Investing Ideas: May 2018
Yep, it’s time once again for my monthly “Investing Ideas” post! In my continuing quest to find good places to invest excess cash, I’m searching for interesting stocks, funds, REITs, ETFs, bonds and preferred shares to potentially buy.
Week after week I’m hunting for good investment ideas. 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 this stringent criteria, but a few do. Every month I try to write-up the best ideas in this regular monthly post.
Readers seem to really enjoy these ‘ideas’ posts, but they 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 there 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. I am not your financial advisor. Please do your own research.
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.
Now that we’ve got all that out of the way, let’s proceed with the investing ideas!
Alliance Data Systems
My first idea for this month is a company you’ve probably never heard of, but you’ve definitely seen their products. Alliance Data Systems (Symbol: ADS) is a credit card company that issues store branded credit cards for large retail brands in the United States (and some in Canada).
An example would be an Ikea Visa Card, or other store branded card. In total, Alliance has 77.8 million of these credit cards in customer hands.
Generally, credit cards are a very good business but the shares of credit card companies are almost always super expensive. That’s not the case with Alliance Data — its shares are currently trading at a PE of 14.9. By credit card company standards that’s downright cheap.
Compared to most of my other investing ideas, Alliance doesn’t really have a dividend history. It’s only been paying dividends for about a year, with a small 1.12% dividend yield.
That said, Alliance recently raised the dividend by 10%, setting a good precedent for future years.
Quality is the big question to answer when investing in Alliance. Is it a high-quality business? Most people only sign-up for store branded cards when there’s promotion offers — Either for the large initial discount (15% off if you sign up today!) or for “points” offered on initial sign up.
People tend to pay-off and ditch store cards quickly after they get the initial reward.
There’s nothing wrong with that kind of business, but the returns on capital are nowhere near as good as those sported by Visa or American Express. General purpose credit cards like those from Visa or Amex are more popular and individuals tend to hold them longer.
There’s also a ton of debt on the balance sheet at Alliance, which is never a good thing.
Let’s not dismiss this idea outright — I should mention that the company has been growing earnings at a steady clip (much faster than competitors like Visa, Mastercard, or Amex). The company expects EPS growth of 15% in 2018, which might cause shares to rise faster than any of the traditional card providers.
I attribute much of this success to some unique attributes the company exhibits — They generate significantly more cash flow than the company generates in earnings per share.
Partly this happens because of points earned on loyalty cards by customers. Those points are usually earned but not redeemed right away. Alliance collects the cash attributed to these points, but doesn’t yet have to pay-out the rewards. Sometimes it can take up to two years before the points are redeemed. The technical term for this is “breakage”.
That excess “unearned” cash typically gets invested, which turns a “not so great ” business into a “pretty decent” business.
As you can see, there are things to like with Alliance but there’s also plenty of things not to like. For now I’m keeping this one on my watch list.
The next idea is a big name cable monopoly — Comcast (Symbol: CMCSA). The shares have been challenged this year, down 20% YTD. While the shares aren’t a bargain, well known monopolies like this rarely go on sale. Primarily I believe the negativity surrounding the shares is mainly about cord cutting in the cable business. The video and voice business is slowly declining as customers “cut the cord”.
The thing is, they aren’t cutting the actual cord. It’s still connected and bringing in data. They’ve just traded the services they use — Instead of watching cable TV, customers are switching to streaming services like Netflix and Amazon Prime Video. This sounds like a big negative for the cable business, but the high-speed data business is growing considerably faster than the video business is declining. It’s a non-issue from a financial standpoint.
What does this mean for investors?
Comcast pays dividends of $0.76 per share, which means a rather average yield of 2.22%. What interests me about Comcast isn’t a large yield, but the rapid dividend growth rate. In a typical year the dividend grows by 10%-21%. This is considerably faster than the S&P 500 (long term average of 6%)
Comcast also owns NBC Universal and Dreamworks Animation. These companies make up the bulk of Comcast’s TV, Movie, and Theme park assets. Media entertainment is a decent business but can be kind of “hit or miss” depending upon what’s the popular entertainment media of the day. In my mind the real asset is the cable business — wires in the ground to take data the last mile into customer’s homes.
In the regions where Comcast provides cable (including my own) the company has a monopoly on high-speed data with no real competition in sight. In many ways it’s hard to construct a scenario where an investor would do poorly in Comcast shares. I expect the dividend should grow faster than the S&P 500.
Signet Jewelers (Symbol: SIG) is a very unloved business right now. The company primarily operates retail jewelry stores and owns most of the major brands — Zales, Kay, Jared, and many other jewelry store brands. It’s a business with significant market share in the jewelry niche.
The shares trade at a TTM PE of 5.41. Signet looks like it could be big bargain. But why are the shares so cheap?
