Investing Ideas: October 2019


With October rolling to a close in slightly more than a week, I thought it was high-time to spit out one of my investing ideas posts.  For those of you not familiar with series of posts, every month I try to write-up the most interesting investing ideas I’ve seen over the past month.

These are investments that I find interesting, unique, and perhaps have the potential to compound money for shareholders.

These investing ideas could be anything — stocks, bonds, REITs, ETFs, preferred shares, etc.  I’ll look at pretty much anything under the sun.  If the potential for good investment returns exists without the need for wild speculation, I might be interested.

This month’s investing ideas theme is “boring” investments — stocks so dull and unexciting other investors ignore them.  Yet even among dull companies there can be good returns for investors…

 

FAQ & Boilerplate Warnings

Before we begin, let’s get a few things out of the way…

Readers 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 a question, please check there first.

Be Warned: DO NOT consider these investing ideas as a solicitation to buy shares.  I’m not endorsing or advising anyone purchase these investments.  These are merely investing ideas that I’m considering this month.  I am not a financial advisor.  Please do your own research.

I’m also not paid to endorse these investments.  I may or may not put money into these investing ideas, but if I decide to buy shares I will disclose it.

With that out of the way, let’s look at this month’s investing ideas!

 

MSC Industrial Direct

MSC Industrial Direct (Symbol: MSM) is a distributor of metalworking tools and other supplies.  The company also sells services to handle maintenance, supplies and repairs for metal working shops, engine rooms, and factories around the globe.

As an example, let’s say you need buy a $30,000 CNC milling machine so your company can make metal parts.  You can’t just head down to the local hardware store to pick up one of those.  This is where MSC has you covered.  Need a fancy $20,000 metal lathe?  Yep, no problem!  MSC can have one shipped to your door in a couple days.

metal lathe
Need an expensive machine tool? That’s MSC’s bread and butter!

What’s that?  You’ve never heard of MSC Industrial Direct?  To be fair, the company does not sell consumer grade products.  It sells professional equipment for professionals that work in metal working shops.  While that might sound like a fairly small and obscure market, MSC does over $3 billion in sales annually, which is enough to generate over $330 million in net income.  Yep, you read that correctly — net profit margins occasionally over 10%.  Usually distributors have razor thin margins, which keyed me into the fact that MSC is a bit unusual.

Looking at the big picture, MSC appears to be a very well run company.  They grow revenues at a 6% to 10% annually, and have been doing so for decades as the business expands around the globe. (Usually through acquisition of smaller companies)

Debt to equity levels are a very reasonable 0.39, and annual returns on equity (ROE) hover around a very healthy 20%.  Not bad!

This is a very boring business that finds a way to grow steadily and return wealth to shareholders in the form of dividends and share buybacks.  Currently MSC has a dividend yield of 4.22% with a payout ratio of 56%.  That’s a little on the high side, but historically the company has kept payout levels lower.

msm payout ratio

Dividends growth rates have average around 11% annually over the last five years, which is excellent. But how has the stock performed?  In a year when the S&P 500 is up nearly 20%, MSC Industrial is down 3.81%.  This rather rotten share price performance can be attributed in a slight slowdown in sales for 2019.  The global economy is slowing a bit, and this is reflected in MSC Industrial’s sales.

It’s been a pretty bad year for MSC shares, so it might be a good time to buy.  You can now purchase shares in MSC for a rather affordable TTM PE of 14.  That price level amounts to a earnings yield of 7.14%.

This is a healthy return for shareholders.  Combine that with a regular net income growth rate of around 10% and the dividend growing at a similar rate, and this is one investment with the potential to do fairly well over the long-term.

 

PepsiCo Inc

Yep, good old PepsiCo! (Symbol: PEP) Pepsi the maker of the Pepsi soft drink  and other soft drink flavors as well as dozens of brands of snack foods around the globe.  While Pepsi is hardly a small unknown company, it’s pretty boring.  Most people think the soda business is in decline, but Pepsi has done surprisingly well when compared to rivals like CocaCola in recent years.

Pepsi vs. Coke
Pepsi vs. Coke

Why the out-performance when compared to Coke?  Well, I believe it stems from PEP’s wider diversification away from sugary drinks, where Coke has pretty much stuck to selling sugar water.  Around 54% of Pepsi’s revenues come from food, namely snack foods like Doritos, Lay’s potato chips, and Tostito’s tortilla chips.

