Investing Ideas: July 2018

Wow, the time sure flies!  We’re half-way through July already!  That means it’s time for one of my monthly “Investing Ideas” posts!

In my continuing quest to find good places to invest excess cash, I’m always searching for interesting stocks, funds, REITs, ETFs, bonds and preferred shares to potentially buy.

Week after week, I’m hunting for good investment ideas, but July in particular was a difficult month to find anything interesting.

In general, I try to find good returns by investing in businesses with a significant margin of safety, a growing stream of dividends, and good returns on capital. My preference is usually for equities (stocks) due to the generally higher returns available, but this isn’t always the case.

Not many investments end-up fitting my criteria, but a few do. Every month I try to write-up my best ideas in this regular monthly investing ideas post.

FAQ & Boilerplate Warnings

Readers seem to really enjoy these ‘ideas’ posts, but they also generate a ton of questions. In response, I’ve put together a Investing FAQ that should answer the bulk of common questions. If you’ve got questions, check that page first.

Please be warned — Do NOT consider any of these investing ideas as a solicitation to buy shares. I’m not endorsing or advising anyone purchase these investments for themselves. These are merely investing ideas that I’m considering this month. I am not your financial advisor. Please do your own research or hire a professional advisor.

I do not currently own shares in these companies, nor am I paid to endorse them in any way. I may or may not put money into these investing ideas. Some investing ideas may require additional research, or need to have certain questions answered before anyone should invest in them.

With that out of the way, let’s proceed with the investing ideas!

Synchrony Financial & Discover Financial Services

This one is something of a follow-up from a previous month.  Remember when I discussed Alliance Data Systems (Symbol: ADS) on my ideas list?

Well, after I published that May Investing Ideas post, the stock promptly went up by 10%, making me feel pretty priced-out.  Any bargain I saw looks long-gone.

However, I still like the consumer lending business — It ebbs and flows with the economy, but in general it’s a very good business when run prudently (not over leveraging, retaining customers with strong credit quality, etc).

So, I kept looking and found two more credit card stocks that might merit an investment — Synchrony Financial (Symbol: SYF) and Discover Financial Services (Symbol: DFS).  They both seem surprisingly cheap compared to titans Visa and Mastercard.

Discover of course is the owner of the Discover card — a cash-back rewards card that’s been around since I was a kid (woops!, did i just date myself?).  The standard card provides cash-back to consumers in rotating monthly categories.

Synchrony Financial has a business similar to Alliance Data’s — They primarily issue store credit cards for major retailers (Walmart, Sam’s Club, Lowe’s, and Amazon).  In general, I would say Synchrony has a “higher quality” customer with better credit quality than ADS.  Synchrony’s charge-offs and delinquency rates are also slightly lower than ADS’s.

To keep track of the many various metrics I care about,  I put together a table for all 3 companies:

All three seem like great companies that I’d love to own long-term.  But if I had to choose one, which would I invest in?

ADS is clearly the fastest growing of the three, but it also has the most debt and the worst customer credit quality (of the 3).  It also needs to retain the most earnings to keep all that growth happening.

SYF is similar to ADS, but they’re run more conservatively.  Lower debt to equity levels, customer credit quality is higher, and of course slower revenue growth levels.  As a result, the dividend yield and dividend growth rate is higher at SYF.

For me, DFS is clearly the gem of the three, with higher net margins and a higher dividend yield.

The only problem is that EPS hasn’t been growing.  That’s right, EPS actually declined by 6% in 2017 at DFS.  The same happened at SYF too – earnings per share declined by 10% in 2017.

Maybe we’ve finally reached a “max debt level” for the U.S. Consumer.  If that’s the case, these stocks are going to suffer in the next recession … at least until the average consumer starts borrowing again.

For now, we don’t know when or where a recession is going to happen.  All 3 companies have projected a reasonable rise in 2018 earnings per share that should reward investors with a growing dividend.

That said, the market hasn’t been kind to these stocks recently:

Over the past 6 months, all three stocks have underperformed the S&P 500 despite a positive earnings outlook.  This implies most investors believe the future is going to be a lot worse for the consumer, rather than better.  If that’s the case, I think DFS is the one to buy.

On the other hand, if the bull market continues and consumers keep buying on credit — ADS might be best way to capture all that growth.