The big reason is that retail sales are declining. Jewelry is primarily sold in retail stores right now. Online sales are growing, but at slower rate. There was also a gender discrimination scandal that resulted in the CEO being fired and replaced. Scandals aren’t good for business, and this probably contributed to sales declines.
New management seems intent on fixing the negative cultural problem, but change takes time.
So yes, the data is clear — the traditional jewelry stores are declining (due to the death of the mall and bad press), but the story is far from finished. Culturally, diamond rings aren’t going to disappear anytime soon.
Customers are still going to buy diamond rings, but the loss of mall traffic and all the negative publicity from scandals is going to hurt Signet for awhile.
The company pays a nice 3.88% dividend that’s been growing since 2010. It sounds good, but is it enough to put up with all the problems? Maybe not.
The big question in my mind, is can they maintain dividends or even grow them in the current environment?
Here’s one way to think about an investment in Signet — The company is on an elevator, currently at floor 99. We know that the elevator is going down. We also have a pretty good idea the elevator won’t go all the way to floor 0. It’ll probably stop at some floor in-between, then start rising again.
For investors, the real trick is knowing what “floor” Signet is going to stop at. I’m not confident this is something I can guess.
Now here’s a odd little business for you — Lamar Adverstising (Symbol: LAMR) is a real estate investment trust (REIT) that owns and operates billboards and transit signs. You know, those giant signs you see alongside the road (or on the bus). Yep, those.
Lamar was actually formed way back in 1920, but recently converted to a REIT. In the age of internet advertising this kind of business sounds ridiculously old-school, but this company is doing surprisingly well.
Not only does the company grow by acquiring new signs, but they’re also slowly converting many traditional billboards into digital displays that change every few minutes. These kinds of signs generate greater revenues than traditional fixed signs and should be a source of future revenue growth.
There are several competitors to Lamar, like OutFront Media, and Clear Channel Outdoor Holdings. Despite having larger competitors, Lamar is growing faster.
To avoid taxation, REITs are required by law to pay out 90% of earnings to shareholders. This results in a hefty regular dividend, currently a 5.47% yield at Lamar. In recent years Lamar has been able to raise that dividend by 10% per year. (For a REIT that’s a fairly impressive accomplishment.)
So are there any big negatives?
If there is a negative, it has to be the company’s impressive debt level — currently at 2.6 billion. Roughly a third of all operating income goes to making interest payments. It sounds high, but for real estate companies this really isn’t unusual.
Over time I expect this company (like most REITs) will grow slowly but spit off plenty of cash flow. If you’re at all interested in REITs this one could make an interesting addition to your portfolio.
That wraps up this month’s investing ideas post! As always, I hope you enjoyed these ideas and found them useful. I welcome your feedback on these ideas, and please feel free to share your own investing ideas!
If you enjoyed this post, or others in my Investing Ideas series, please let me know in the comments. This series is still an experiment, so I’m very curious to hear your feedback!
Until next time!
22 thoughts on “Investing Ideas: May 2018”
I like the idea of ADS and LOVE LAMR business model. It’s great to see other dividend investors around here. Not very common in the FI space.
Thanks Guyon_FIRE! There’s actually few of us around, but it isn’t terribly “fashionable” right now.
Ugh, I hate Comcast. Maybe I should buy a few shares so I don’t hate them so much. Is it okay to invest in the most hated company in the US? Someday, a new company will take them down.
LAMR sounds interesting. I like the billboards and it will keep working until people never leave their home. That’s years in the future, right?
Thanks for the analysis. I really enjoy these.
The sign of a customer that hates a company yet STILL buys their product is the sign of a strong monopoly!!
I think the fiber internet guys tried to take down comcast a few years back but it was just too expensive to get fiber optic lines installed to so many customers. They gave up. Even google fiber has been ‘paused’. I highly doubt someone can take Comcast down.
As far as LAMR goes, I think we’ll still go outside for a very long time. 😉
Recently few of my family members have experience with online jewelers. Similar to other online businesses, what they really enjoyed was how transparent the information was. Different grading and price levels are readily available, and some online retailers do have physical stores for customers to try on different ring sizes/styles (not the actual diamond of course). Price was competitive and return was very easy as well.
My guess is, except few of the key diamond markets, like the diamond district in NYC (where they have custom design available and price match too), most of the chain retailers are going to experience a slow death. How slow it is, depends on how fast the consumers catch up to the online business model. This is where I would not want to put my money for long term (and short term as well). As always, these ideas are great exercises to look at different business models, keep them coming !! 😀
Thanks YSL! I appreciate your thoughts on the diamond business! It’s cheap, but I think this one is just too hard to “predict” what will happen. Same store sales declines have been slow, but there’s nothing that says it can’t accelerate.
I like the ideas, Mr Tako. I picked up some Tiffany (TIF) back when it was in the low 60’s per share and it has done pretty well since (shares are over 100 now) so if you can enter at an attractive valuation you have a nice tailwind. Plus, I love those increasing dividends!