This diversification has served Pepsi well now that sugary drinks sales have been vilified as a major reason for obesity.  Sales of sugary soft drinks have been slowly declining.  Pepsi’s sales growth has stagnated in recent years to a mere 2%-4% growth (depending upon the year).  Meanwhile, CocaCola’s revenue has seen steady declines for the last 6 years.

To be clear:  Snack foods are what’s driving revenue growth at Pepsi, without it they’d be a similar position as Coke.

pepsi revenu per share
Combined with share buybacks, the revenue per share situation at Pepsi isn’t too terrible.

So why is Pepsi a good investment?  This is a high quality company with global reach and dozens of brands.  Not all of their products are seeing declines.  They also have the free cash flow to continuously acquire new businesses in the search for the next great snack food or beverage that will drive growth.  Example:  Pepsi acquired Sodastream in 2018.

Long-term, people are always going to love snack food, and flavored water is here to stay (even though I recommend avoiding it).  Preferences may change over the years, but it’s safe to say those two foundations of modern life aren’t going anywhere.  Despite the recent unpopularity of sugary sodas, Pepsi is a stable business.

While investors wait for the company to find its next big growth engine, they can pick up shares today with a TTM PE of 15.5 and a 2.81% dividend yield that continues to grow every year (albeit a slower increase in 2019 at 3%).

Shares aren’t cheap, but rarely do high quality businesses go for “cheap”.  My biggest concern around investing would be Pepsi’s debt levels.  They’re fairly high by most standards, with a debt to equity level of 2.3 in the most recent quarter.  That’s higher than I usually like, and higher than Pepsi has maintained historically.

Is the high debt level a problem?  Probably not, but it’s worth keeping an eye on if you invest in Pepsi shares.

 

TD Ameritrade Holding Corp

If you spend any amount of time in the investing world, inevitably you’ll come across TD Ameritrade (Symbol: AMTD).  TD Ameritrade is a securities brokerage house that sells all the usual products in the investing world — stocks, bonds, mutual funds, ETF, options, futures, and so forth.  Nothing terribly unusual… in fact it’s pretty boring.

Essentially TD Ameritrade sells investing “commodities” exactly like any other brokerage house around the world.  So why am I so interested in a seller of “commodities” now that stock trading at many brokerages (including Ameritrade) is now commission free?  Isn’t that a recipe for lower profits?

Maybe, but we’ll get to that in a minute.  I think Mr. Market threw out the baby with the bathwater on TD Ameritrade.  At the beginning of October, AMTD dropped 20% in the span of just a couple of days on the announcement.

td ameritrade price
The share price of TD Ameritrade (the light blue line) dropped much further than E*trade or Charles Schwab after the announcement.

Yet the company recently announced record growth in revenues and assets under management in the fourth quarter.  According to CEO comments, dropping commissions to “$0” has already created a 49% increase in new accounts opened in October.  That’s huge!

So how can a brokerage house make money on $0 trades?  Well, we must first remember one very important rule of the universe: There is no free lunch.  Despite claims to the contrary.

There’s a side to this “zero dollar” story that you the investor aren’t being told — Every stock trade that gets executed goes through a “market maker”.  The market maker matches up buyers and sellers of stocks (and other assets) and then profits from the difference between the “bid price” and the “ask price”.  Depending upon the security this spread can be only a few pennies to several dollars.

That’s how things previously worked on Wall Street.  The brokerage house got a commission and the market maker got his spread.  Now we live in a whole new world of “no commissions”, but lunch still isn’t free.

What we don’t know in this brand new world of stock trading is how much that bid-ask spread is going to grow from the “old days” in this zero-commission world, and how much of a cut TD Ameritrade is going to get by sending trades to their “favored” market-maker.  Technically the money they earn from routing trades to the market-maker is not a commission, but they still make money.  It’s called “selling order flow“, and it’s perfectly legal in the United States.

In other words, Wall Street has now become less transparent than ever before, and it’s now very unclear how much investors are going to be truly paying to execute trades.  Yuck!  I’m not the only one that believes this will happen — A recent Yahoo Finance article mentioned this as well.

Imagine for a moment that TD Ameritrade’s “cut” is .01 of a share’s stock trade.  If a investor trades 100 shares, that’s a $1 “commission”.  If it’s a thousand shares, that “commission” jumps to $10.  See how this could work out extremely well for TD Ameritrade?

