Plus, whether it’s time to overweight stocks.
Hello, and welcome to The Morning Filter. Every Monday, Susan Dziubinski sits down with Morningstar Chief U.S. markets strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead.
Key Takeaways:
2:15 Tariffs & The Markets
12:29 On Radar: Inflation, Bank Earnings
15:48 Is It Time to Overweight Stocks?
29:42 Stock Picks of the Week
Read about topics from this episode.
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Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar Research Services Chief US strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead.
Well, good morning Dave, and I hope you had a restful vacation because you’ve come back to a stock market mess. So we have to start this week’s show by talking about tariffs. Now the market really kind of collapsed last week after the Trump administration announced sweeping, larger than expected, tariffs, and futures don’t look too hot this morning either. So recap the stock market’s response for viewers.
David Sekera: Hey, good morning, Susan. The vacation started off pretty restful, but as you noted, by the end of the week, it really wasn’t much of a vacation. A couple of flight delays and a couple of cancellations on the way back didn’t help either. But at this point, let’s get going.
Unfortunately, I’m bringing out the “Good Grief,” the Charlie Brown mug this week. Yeah, it’s pretty ugly out there. In fact, it looks like futures are down another 2% or so premarket today. I think we’re just in one of those markets right now where it’s a sell-first, ask-questions-later kind of mentality. There are a couple of exceptions, but pretty much everything was down last week. Now, having said all that, to a large part, this actually is playing out in line with what our valuations were at the beginning of this year. So if you remember in our 2025 US Market Outlook, we noted that stocks were trading at a pretty rare premium over fair value.
In fact, since 2010, less than 10% of the time had the market been trading at that much of a premium or more. So getting to the numbers here, year to date through last Friday’s close, Morningstar US Market Index, and that’s our broadest measure of the stock market, is down 13.76%. Of that, the market fell 9% just this past week alone. And for a little bit more context, I’d note the market is down a total of 24% from its Feb. 19 high. So again, we are now officially in that bear market. But also to put it in a little bit more context, like I was talking to my parents this past weekend, if you felt fine about your financial position last May, I think you should also still take some comfort—and again, it’s assuming that you had a portfolio that was well diversified—but really those markets selloffs just take us back down to where we were almost a year ago today.
Now taking a look at our 2025 outlook, we also noted to investors how positioning this year was going to be increasingly important. That has worked out as well. Originally, we had recommended being overweight value stocks, market weight core stocks, underweight growth stocks. And until last week, value was actually up for the year. It was looking pretty good, but it did fall 8% last week with the rest of the market. So it is now down 5% year to date. Core stocks are down 15% year to date, but the worst of the selloff has been the growth category, that is down the most. It’s down over 17.5% year to date as well. And then when I look at our sector valuations, those are also largely playing out mostly as expected. There’s a couple of exceptions here and there, but for the most part, the sectors have been converging toward our fair value.
So for example, the technology sectors perform the worst. That’s down 22% year to date. That’s followed by the consumer cyclical sector. That’s down 19% year to date. Those were some of the more overvalued sectors coming into the year. Energy, which was one of the more undervalued, that’s actually still in the green this year. That’s up a little bit over 1%. And then consumer defensive is unchanged. Now, if you remember, that is one sector we highlighted as being overvalued coming into the year, but that was really just because it was skewed so much by the top three largest positions in consumer defensive: Walmart, Costco, and P&G. Walmart is still a 1-star-rated stock; however, it is down 8%. So what we’ve seen is that the losses there in Walmart have actually been offset by undervalued food stocks, which have actually risen year to date.
Dziubinski: Dave, what impact does Morningstar think tariffs will have on the economy, and is Morningstar now expecting a recession?
Sekera: The Morningstar US economics team just put out an updated forecast. They did lower their expectations for GDP. So for 2025, we lowered our GDP expectation to 1.2% from 1.9%. And then for next year, we lowered it in 2026 to, I think, 0.8% from 1.6%. And then in 2027, lowered it to 2.1% from 2.5%. As far as the recession goes, our base case is still no recession, but Preston did change his outlook here. At this point, he estimates the probability of a recession in the near term as high as 40% to 50%.
