think we do need to acknowledge that this has been a worse situation than what we originally realized.
So to get to it, the long story short here is labor and material costs have both risen pretty significantly over the past few years. And in fact, they’ve risen ahead of what was contemplated about a decade ago when they signed the original contract to build the current batch of submarines for the US government. And according to Nic, it appears that building these submarines might actually be unprofitable right now.
Now, what the market’s been expecting is that Huntington has reportedly been negotiating its next contract with the US government and the next batch of 17 submarines. Now, the market’s been expecting that the US government will provide enough incentives and work enough margin into this contract really to be able to make up for the excess costs in that previous contract.
However, for whatever reason, the contract is taking much longer to finalize than what the market has been expecting. We’ve expected actually to see this contract, it would be publicly announced by now. So taking a look at the stock action, looks like to me a lot of investors are just throwing in the towel on this one, that we probably have institutional investors telling the traders to just get me out of this position.
Looks like they’re pushing this thing down. They’re just hitting up, hitting any bid that’s coming up; it also could just be that they want to get out before year-end. They may not necessarily want to show this position on their portfolio when they have to report the year-end positions. And lastly, I’d also notice no- note of that—Jeez, I need some more coffee this morning!
And also note that this is a small-cap stock. So it does have a smaller base of institutional investors that know the name, or a smaller base of investors that are willing to take larger positions as that stock falls.
Dziubinski: All right. So then what was Morningstar’s take? Did we make any changes to our fair value estimate on Huntington stock?
Sekera: Counterintuitively, we actually slightly increased our fair value to $326 a share from $322. Of course, on a percentage basis, that’s de minimis. So really, to me and that’s really thinking about our stock price is unchanged. The only reason that we increased that fair value is because we are incorporating lower capex spending into our model for both the medium and the long term.
I’d also no- note of—wow, why am I having such a tough time this morning? I’d say we also updated our uncertainty rating on this one to medium from low, and we think that just better reflects the risk to quarterly results, which, of course, on a company’s fixed-price contract like this, their revenue recognition is regulated based on when the company is able to meet certain completion end points.
And that’s when they can realize that revenue. So when they’re not meeting some of those completion end points, that pushes off the revenue recognition until the next quarter.
Dziubinski: So then would you say that Huntington is still a buy?
Sekera: Going to put me on the spot here? All right. Well, first of all, I would say I think this is really just a good example of why, when I look personally to build a position, I usually start with about a half a size position. The reason being is that then leaves me some dry powder. That way, if a stock does sell off, it gives me the ability to sit back, reevaluate the position, determine whether or not we think the long-term investment thesis still holds true, whether or not we still believe in our long-term intrinsic valuation.
And if that’s true, then we’re able to buy maybe another quarter-size position and dollar-cost average down. So in this case, yes, we do still think it’s a buy. In fact, after the selloff, it’d be more of a buy now than it was before. But, you know, I’ll just caution investors that the status of this contract is hard to estimate right now.
My guess is this contract is probably going to be delayed until the Trump administration takes over. You know, they may want to get their own hand in the mix of the negotiation here. So this might be more of a middle of next year event at this point. But ultimately, after talking to Nic and really thinking through what the US Navy is looking for, we still think that they’re looking at really that strong necessity to have that strong submarine program.
Dziubinski: Well, as we mentioned at the top of the show, Dave, earnings season is winding down. So how did third quarter earnings pan out?
Sekera: Generally, I’d say third quarter earnings pretty much shaped up as we expected, with the US economy running at a faster rate than ourselves or I think really anyone else expected at the beginning of the quarter. You know, most companies had no problem either meeting or beating the guidance. The only problems were guidance for the fourth quarter has disappointed.
Now, I’ve heard of really only a few instances where management expressed that caution regarding how the economy is doing and maybe expected it to slow a little bit. And in those cases, you know, provided that conservative revenue guidance in anticipation of that slowdown, but really not nearly as many as maybe I think a lot of people would have expected.