Wall Street isn’t going broke.  My guess is that this will take several years to shake out, and the SEC might have to eventually put some controls on the bid-ask spreads.  Meanwhile, I believe brokerages like TD Ameritrade intend to make less per average individual transaction, but make it up in greater trading volumes.  (In other words, the number of trades will grow over time as investors believe trading is “commission free”).

So as a investor looking to potentially buy shares of TD Ameritrade, I don’t see a profitability problem long-term.  I see uncertainty for a few quarters, but right now TD Ameritrade shares are selling for a PE of 9.6 and sport a dividend yield of 3.19%.  That’s none too shabby for a broker able to grow revenues at 10%+ a year.

If you believe profitability will eventually recovered at zero-commission brokerages, then shares of TD Ameritrade might be a bargain.

 

TE Connectivity Ltd

Last but not least is TE Connectivity (Symbol: TEL).  TE Connectivity is a maker and seller of electronic sensors and connectors.  Try to stay awake for this one!  While it might not sound terribly exciting, it is assuredly a good business.  TE’s net profit margins are a very healthy 10% (or even higher!), and returns on equity frequently exceed 20%.

Meanwhile the stock trades at a very affordable TTM PE of 10.2.  So why is it so cheap, you’re probably wondering?

Well, TEL shares always trade around these levels.  There’s nothing new or exciting to happening, so don’t buy-in expecting fast multiple expansion anytime soon.  Any investor in TEL should really be in for the long run — Holding shares for many years, collecting dividends (1.96% yield), and letting the company slowly expand.

Therein lies TEL’s biggest problem — revenue growth has been slow over the last decade, and that means share buybacks and acquisitions to grow the company are the key to producing good returns from this stock.

tel revenue

It’s a good thing then that in the most recent quarter the company announced free cash flow generation was up 27% year over year, and the company announced they’re purchasing another sensor company.  There’s plenty of opportunities for growth and/or share buybacks here.

I believe the situation is less dire at TEL than the market gives the company credit for.  Even though it exists in a not-so-fast growing market, the company has been steadily buying back shares and growing dividends at a roughly 10% annual clip… something only patient investors can appreciate.

Not only that, but the company’s margins have expanded in recent years, allowing for greater levels of free cash flow that have fueled growth acquisitions and larger share buybacks.  I believe the growth story is only getting started here and patient investors could do very well with this “boring” stock.

 

The Boring Ending

That’s it for October folks!  Thanks for reading my boring investing ideas post!  Let me know if you agree or disagree with my analysis in the comments!  I certainly don’t know everything, so it’s always good to learn from readers like yourself!

Feel free to drop any additional “boring stock” investing ideas you have in the comments too!  I’m always curious to take a look at unloved companies the market ignores!

 

[Image Credit: Flickr]

6 thoughts on “Investing Ideas: October 2019

  • October 24, 2019 at 12:26 AM
    Permalink

    Hi Mr. Tako,

    Thank you for the post. Your ideas are always interesting and with, at least, one Investment idea out of radar. Through your posts I got to know DFS and LUV, both at my current Portfolio.

    All the best.

    Cheers!

    Reply
  • October 24, 2019 at 7:01 AM
    Permalink

    AMTD sounds good. I’ll put it on my list.
    What about BA? They’re in trouble right now, but people will keep flying in the future. They’ll recover someday.

    Reply
    • October 24, 2019 at 4:45 PM
      Permalink

      Some day, I think you will be right about BA. That day might be a ways off though. Hard to say. This fiasco has certainly damaged Boeing’s reputation — I hear even Southwest is looking to move to a mixed Boeing/Airbus model.

      Reply
      • November 9, 2019 at 9:30 AM
        Permalink

        Glad to finally see someone thinking the same on BA I do. It’s a big mess indeed and the management in my opinion is not trustworthy anymore. They will survive and they will be very profitable again – just not anytime soon. Their shares still trade at a premium compared to the intrinsic value and the near future prospects which is not justified in my point of view. I am actually expecting a big downturn not too long from now. Either after the next quarter earnings report or when recession finally hits. This might be a chance to invest then.

        Reply
  • October 26, 2019 at 6:58 AM
    Permalink

    Hi Mr Tako,

    Thanks for sharing these ideas. I’ve got it on my to do list to go through a few annual reports of MSM now. I hope all is well for you in the PNW up there.

    -Mike

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *

Do NOT follow this link or you will be banned from the site!