Dziubinski: So then, what about inflation, Dave? What are Morningstar’s expectations for inflation with tariffs now in place?
Sekera: Yeah, so we increased our inflation expectations here. Looking at personal consumption expenditure index, again, the Fed’s preferred measure of inflation, we’ve bumped that up to 3.3% for 2025, that’s up from 2.4%. And for next year, for 2026, we’ve now increased that to 2.6% from 1.9%.
Dziubinski: Given the potential impacts of tariffs on the economy and on inflation, what does Morningstar think the Fed will do next? Might we see rate cuts sooner rather than later?
Sekera: Well, let me give you a couple of different perspectives here. So in Preston Caldwell’s write-up, he’s chief US economist, his quote here that I pulled out is, “In terms of monetary policy, tariff hikes without more tax cuts and uncertainty suppressing spending would call for more interest-rate cuts as compared to the baseline. But if the tariff shock is more inflationary, the Fed could be forced to put rate cuts on hold for an extended period.”
And then taking a listen to what Fed Chair Powell had to say, he was at a conference last week. Now, as expected, his commentary was largely noncommittal. However, he did indicate he thought tariffs will lead to higher inflation and slower growth. However, he also acknowledged that the size and the duration of these effects are highly uncertain. So he really just reversed—or used his typical boilerplate language—that the Fed will react to support its dual mandate as necessary, so kind of nothing answer there.
So really getting to where the rubber meets the road, where people are putting real money to work in the marketplace, took a look at the market-implied probabilities based on the futures market this morning. So right now for the May meeting, futures jumped to as high as a 53% probability of a cut at the May meeting. In context, that was only 14% a week ago. And then for the June meeting, there’s now a 43% probability of one cut by then, a 53% probability of two cuts by then, and a 4% probability of three cuts. And at this point there is zero probability that fed-funds rate actually remains where it is today.
Dziubinski: Let’s talk sectors and industries, Dave. Which seem particularly vulnerable if the tariffs do in fact stick around for a while, and do you think that risk is already being priced into the market?
Sekera: At this point, I think it’s very hard to make any wide generalization of how the tariffs will impact companies by sector. In some cases, such as the consumer sectors, especially like the retail industry, those companies where their inventory is largely sourced from tariff countries, I think those will be under pressure. I think that’s a good example of that. But even there, depending on where they source from and how much, you’re going to have different impacts across different companies.
One example our equity analyst team had highlighted in the past was Dollar General DG versus Dollar Tree DLTR. Very similar companies, but Dollar Tree imports 40% of their merchandise, whereas Dollar General only imports 4%. So again, I think it’s going to be much more idiosyncratic to companies as it is necessarily going to be at the sector level.
Plus, it also just depends on what might be excluded from tariffs. So for example, if you look at the healthcare industry, pharmaceuticals were excluded from the tariffs but not medical devices. So in that case, no impact on Bristol-Myers BMY, but again, could be bad for Medtronic MDT. Even in the technology sector, semiconductors themselves, I believe are excluded from the tariffs, but the components that you need in order to actually utilize the semiconductors were not. So again, those companies will be impacted.
Now here in the short term, I think it’s going to largely depend on how much and how quickly companies can revise their sourcing to countries with lower tariffs or find domestic sources. Whereas in the medium term to longer term, what manufacturing can be expanded within the US, how quickly it can be expanded, and how quickly can you onshore different types of manufacturing.
And then lastly, you also have to point out, it’s going to depend on those companies where their products may still be excluded from the tariffs because they fall under the USMCA. That’s the US-Mexico-Canada trade agreement, in which those projects will not be subject to additional tariffs. So for companies like the automakers, that’s going to make a big difference among the companies. So you have some of the foreign auto manufacturers that import most of their vehicles versus some of those foreign auto manufacturers that make it here in the US. And of course then the big three who make the predominant amount of their vehicles sold in the US, either here, Canada, or Mexico. So again, very idiosyncratic to individual companies.
Dziubinski: Has Morningstar made changes to its fair value estimates on stocks as a result of the tariffs taking effect?
