2 Stocks to Buy During This Market Pullback
It seems as if we are entering a long-overdue market pullback. Stocks have continued to move higher over the past few years, even though the economy has been weak. Low interest rates and easy money from the Federal Reserve have made it inexpensive for companies to repurchase their own stock. Furthermore, low interest rates have made comparatively high stock dividends especially appealing: The S&P 500 yields less than 2 percent, when it historically yields more than twice this on average.
But while stocks were rising, so was optimism that wasn’t necessarily warranted. Few companies were growing their earnings per share through strong organic sales growth — techniques such as stock repurchases and expense cutting thickened the bottom line without a parallel rise in sales. Furthermore, those companies that are growing their sales saw their stocks soar. Growth is a rarity in this environment, and those companies growing their profits through sales growth were also benefiting from share repurchases and cost-cutting measures. This inflated these companies’ earnings per share growth figures.
As a result, we saw growth companies trade at over 30 times earnings, and speculative momentum drove them higher. Now, with the market reversing, these same names are declining the fastest. How do we separate out the winners from the losers? My approach is to find companies that are benefitting from secular tailwinds. Thus, even if the economy weakens, these companies will be able to continue to grow. While this growth may slow somewhat, this slowing growth should generate more pessimism than is warranted, and opportunities will arise.
Here, I have singled out two opportunities that investors should consider. I wouldn’t buy them just yet — I think they can see more downside, and they are not cheap enough yet for my tastes. But they are on my radar, and I am picking out price points at which I would begin to buy them.
1. Mastercard (NYSE:MA)
All over the world, more and more transactions are taking place using credit and debit cards. They are far more convenient than cash or checks, and while there are security issues, as evidenced by the December security breach at Target (NYSE:TGT), there are added security benefits to using a credit or debit card. For instance, if your card is stolen and the thief uses it to make purchases, the victim is not responsible for the loss. Furthermore, the theft is clearly traced. If you have cash stolen from you, you do not have the same protection. Cash is extremely difficult to trace, and it is very difficult to prove that you even had it in the first place.
Given the convenience and security of using credit and debit cards as opposed to cash, companies that offer services in this industry are benefitting from a secular tailwind. Even if the economy weakens and the total number of global transactions declines, there is enough momentum driving consumers and businesses toward cashless transactions that companies such as Mastercard will likely see sales growth.
Mastercard’s stock is down 18 percent for the year. It started the year trading at a lofty valuation, and now it is becoming more attractive. The shares trade at roughly 27 times trailing earnings and at 23.5 times 2014 earnings estimates. Meanwhile, the company has a long-term growth rate of about 20 percent. With this being the case, I think the shares are starting to become attractive.
23.5 times earnings is a reasonable price to pay for a company growing at 20 percent per year, especially since this growth is unlikely to be derailed. However, negative momentum in the stock leads me to believe that we can see an even better entry point — stocks rarely trade at “fair value.” Rather, they fluctuate from being overvalued to being undervalued. So I wouldn’t be surprised if we see Mastercard shares trade at 2 times earnings, or at about $61 per share (Friday’s close was $68.68).
2. Kansas City Southern (NYSE:KSU)
Rail transport is a booming industry. The companies involved offer an invaluable service at an attractive price compared to their trucking competitors. This is because rail transport is energy and labor efficient. Furthermore, there are only a handful of companies involved in rail transport. All of the companies involved are comfortably profitable, and they operate as an effective oligopoly.
Kansas City Southern is the fastest-growing of the North American rail transport industry. Its stock was a high flier until it reported fourth-quarter earnings that disappointed the market. The stock fell from a high of $126 per share to $95 per share as of the time of writing. This is just 21.6 times 2014 earnings expectations.
Over the past few years, earnings have grown at 25 percent annually. Growth last year would have been even more rapid if the company didn’t have to take a $111 million write-down in the second quarter. With the company trading at just 21.6 times 2014 earnings expectations, investors are concerned that growth is slowing — 2015 earnings expectations are 17 percent higher than 2014 expectations. However, this growth deceleration may not be as pronounced as analysts believe it to be. Given the strengths of the rail transport industry, I’m not as pessimistic as the analysts.
Furthermore, I think that Kansas City Southern has unique growth drivers that make it especially attractive. Aside from Union Pacific (NYSE:UNP), Kansas City Southern is the only North American rail company with a significant Mexican footprint, and Union Pacific’s is relatively small compared with the enormous American/Canadian business. This business is growing very rapidly for Kansas City Southern. The intermodal transport business between the U. S. and Mexico grew at 70 percent last quarter! While this growth rate probably isn’t sustainable ,Kansas City Southern is the only rail with growth drivers as dramatic as this.
Given analysts’ concerns over growth, I wouldn’t be surprised if the stock falls further, especially if the overall market remains weak. Nevertheless, I think this stock is a buy at around 20 times 2014 earnings, or at about $92.50 per share. I think it is a strong buy at 18 times earnings, or at about $83.25.
Disclosure: Ben Kramer-Miller has no positions in any of the stocks mentioned in this article.
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