Awesome sauce Mike! (And congrats on buying Tiffany at such a low price!)
Mr. Tako, I’m an avid reader of your blog, although I usually don’t comment. I just wanted to say thank you for sharing these monthly investment ideas. I find them very useful. I also opened a position with CMCSA this month. Keeping my fingers crossed!
Thanks Pablo! It’s readers like you that “come out of the woodwork” that make me continue writing!
Over time, if you hold those Comcast shares for at least 5 to 10 years, I think you’ll do fine.
I have a suggestion. Stock to consumer staple stocks for fresh buying. Kimberly Clark, Proctor & Gamble, General Mills to Anne a few OR do as I did yesterday, buy a couple of ETF’s representing this sector: RHS, VDC & XLP.
Nothing offers a better value in this current market than the consumer staples.
I’m not sure if I agree. How are you valuing these businesses? Discounted Cash flows?
Sure, they have large dividends but that’s only because the payout ratios are huge.
Most of the big consumer product companies you listed have seen sales declines in recent years. Customers just aren’t buying their products like the used to. This would be my main concern investing in these businesses.
What kind of earnings growth do you expect in the next 5 – 10 years?
I’ve been reading up a lot on diamonds, specifically engagement rings, and I had no idea so many of those brands were owned by Signet Jewelers. I don’t know if they’re at floor 99, but they’re definitely up there and the trend is certainly down. I think the slide will be slower than expected, since they do own some big online brands (James Allen), but now would not be a good entry point.
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Yeah, the elevator was just a metaphor. It could be floor 15 or 25, the number doesn’t really matter.
I’m not sure that I understand the business well enough to know when the “right” entry point would be either.
Hi Mr. Tako,
Just wanted to leave a comment to say that I’m a big fan of your blog. Your value-oriented mindset is really refreshing! My two cents on your ideas:
1. Alliance Data Systems is “cheap” because of the secular decline in brick and mortar retail and when consumer loan growth slows (it’s already started to), this business may decline sharply. “Cheap” is, of course, extremely relative in a 9 year bull market.
2. Comcast is more attractive. I agree the decline in cable is overstated. That said, the risk here is trying to catch a “falling knife.” The dividend, even with the growth factored in is looking more unattractive by the day if you consider the 10 year US treasury yield is now 3.1% and climbing. Actually, most dividend yields in the S&P look unattractive relative to that risk free rate. Which is sort of our predicament right now.
3. Signet Jewellers counterpoint: recession is around the corner and luxury items are the first thing to go. Also, there’s probably more than one cockroach in the kitchen.
4. Lamar advertising is an interesting business, but investing in REITs in a rising rate environment is tricky because these stocks basically behave like bonds. And bond values fall when interest rates rise.
Hi Ivan. It’s great to read your insights.
1. Consumer loan growth slowing? Maybe. We’ve seen one bad data point, but it takes more than that to define a trend in consumer behavior. I think your overly discounting how stable the ADS business is. Look at how it grew through the Great Recession. The recession was a non-problem.
2. Totally agree on how unattractive S&P 500 yields are. By those standards Comcast is a high yield stock!
3. To say a recession is “right around the corner” is predicting the future. Maybe you’re pretty good at that, but I seem to have lost my magic crystal ball. I can’t predict the future, but I do agree there’s a few things to fix at Signet.
4. As far as how REITs respond to rising rate environments, I kinda could care less. As a long term shareholder, I mostly care how the business is going to behave. Will it continue to create value under rising rates? I’m a long-term holder so market movements one way or another don’t bother me.
Thanks for the write-up. Signet is definitely an unloved child right now. The company is headquarted locally for me, so I am always interested in following a local story (good or bad). I’ve never considered Lamar, but I’ll have to look more into it now. Thanks for the background research! Some of the names on my watch list include PEP, LEG, and a few others.
Thanks Dividend Diplomats! I’ll have to take a look at LEG — I’m not familiar with it.
Interesting that Signet owns those big diamond brands! AND that they own James Allen. That’s a very low P/E and I agree that diamonds are ingrained in western culture (and some parts of Asia that I suppose are influenced by western society, such as Hong Kong). My friends over there have $25,000-$35,000 rings that they have insurance on. I can’t imagine having a ring the same price as a mid-sized car.
Huh, I didn’t even know there were REITS for billboards and transit signs. Interesting. When you mention they’re changing some of the fixed billboards for the digital ones that change every few seconds, it reminds of all the changing ads I see in Europe (they have lots of them at bus stops). Oddly enough, haven’t seen many of them in North America.
They’re coming to the States, just slowly. Most of the major sign companies in the U.S. are REITs, which means they don’t have a ton of money for expensive capex.
Interesting ideas, Mr. Tako. Even though I’m no longer an active investor, it’s nice to see your insights about specific companies and business trends. I think Lamar looks quite promising!
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