Now, the other thing going on is the cost-cutting efforts that were put in place earlier this year in anticipation of a potential slowdown this year are all yielding very positive results. You know, we’ve seen large management teams guide to much stronger operating margins. So what we’ve seen here is those companies that report strong third quarter earnings, but maybe weaker-than-expected revenue guidance.
You know, the downward stock price movement has actually been relatively largely muted at this point. But considering earnings should have been pretty easy to meet or beat, any company that’s guiding down toward weaker earnings, those are the instances where we’ve seen those stocks got hit much harder.
Dziubinski: Well, gaze into that crystal ball of yours and what are your expectations for fourth quarter earnings?
Sekera: Well, of course, we are not short-term traders. But having said so, right now it looks like the fourth quarter is really shaping up to be a lot like what we saw in the third quarter. The economy is still running at a rate that’s better than expected. And in fact, if I look at the Atlanta Fed GDP now, that’s running at a 2.5% run rate, that’s higher than our own forecasts.
Our US economist Preston Caldwell recently bumped up his GDP for the fourth quarter to 2%. And I think it’s pretty likely that cost-cutting programs are still going to keep margins relatively elevated and should bolster earnings for this quarter. So at this point, I think the real key won’t be until next February.
And of course, that’s when they’ll report earnings for the fourth quarter. But more importantly, we’ll get some guidance for both revenue and earnings for 2025, and we’ll see how that shakes out. And of course at that point in time, we’ll hopefully get more details on what the Trump administration, what they’re going to actually try and do and get done, as opposed to just the campaign trail rhetoric that we’ve heard thus far.
How much are they going to focus on taxes? Are they going to try and cut corporate business taxes down to 15%? Yeah, we’ll focus on what they’re talking about as far as tariffs. Is it going to be the across-the-board tariff? Is it going to be just on China? You know, are they going to have tariffs on Mexico?
And of course, even within the tariffs, what are the carve-out provisions going to be? That’s really going to be, I think, what makes or breaks a lot of the stocks in the first part of next year. Now, of course, we also have the Federal Reserve. Their next meeting would be in January, on the 28th and 29th, and then they have another one on March 18 and 19.
So if inflation remains sticky over the next couple of months and doesn’t moderate as we expect, at that point, we could see the Fed halt any further easing to the monetary policy. Now, when I think about what’s going on in the US market, it is trading at a pretty high premium to our fair value at about 6% right now.
So I think we’re probably going to be, you know, in a pretty steady environment through the end of this year. As we’ve talked about, those macro dynamic tailwinds I think are still overpowering some of the headwinds. But in early 2025, I wouldn’t be surprised if we see some heightened volatility, maybe some selloffs and some downward price action.
But for now, I think things are looking pretty good through the end of this year.
Dziubinski: All right. Well, we’ve arrived at the part of the show everyone’s waiting for, Dave, and that’s for your picks of the week. This week you’ve brought us five stocks that Morningstar likes after earnings that are trading at 4- and 5-star levels, which means we think they’re undervalued. Your first three stocks this week are all undervalued, large-company stocks.
So before we get into them, talk a little bit about valuations among large-company stocks today.
Sekera: Yeah, I mean, large-cap stocks are trading very overvalued in our mind, probably a 7%-8% premium over fair value. Going back through 2010, there are only very few instances where we’ve seen large-cap stocks trade at that much of a premium. And unfortunately, the last couple of times that we’ve seen them trade at that kind of premium have also been instances where the market has peaked out.
Is that going to be true here today? Well, we shall see. Once the guidance for 2025 comes out, if that guidance is in line or higher, then maybe we still have some more room to run. But at this point, I think large-cap stocks have probably pretty much run their race. We see much better value in mid-cap and small cap.
Dziubinski: All right. So your first pick this week is Microsoft. Give us the key metrics on the stock today.