Sekera: Where our analyst team has been able to quickly identify those companies that we estimate that tariffs will have an immediate and a substantial impact on their business—and again, not just today but changing our valuations because we’re changing our forecasts over the next couple of years—yes, we have cut our fair values in those individual cases. However, in a lot of other cases, our equity analysts have held their fair values for now until, I think, we have better clarity on how it may or may not impact those companies.
Dziubinski: Now, of course, tariffs will be something investors are going to continue to watch this week, but also on radar: We have both the CPI and PPI numbers for March coming out. Do you think the market’s going to be extra-attuned to those figures given the development with tariffs, or are the numbers somewhat old news because they don’t reflect anything tariff-related?
Sekera: I think the answer there is yes. And again, not to sound like an economist here, but it’s going to depend. I think if inflation is in line or even better than expected, it probably really doesn’t matter to the market, because as you mentioned, I think the implications of that for inflation going forward is probably pretty low. I think people probably ignore what that print is. Now, having said that, if the number comes out higher than expected and inflation isn’t moderating and it’s already starting off at a higher level than what we would prefer, then I think that actually could be really bad news. And I think that could hit the market as people would then be expecting inflation to go even higher from there.
Dziubinski: Now we also have earnings season kicking off this week with a couple of large banks reporting on Friday, and that’s JP Morgan JPM and Wells Fargo WFC. The US bank index was down about 14% last week. How do banks look heading into earnings from a valuation perspective?
Sekera: And by the way, the banking sector and the financial-services sector overall was one of the more overvalued sectors recently, so not necessarily a surprise that it pulled back that much, but again, it’s all going to depend on the individual banks. For example, JP Morgan, the biggest and baddest of the US banks, was the most overvalued at the beginning of the year. It’s down 12% year to date, but it’s still a 2-star-rated stock. We still think that one has further that it can come down. Whereas Wells Fargo, that’s down to 13% year to date. So that’s a 3-star-rated stock. But then both Citi C and Bank of America BAC down 17% and 22%, respectively, are now actually both rated 4 stars. And at this point, the regional banks, they’ve fallen enough across the board. Generally, those are all 4-star-rated stocks, a couple now that are cutting into 5-star territory. But our pick there is still going to be economic wide moat US Bank USB, 4-star-rated stock, now at a 30% discount, and it sports a 5.4% dividend yield.
Dziubinski: Dave, what impact could tariffs have on forecasts that we’ll hear from the banks?
Sekera: I think the tariffs in and of themselves have very little, if any, direct impact on the US banks. So in this case, and like a lot of the other cases, it’s going to be whether or not there’s secondary impacts of the tariffs. For example, if the tariffs were to lead to an economic recession, our analyst team noted that they may end up reducing their valuations for the banks up to the midteen percentages. And the reasoning here would be that we would end up revising our projections, in a recession scenario, we would increase our loan-loss provisions as we’d expect higher charge-offs. That would lead to lower net interest income. We’d expect slower loan growth, we’d look for less fee income, and we’d reduce our investment banking estimates as well. I will be interested in hearing commentary from the banks on their thoughts regarding the tariffs, but at this point, I highly doubt that they’re going to say anything meaningful at this point.
Dziubinski: Dave, let’s talk a little bit about how investors should be thinking about their stock portfolios today after we had that wild and uncertain first quarter. And it seems like we’re having a more wild and even more uncertain start to the second quarter. So first, let’s talk about the market’s valuation overall. Is the US stock market undervalued today?
Sekera: And this actually reminds me of one of the famous Warren Buffett quotes out there that you should be greedy when others are fearful and fearful when others are greedy. So at this point, yes, the market actually has fallen to pretty substantially undervalued levels. As of last Friday’s close, the US market is now trading a 17% discount to a composite of our fair values. I think—investors, you’re going to have to be willing to stomach a lot of volatility here in the near term. I think you’re going to have to have a lot of intestinal fortitude to be able to ride this out. Taking a look at futures, they’re down about 2% this morning as well. But to be honest, I actually can also see scenarios where I think you could see a couple of days where maybe stocks actually pop pretty quickly if there’s any positive news, if you have a number of different countries that start coming to the negotiation table.
