What we are looking for
A Nasdaq 100 company perhaps unfairly involved in the latest sell-off.
On July 10, the Nasdaq 100 hit an all-time high. Then it began a slow descent that was accelerated by last Friday’s disappointing U.S. payrolls data and the announcement that the U.S. unemployment rate for July was higher than expected at 4.3 per cent – the highest level since the pandemic days of 2021 – fuelling fears of a recession.
As of Tuesday’s close, the index was down more than 12.5 per cent from its peak. But from the beginning of 2023 through to the recent peak, the index had almost doubled in value, as a handful of mega-cap technology high-fliers rode the generative AI hype to eye-watering valuations. The recent sell-off, in addition to recession fears, can be attributed to investors starting to question how long it would take for their billions of dollars of AI investments to bear fruit (the further in the future that earnings are expected the less they affect the valuation of a company today). Indeed, these have, for the most part, been the companies that have experienced the most dramatic stock-price drops recently: 17 of the index’s 20 worst performers since the peak, and more than three-quarters of the bottom 50 per cent, are from the tech sector.
Defensive sectors such as health care, utilities and consumer staples (or “non-cyclicals”), which are relatively less sensitive to the business cycle and recession fears, are much more prevalent in the top 50 per cent, representing almost 40 per cent, versus less than 10 per cent for the bottom half. While these companies have fared better, they may still be relatively undervalued after the recent sell-off. With the prevalence of passive investing today, these stocks would have been collateral damage as investors exited their broad-index positions and threw the proverbial baby out with the bathwater. With that in mind, we will look at companies in these sectors that have not performed as poorly as the overall index, whose valuations are grounded in near-term earning projections, and even more importantly, cash flows.
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The Screen
- We start with a universe that is the top half of performers in the Nasdaq 100 index since the index peaked on July 10, and screen for those in three defensive sectors – consumer non-cyclicals, utilities and health care.
- Next, we filter for those whose price to forecast (FY1) earnings, and cash flows, are below the index median values of 28.46 and 20.84 respectively.
- Rather than using the simple average of these forecasts, we use the SmartEstimate, an LSEG proprietary measure that is historically more accurate, as it gives greater weight to analysts that have been more accurate forecasters in the past, as well as more recent forecasts that would benefit from the most up-to-date information.
What we found
Some of the consumer staples companies will no doubt be very familiar to many readers. Mondelez MDLZ-Q – maker of brands such as Oreo, Ritz, Cadbury and Toblerone (not exactly the first things that come to mind when one imagines consumers reining in spending) – in particular, is viewed favourably by Wall Street. The street consensus recommendation on the stock is a buy, and the average target price of $78.46 implies more than a 13-per-cent expected return over the next year. Three analysts reviewed their recommendations on Tuesday, after Monday’s sell-off, and all three reaffirmed their buy (or “outperform”) rating.
There are also interesting names in the utilities sector, with two of the three – Xcel Energy XEL-Q and American Electric Power AEP-Q – generating a significant amount of power (and revenue) from low carbon sources across wind, solar, hydro, nuclear and biofuels, business segments that should benefit from a shift to a cleaner energy mix. LSEG’s FTSE Russell Green Revenues methodology calculates that both generate more than a quarter of their revenue from “green” activities. Additionally, almost a quarter of the bonds that Xcel has issued, by value (about US$7-billion), are earmarked for further green investments.
Hugh Smith, CFA, MBA, is Director, Analytics at London Stock Exchange Group