Sekera: Four-star rated stock, trades at a 15% discount to fair value, although it’s only I think about 0.8% dividend yield. Maybe not necessarily a stock for those looking for high dividend yields, but a high-quality company, wide economic moat. Our analysts noted that moat primarily is coming from switching costs, but they also do have network effects, they’ve got cost advantages as secondary moat sources as well. And it’s also a stock we rate with a medium uncertainty.
Dziubinski: Now, Microsoft stock fell after reporting earnings at the end of October. The stock’s only up about half as much as the broader market this year. Why do you think that is?
Sekera: You know, like anything else, the short answer is I don’t really know. It’s always impossible to tell why a stock may trade the way that it does in the short term. Taking a look at the charts here, maybe it could be some technical factors. Maybe institutional investors were already full on the name to start off with, could also be maybe less interest in some of the large-cap stocks as people are rotating out of the large caps and into mid- and small caps.
Maybe it’s just the market rotation out of tech and into defensive. But at the end of the day, there’s always a lot of noise in the market, especially in the short term. And as long-term investors, what we try and do here at Morningstar is help people look past the noise and only focus on signal.
So at this point, we do think the stock is undervalued from a long-term intrinsic valuation standpoint. So this might be a good stock, especially if we saw any selloffs in that large-cap category. One to keep on your buy list.
Dziubinski: Microsoft’s been a pick of yours several times on the Morning Filter this year. What’s Morningstar’s thesis on the stock and what’s the market missing?
Sekera: You know, it could be that maybe the market’s a little too focused on the revenue guidance. It was a little late last quarter as compared to expectations. But they did have better-than-expected margins, so that did lead to better-than-expected earnings growth. Now, fundamentally, when I think about Microsoft and look at its different parts of its businesses, it is doing very well overall.
But more specifically, Microsoft is one of these instances where they’ve been able to capitalize on the increase in demand for artificial intelligence computing power. Specifically, they are seeing demand increase for both the hyper cloud environment in general, but most specifically on its cloud platform, Azure. That’s the platform to support all that AI growth.
And that part of their business, according to their analysts, had actually been constrained by not having enough capacity for the amount of demand. As they build out capacity there, we actually expect to see accelerating growth over the next two quarters. The other thing that I like here is that even though they are spending more money on capex to build out that platform, they’re still able to maintain and even bolster their margins.
And that’s really a large reason we’re expecting or forecasting a compound annual growth rate over the next three years of about 15%.
Dziubinski: All right. So your second stock pick this week is Alphabet, which is another name you’ve recommended more than once this year on the show. So run through some of the key data points on this one.
Sekera: So Alphabet’s a 4-star rated stock, trades at a pretty healthy 22% discount to our fair value. Not necessarily a name for dividend investors—I think it’s only about a 0.5% dividend yield. But again, high-quality company, wide economic moat. In this case, that moat is derived from their intangible assets, network effect, cost advantage, and customer switching costs.
So four out of five of those moat sources, and a stock that we rate with a medium uncertainty.
Dziubinski: Unlike Microsoft, Alphabet stock has pretty much kept pace with the market this year. And the stock did just fine after the company reported earnings in late October. Yet Alphabet still looks undervalued to Morningstar. So why does Morningstar think the stock has more room to run?
Sekera: I mean, fundamentally, the company, as you noted, is still hitting on all three main business lines, you know, their search and advertising, YouTube, and more specifically Google Cloud, they’re all growing at a strong pace. But really, it’s Google Cloud growing at like a 35% year-over-year rate that’s really shining, you know, at this point in time.
But they’re also noting that even in the search business where they have their artificial intelligence overviews, that also is leading to more user engagement and more ad clicks as well. Taking a look at our model here, for the next three years, we have a compound annual growth rate of almost 12% for revenue.
Looking to get very good operating leverage off of that. So over three years, our compound annual growth rate for earnings is 21%, yet the stock is only trading at 21 times this year’s earnings forecast. So for now, we think the market is just overpenalizing the stock for the antitrust concerns. Really, three main antitrust cases out there.