So for example, if you watch Nike NKE stock; last week, initially it felt pretty hard after the tariffs were announced, but then it actually took a pretty good pop on Friday, the reasoning being that it was reported that Vietnam had reached out to discuss negotiating, reducing its tariffs on US goods as well as making pledges to purchase US goods. So again, with Nike making a lot of their shoes in Vietnam, that’s actually good news there. So I think this might be one of those instances where those countries that come to the table first probably can get the best terms. And as more and more countries come to the table in order to renegotiate tariff terms, that actually then puts more pressure on those other countries that may be trying to hold out. So again, a lot of volatility here in the short term. I think we can have some pretty negative days, but I can also see some instances where you can have a lot of green on the screen as well.
Dziubinski: Dave, given how undervalued the market does look, are you suggesting that investors just maintain that market weighting in stocks, or is it attractive enough at this point to start overweighting stocks?
Sekera: According to our valuation, Susan, yes, I think now is a good time to start maybe a small tactical overweight position. But again, don’t go all in all at once. I think you’re going to want a dollar-cost average into the market from here.
So what do I mean by that? I would figure out what’s going to be the total amount that you’re willing to be overweight US stocks, and then you’re going to want to buy maybe a quarter or a third size of that position into stocks. But then what you need to do is set a target as far as where you’re going to buy that next quarter to third, maybe pick another 5% down from where you made that purchase. And then as the market falls, you’ll continue to keep moving into a larger and larger overweight position, dollar-cost averaging down.
And of course then when you do have the markets move back up, that’s the time you want to take some profits, take some overweight back to more of a market-weight position. So again, just as an example, this is not investment advice, but just an example: A lot of investors have a 60/40 portfolio, 60% equity, 40% fixed income. Let’s just say that you’re willing to go to a 70/30 portfolio. So to me, you could reallocate 3% out of fixed income and into equity today, set your target, i.e. another 5% down. If the market drops at 5%, that’s when you reallocate that next 3% out of fixed income into equity, set your next target. Maybe that’s down another 5%, and that’s when you make that full overweight position. So taking a look at where futures are now, when you get to that full overweight position, that would mean that the market had fallen about a total of 25% year to date and a total of 35% from its Feb. 19 highs.
Dziubinski: A viewer, an audience member named Bruce, asked what you mean when you say “a market weighting” in stocks overall or in an investment style or in a sector. So how can an investor assign a numerical value to that market weighting?
Sekera: There’s really two ways to think about it, whether you’re an institutional investor or more of an individual investor. But when I think about it from an individual point of view, it’s really the market weight is whatever your targeted portfolio allocations are. So depending on your individual financial situation, your risk tolerance, investment goals, and so forth, you need to have an idea of what percent you want to have an equity versus what percent you want to have in fixed income. So more-conservative investors may be 60/40, maybe younger investors with a longer time frame or more aggressive investors might be 70/30, but whatever that allocation is between equity and fixed income.
And then within those allocations, you want to have a percentage as far as how much is going to be invested in different parts of the equity market. Typically, that would be in line with the market capitalizations of those different parts of the market. So again, a certain percentage of stocks should be in value versus core versus growth. Certain percentage of that portfolio allocation should also then be spread between large, mid-, and small caps.
So you can look at things like the Morningstar US Market Index to get an idea of what those weightings are by style, by category, by capitalization, and by sector as well. So for example, the Morningstar US Market Index, it ranges anywhere from a high of being a 30% market cap in tech, 14% in financials, all the way down to only a 2% market cap in basic materials. So in that case, if you want to be overweight technology as compared to the market, then you’d want to have a greater percentage of your own portfolio in technology stocks, or if you wanted to underweight technology, then it should be lower than that 30% market capitalization.
Dziubinski: Now you referred to value versus growth. Let’s talk a little bit about that. At the start of the year, you had suggested that investors overweight value, market-weight core, and then underweight growth stocks. So now given the outperformance of value as compared to growth, what are you thinking today?
Sekera: Value remains the most undervalued at a 22% discount today. Now, growth stocks have fallen, but at this point, I think they’re only trading at about a 15% discount, and core stocks, they haven’t fallen as much as the growth category, and right now, they’re at about a 13% discount. So the value stocks being the most undervalued at 22% and core stocks being the least undervalued at a 13% discount. So using these valuations, I still think you remain overweight value stocks today, but I think you can start moving your growth portfolio allocation to a market weight from an underweight. And in order to do that, I would start moving your core position from a market weight now to an underweight.