Gamestop

Gamestop (Symbol: GME) is a very controversial stock idea right now.  This unloved retail stock has fallen 17.42% YTD and dropped 51% over the last two years.  It’s one really unloved stock.

What does Gamestop do?  They’re primarily a retailer of new and used video games, using small format stores in mall-based locations.  Yes, video games are actually a growing market but this stock is tanking.

So what gives?  Well, there’s a bunch of reasons why the stock could be falling:

• It is a brick and mortar retailer, located in malls.  This is a class of stores having a very tough time right now.
• It’s losing business to digital-only sales, and to companies like Walmart and Amazon.  The next generation of game consoles will probably be “streaming only” devices.
• The dividend payout ratio is over 100%.  For 2017, the payout ratio was 447%.
• Growth has basically stopped at the retailer.
• Profitability of the company’s existing physical stores is declining.

Sounds like a pretty horrible investment, right?  Gamestop is definitely a business in decline, and company management seems to knows it.  This is exactly why it has such a huge dividend yield — they’re cashing out.

This has depressed the stock so much that the company now sells for less than book value (70% of book)

The big question for investors is, how long does the company have left?  Even with that huge 9.8% dividend yield is this a worthwhile investment?

It’s hard to say, but I really doubt they’ll be around for 10+ years (enough to realize 100% of the purchase price in dividends).

I personally couldn’t guess how long the retail stores can remain profitable (I can’t predict the future), but I would guess it’s closer to a couple years instead of a few months.

While many people love the convenience of digital copies, there’s a whole separate group of gamers that still enjoy owning physical game copies instead of digital versions.  (Physical copies can also be later resold after the game owner is done with a game.)

So why is this an interesting investing idea?  There’s a catalyst that might help realize some value.  The company has announced that they’re in talks with third parties on some kind of transaction — Perhaps selling the whole company or possibly part of the company.

While all that gets sorted out, there’s a massive dividend for investors to collect… as long as they can deal with a little uncertainty.

AFLAC

Now, let’s pretend for a moment that you don’t believe the US consumer is going keep visiting Gamestop to buy his or her games on a credit card.  Maybe your view is that the trade war with China, rising interest rates, and a over-extended consumer mean we’re bound to see a recession.

If that’s the case, then Aflac (Symbol: AFL) is the stock for you.  Aflac is a company that offers (primarily) health and life insurance in Japan and the U.S.  It also happens to be a very defensive stock.

Why is it defensive when the US economy could go to crap next week?  Well, for one, the vast majority of the company’s earnings (roughly 3/4) actually occur in Japan.  Aflac has done very well in Japan and 1 in 4 households has insurance through Aflac.  That’s pretty incredible market share.

On top of that fact, even during recessions as long as individuals remain employed they’ll retain their insurance and give up discretionary purchases (travel, dining-out, etc) before they’ll cancel insurance policies.

Finally, rising interest rates tend to help insurance companies that need to continuously buy large quantities of bonds.  Insurance companies tend to hold bonds to maturity so falling prices (from rising rates) isn’t a problem.  When interest rates rise, so does interest income on newly purchased bonds for insurance companies.

(It’s worth noting, that in Aflac’s case, most of their income is derived from premiums, not interest income.)

These three main facts make this stock a solid investment during a US recession.  Just take a look at how it performed during the last recession — The share price declined considerably (like most stocks), but earnings and dividends just powered on through.

Check this out:

Barely a blip from the recession.  Free cash flow just kept growing… but that’s all in the past.  What might the future bring for Aflac?

Well, obviously this is not a fast growing company being so heavily invested in Japan.  Revenues are growing a mere 2.9% YoY, but the company is committed to rewarding shareholders — The dividend was recently increased by 18.2% and the company bought back 3% of shares outstanding, providing ample returns for shareholders.

Dividend yield is an “OKish” 2.42% at current prices.

The company expects 2018 earnings per share to come in around 3.80 per share, and at today’s 43.06 share price that’s a Forward PE of 11.3.

That’s a surprisingly affordable berth to weather any upcoming economic storms.

Final Thoughts

That wraps up July investing ideas post!  I hope you enjoyed these ideas and perhaps found them useful.  As long as readers enjoy these posts, I’ll keep sharing my ideas.  I’m also curious to hear your feedback.  Please feel free to share your own investing ideas in the comments too!

If you enjoyed this post, or others in my Investing Ideas series, please let me know!

[Image Credit: Flickr1, Flickr2, Flickr3]