We think the Google search antitrust case is probably the most material to the company. So we are waiting for the DOJ to come out with a recommendation to the courts, maybe by the end of this year. And in that recommendation, we think there’s a pretty high probability that they may try to call for the divestiture of Android and Chrome.
Of course, you know, even after that recommendation comes out, we’ll have a very long appeal period. But really, mostly what our analyst is pointing to is that we just don’t think that Alphabet is going to get broken up. In order to impose a breakup, the DOJ has to prove that other remedies wouldn’t work that would effectively do the same thing as a breakup.
So all of that would have to get instituted, tried, and measured even before they could get to the point to really try and push the case for that breakup.
Dziubinski: Your third pick this week is a drugmaker, GSK. Give us the overview.
Sekera: Five-star rated stock, 43% discount to fair value, healthy 4.7% dividend yield. Company with a wide economic moat. That economic moat is going to be based on their patents, economy of scale, and their network as well. And another stock with a medium uncertainty.
Dziubinski: Now GSK stock is in the red this year. Is Zantac litigation the reason why, or are there other factors at play here?
Sekera: Well, that Zantac litigation was one of the reasons why we thought GSK had been trading below our long-term valuation earlier this year. That’s actually since been resolved. Now, the settlement did come in probably at the high end of our expected range, but it wasn’t enough for us to change our valuation. Yeah, there’s some other factors out there that impact the stock as well, including the foreign exchange rate with the US dollar.
I’d note that back in 2022, when the US dollar was appreciating, this stock did relatively poorly. Now as the USD strengthens again here, we did see that stock recover. But again, it could be that maybe the market is just selling off on expectation of even further dollar strength going forward. Mostly, though, I would say the recent downdraft really at the end of last week was, you know, after the election of Trump, he announced that RFK Jr. was going to be put in charge of the Health and Human Services.
Now RFK Jr. is a pretty well-known skeptic regarding the safety of certain vaccines, especially in children. Now, GSK did get hit, although I’d note that like Pfizer and Moderna, those stocks were hit pretty hard after that announcement. So in the case of GSK, about one third of their business are vaccines, although I don’t think GSK would be as adversely affected as either Pfizer or Moderna.
GSK was not involved in the mRNA vaccines. And in the case of GSK, their largest single vaccine is for shingles, which of course is more for older adults.
Dziubinski: So then what’s Morningstar’s long-term thesis on GSK?
Sekera: Again, it is a UK company, but it is one of the largest global pharmaceutical companies out there, a very wide portfolio of drugs across several different therapeutic classes: respiratory, cancer, antiviral, and of course vaccines as well. Our investment thesis here is that we see relatively minor near-term patent losses.
We think that they should have pretty steady growth over the next three years. And we’re forecasting average annual sales growth of 4% over the next five years. And we think new products should offset any generic competition that they do see from some of those patent losses. In my mind, really, this is just truly a value stock.
Looks pretty attractive to me as it trades at about 9 times 2024 earnings estimates.
Dziubinski: And your last two picks this week qualify as reflation plays. Explain to viewers what reflation means.
Sekera: Well, a reflation play is really going to be trying to invest in those stocks that should benefit in anticipation of an economic recovery, especially after a period of stagnation or if we were to have had a recession. So I think the idea here is that, as economic growth is expected to start to accelerate, it could lead to a rise in inflation, higher interest rates, but probably also an increased demand for goods and services.
And I think also propping up the trade right now is we do have the Fed, the ECB, and China all easing monetary policy. I think all of that is expected to bolster global economic growth, possibly driving inflation as well. And of course, now we have the reemergence of the Trump administration, which generally I think most people in the market think they’ll lower regulations and his ability to try and drive a positive economic environment based on some of the policies that he’ll probably try and put through.
Dziubinski: But even if inflation doesn’t tick back up, you still think these are good stocks to own at current prices, right?
Sekera: Exactly. These are stocks that trade at both pretty significant margins of safety from their long-term intrinsic valuation. And we think that their underlying businesses will benefit from that stronger economy, probably starting really in the second half of next year. And what I also like, too, is that both of these stocks pay relatively high dividend yields, so you get paid while you wait.