Dziubinski: Despite the rotation we’ve seen in value versus growth this year, we haven’t really seen a leadership rotation between large-cap stocks and small-cap stocks. And in fact, we saw the small-cap-focused Russell 2000, that was the first index to enter bear market territory last week. So, why haven’t small caps performed better?
Sekera: And I think a lot of it also just has to do to why stocks are down. So if you remember, we talked about a couple of weeks ago, I think as John Rekenthaler had written an article where he was making the assertion, and I completely back up his assertion as well, that the first part of the selloff wasn’t due to the tariffs. It was really a lot of these overvalued, overextended AI stocks that got into 2-star and 1-star territory that sold off first. But now when you look at the market, I really think it’s now the market pricing in the tariffs at this point. So when I look at returns by capitalization, there’s actually not that much of a difference between large cap and small cap. I mean they’re both down. Large caps are down 14.2% year to date. Small caps are down 14.9% year to date.
Now, typically in a down market, I would expect small-cap stocks to fall faster to the downside and to a greater degree, as large-cap stocks are generally going to be considered safer. In my view, considering the differential here is less than 1%, I think that tells me that the market does agree that small caps were actually probably undervalued to some degree even before the selloff began. For investors willing to tip their toe into the markets today, I think they’re seeing a lot of attractive valuations in the small-cap category today as well. And then also to some degree, I think that people are expecting that large-cap stocks are probably more exposed to tariffs than a lot of the small-cap companies.
Now looking forward, I do have to note historically small caps do best when the Fed’s easing monetary policy, long-term interest rates are declining, and the economy is viewed as bottoming out and poised to start rebounding. And in my view, that’s just not the environment that we find ourselves in today. I know the market is pricing in cuts to the fed-funds rate, but I would say monetary policy, I think, is pretty cloudy here today. Long-term interest rates are declining as investors are heading for safety in US Treasuries. But the economy is still going to be weaker than I think what we originally forecast. We are looking for the economy to weaken sequentially each quarter through the end of this year before we can start looking for, maybe in later 2026, kind of a reacceleration to the upside. So I think until all of those three factors you’ll get in line, it might be at least a couple of quarters, if not longer, before we start to see that market sentiment shift toward small caps. So they are very undervalued, but it may be a little while before they start to work.
Dziubinski: Dave, given stock market valuations, tariffs, and this economic uncertainty, how should investors be thinking about their portfolios today?
Sekera: Again, it’s going to be hard to swallow, but I think now with as much as the market has fallen and as attractive as it looks on a valuation basis, now is a good time to start that small tactical overweight position in US equities. Within that overweight position, by style, overweight value, I think you start moving into a market weight position in growth from being underweight, and then to pay for that, start to move into more of an underweight position in core from a market-weight position. By capitalization, I think you can start moving back into a market-weight position in the large caps from that underweight position and then start moving to underweight in mid-caps away from the market weight and still have to remain overweight in small caps because they are still so undervalued.
Dziubinski: All right, well, I have a little bit of a commercial for our audience. Tomorrow, which is Tuesday, April 8, Dave and Morningstar economist Preston Caldwell have developed an hourlong webinar that they will be airing live, covering the impact of tariffs on the economy and on stocks. And we’ve provided a link to the webinar in the show notes if you want to register and join us.
All right, so Dave, before we get to this week’s picks, I’d like to get your thoughts about some news from a company that we’ve talked about before as one of your favorite core holdings, and that’s Johnson & Johnson JNJ. Now, last week, a judge rejected the company’s $10 billion talc settlement plan. What was Morningstar’s take on that news?
Sekera: The quick simple takeaway here is that there was no change to our fair value. So what’s going on is that instead of paying the one large lump sum in order to dismiss all the claims, J&J is now going to end up having to litigate all of those claims. J&J came out, they said that they expect that the number of claims will actually end up being reduced significantly before they end up reaching the courts. Our equity analyst noted that J&J does have a very strong track record of winning a lot of these individual talc cases in the past couple of years.
So overall the decision creates more uncertainty as far as the timing of payouts, but we expect smaller expenses could end up stretching out over several years, which actually reduces the present value of the costs there. Plus, in our opinion, we think it probably reduces the overall payment amount as well. But it does increase the risk here that you could have tail risk that some of these claims as they go through the courts could be a much higher than expected as opposed to the certainty of the payout that they had agreed to before. So again, kind of the takeaway here: No change to our fair value, but I think this is going to now just be an overhang on the stock as this just gets stretched out over the long term as opposed to being past them in the rearview mirror.
Dziubinski: Now, J&J stock did fall on the news, pulled back a little bit. Is the stock attractive today?
Sekera: The stock did sell off when the news hit the tape, but I’d say overall the stock is still down less than the market over the course of the week. I think a lot of people are still looking at this as being a good solid name to own for the long term. The stock is still rated 3 stars, but when I look at that 3-star rating, I’d note it’s at the very bottom of that range. In fact, it looks like it’s about to trip into 4-star territory. So if it falls any further from here, again, I still think it’s a good long-term core position for investors in their portfolio.
Dziubinski: All right, sounds like one for a watchlist. Now we’ve arrived at the stock picks for this week. It’s a difficult market environment, loaded with uncertainty. So what are some of the qualities you think investors should be looking for when it comes to buying stocks today?
Sekera: I think it’s too early to be reaching too far down into the risk spectrum at this point. I think there’s just going to be a lot of negative sentiment in the market for quite a while as the market tries to figure out what the impact of the tariffs are going to be and how long they might be outstanding before they start getting negotiated away.
So from my point of view, the characteristics that I’m specifically looking for will be companies with either a narrow or a wide economic moat, those stocks that were already trading at a large margin of safety and trade at even a greater margin of safety at this point, stocks that trade at a pretty modest market valuation, companies that trade at relatively low forward P/E ratios. Again, that’s not how we value stocks, but again, stocks that are already trading at lower PE/s probably have less downside risk at this point. I’m looking for those stocks where you don’t need to assume or make projections where you have to have really rapid growth in sales or margins in order for that valuation to work. Stocks that pay a decent or an attractive dividend yield, stocks that’ll be going to be considered defensive by the market in nature, stocks within the value category. So I think all of those are different characteristics that I’m looking for. Plus, I’d also look at the financial stability of the company. Take a look at the balance sheet, look for companies that have investment-grade ratings as well. And then lastly, those companies that have low or no direct impact from the tariffs.
Dziubinski: All right, so with all those criteria in mind, let’s get to your picks. Your first pick this week is Campbell’s. Run through the numbers on it.
Sekera: And all the picks this week are coming from our second-quarter outlook. So these are all picks that were highlighted by our sector directors as being undervalued attractive picks. So first, the Campbell’s Company, 5-star-rated stock, trades at a 36% discount to fair value, has about a 4% dividend yield right now. It’s a company we rate with a medium uncertainty and a wide economic moat. That economic moat being based on two moat sources: intangible assets—we think the company has very strong brands, pretty entrenched relationships with the retailers—and we also think the company does have a cost advantage.
At this point, we don’t really foresee any inordinate impact from the tariffs. Campbell’s is a stock that’s in the value category. It is rated investment-grade. Taking a look at the market multiple, only trades at 13 times our 2025 EPS estimate, and it’s a new pick to our best picks list for the quarter.
Dziubinski: Consumer defensive stocks are doing relatively well this year, and the sector overall looks about fairly valued. What’s with the really deep discount on Campbell’s? What’s the market missing here?
Sekera: And again, all of the food companies in our view are probably trading at pretty good discounts. So again, it’s not just necessarily Campbell’s, this is just one of the ones we’re highlighting this week. But specifically here, we think the market’s overextrapolating some disappointing results from last quarter too far into the future. And again, the value of a stock is the present value of all the long-term future free cash flow a company is going to generate. So in this case, when we look at how Campbell is running its business, our analyst thinks that the company’s judiciously reinvesting in its brands, it’s keeping pace with involving consumer trends. They’ve been altering their price points, adjusting their pack sizes just to make sure that their mix of products appeals to a more value-oriented consumer today.