Dziubinski: All right. Well, let’s get to them, Dave. You know, speaking of dividend yield, your first pick is Dow, and that’s a really attractive dividend yield on this one. Run through the numbers on the stock and briefly explain how it fits that reflation theme.
Sekera: So it’s a 5-star rated stock, trades at a 37% discount, and as you know, high dividend yield at about 6.4%, a company we rate with a narrow economic moat, in this case really due to cost advantages it has due to its ethylene and poly polypropylene manufacturing operations in North America. A stock we rate with a medium uncertainty.
Now the thing with this company is, over the past few years they’ve suffered from both supply chain disruptions as well as that broader global economic slowdown, specifically in China and in Europe, because the US economy has held up better than expected. And also what I’d note here is that they are a commodity chemical producer. So, of course, their results are going to be subject to pretty high operating margins. So, a small increase and or decrease in volumes can have a pretty large impact on profits overall. So in this case, we expect that a global economic recovery will certainly bolster volume. And as a producer with cost advantages, its profitability should be much better than peers in an environment where inflation either remains sticky or could even start heading back up.
Dziubinski: So then when does Morningstar expect a recovery here? And what’s our long-term outlook for the company?
Sekera: Yeah, we pushed our recovery expectations back a little bit. So what happened here is that when Dow reported third quarter earnings, guidance for the fourth quarter came in a little below the median consensus estimates. So at this point, we reduced our forecast for the remainder of 2024 and into 2025 as compared to our prior outlook. Specifically, we lowered our long-term forecast for revenue growth to a 2.5% compound annual growth rate over the next five years.
That was 3% before, but we still forecast its operating margin will gradually expand over that time period. We’re looking for it to expand to 11% by 2028. Our prior forecast was for 13%, but yet the stock still trades at 19 times this year’s projected earnings. But if we are correct about margin normalization, starting in next year and going forward, it’s only trading at 13 times our projected earnings for 2025.
Dziubinski: And then your last pick this week is Devon Energy. Give us the metrics on this one and how it fits that reflation idea.
Sekera: So it’s a 5-star rated stock, trades at about a 20% discount, 5.2% dividend yield, although I will caution that their dividend policy is what’s called a fixed plus variable. So they do have a small fixed dividend. And then, every quarter that’s going to go up or down based on their earnings. The company’s stated capital allocation strategy is to return 70% of free cash flow to shareholders.
So as that free cash flow goes up and down, that will impact the variable part of their dividend. Company has a narrow economic moat, medium uncertainty. The reflation play here is as a global economic recovery starts, that should spur demand for oil. And if that happens, we could see a pretty sharp increase in spot oil prices.
Of course, changes in oil demand in the short term can have some outsize impact on prices. And if so, that earnings growth in the short term could be a catalyst for the market sentiment to improve for the energy sector. Energy, specifically oil, has had a tough time over the past couple of months as oil prices have languished and generally traded downward.
Dziubinski: Yeah, and talk a little bit about why the stock is having a tough year. It’s because of those oil prices, right? And then why do you like the stock anyway?
Sekera: Oil prices started off pretty good and on an upward trend, but they peaked in April. They’ve been on pretty much a downward trend ever since. So pretty negative sentiment in the market right now, specifically for those names that are involved in exploration and production. But Devon recently reported their earnings, there was no change to our long-term assumptions.
We still continue to view the company as a pretty steady, low-cost provider. Their assets are in the low end of the US shale cost curve. So we think even in this low price environment, they’re still able to have pretty strong profitability. As such, our fair value is unchanged at $48 a share after those earnings.
Dziubinski: Well, thanks for your time this morning, Dave. Viewers who’d like more information about any of the stocks Dave talked about today can visit morningstar.com for more details. We hope you’ll join us for the Morning Filter next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.
Got a question for Dave? Send it to [email protected].
link