When I look at our projections here, we’re only forecasting on average 2% type top line growth from 2026 to 2029. I think really probably the biggest differential in our view versus the market right now is going to be its operating margin. At this point, it doesn’t appear the market’s giving the company any credit for cost savings from the cost savings that they’re currently putting through. Whereas when I look at our margin forecast, we’re looking for it to expand from 14.6% this year to 17% by 2029.
Dziubinski: All right. Your second pick this week is ExxonMobil. Give us the key metrics on this one.
Sekera: Exxon is rated 4 stars, trades at an attractive 23% discount to fair value, almost a 4% dividend yield. Now it does have a High Uncertainty Rating, and again, you’re going to have a High Uncertainty Rating pretty much in any of the energy and specifically oil companies. But we do rate the company with a narrow economic moat based on its cost advantages.
Dziubinski: So then why is Exxon a pick today?
Sekera: Well, generally it just fits in most of the parameters that I mentioned earlier, when I’m talking about what I’m looking for in the marketplace today. It does have a narrow economic moat. You don’t have to assume rapid growth in order to support its valuation. In fact, I opened up the model, took a look at it this weekend, and we’re actually forecasting declining revenue over our forecast period. Trades at a pretty modest market valuation. I think it trades at just under 12 times our 2025 earnings estimate. Attractive dividend yield, very strong balance sheet. I believe it’s still rated AA by Moody’s and S&P. It’s in the value category. So as we have that rotation into value, it should have some benefit from there. Plus, as an oil company, I think it’s a good inflation hedge in your portfolio. Exxon has long been our go-to pick among the global majors. It remains that. And when we look at the global majors, we still think that Exxon is probably the best positioned to be able to deliver earnings growth through 2030.
Dziubinski: And then your final pick this week, it’s a smaller company, and it’s been a pick of yours in the past: International Flavors & Fragrances IFF. Give us the highlights.
Sekera: Four stars, almost a 40% discount to fair value, dividend yield a little on the lower side than I’d prefer, but still 2.2%. Does have a High Uncertainty Rating, but again, most basic material companies are going to have that High Uncertainty Rating. Has a wide economic moat based on two moat sources, intangible assets and switching costs.
Now it is in the basic materials sector, but when I look at the company and their underlying business, in my mind, it is more of a defensive company than I think you would expect. In fact, 50% of its revenue comes from the food and beverage sectors. And if you add in healthcare and biosciences, that takes its revenue up to 70%. So again, very defensive-oriented clients here. We just added this company back to our best picks list this past quarter, but as you mentioned, it has been a pick of ours several times over the past.
Dziubinski: Talk a little bit about the impact of tariffs on International Flavors and Fragrances. There’s a little bit of a story here, right?
Sekera: Well, there’s actually even a longer-term story here other than just necessarily the tariffs here in the short term. So when you look at how this company’s performed really over the past five years, the pandemic really played havoc with its underlying business. Originally, it pulled forward a lot of future demand. Then if you remember, we had the shipping issues, all the bottlenecks, that took a toll on its business and its consumers’ inventory management systems. So the investment thesis here generally is that we see its underlying business still normalizing, we’re still looking for inventory levels to normalize going forward as well. And when you look at our model here, we’re only forecasting pretty modest top line growth. So we’re looking for 10.8 billion in revenue this year, only going to 11.4 billion by 2028. We have pretty modest recovery and operating margins. Operating margins were as low as 5% in 2023.
We expect them to be almost 10% this year and then recovering to only 12% by 2028. To put that in context, operating margins were 17% prepandemic. So I still think we’re looking at relatively modest projections here just to get to what our valuations are.
Now as far as tariffs go, I think the stock was hit there. We do think that there is downside risk to IFF. The company does source a lot of its ingredients globally. However, when we look at the company’s sales, our team estimates that about 70% of revenue is generated outside the US, so that actually will reduce the impact of the tariffs to quite a substantial degree.
Dziubinski: All right, well, thank you for your time this morning, Dave. Those who’d like more information about any of the stocks they’ve talked about today can visit Morningstar.com for more details. We hope you’ll join us next week for The Morning Filter on Monday at nine A.M. Eastern, eight A.M. Central. In the meantime, please like this episode and subscribe, and have a great week.