Plus, our Q4 2025 stock market outlook.
On this week’s episode of The Morning Filter, Dave Sekera and Susan Dziubinski discuss what impact the government shutdown may have on the Federal Reserve’s October meeting. Dave explains why he’s watching the earnings reports from Pepsi PEP and Delta Air Lines DAL this week and reveals whether Carnival CCL or Nike NKE are stocks to buy after earnings.
They cover whether the U.S. stock market looks overvalued at the start of the fourth quarter, if investors should underweight red-hot growth stocks, and which sectors look most attractive today. Morningstar chief Europe market strategist Michael Field joins the podcast, focusing on investment opportunities in Europe. The episode wraps up with 4 new stocks to buy and hold in the fourth quarter that haven’t been picks before.
Episode Highlights
The Economy, Earnings, Stocks in the News
Q4 2025 U.S. Stock Market Outlook
Investing in Europe Stocks Today
Stocks to Buy and Hold for Q4
Read about topics from this episode.
Register for Dave’s Q4 2025 Market Outlook Webcast: Morningstar's Q4 2025 US Market Outlook - No Margin for Error: Stocks Fully Valued
Got a question for Dave? Send it to themorningfilter@morningstar.com.
Follow us on social media.
Dave Sekera on X: @MstarMarkets
Dave Sekera on LinkedIn: https://www.linkedin.com/in/davesekera
Facebook: https://www.facebook.com/MorningstarInc/
X: https://x.com/MorningstarInc
Instagram: https://www.instagram.com/morningstar...
LinkedIn: https://www.linkedin.com/company/5161/
Viewers who’d like more information about any of the stocks Dave talked about today can visit Morningstar.com for more details. Read more from Susan Dziubinski and Dave Sekera.
Subscribe to The Morning Filter to get notified when we post. We’ll see you next Monday!
Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday before market open, Morningstar chief US market strategist Dave Sekera and I sit down to talk about what investors should have on their radars for the week, some new Morningstar research, and a few stock ideas.
Well, good morning, Dave. Due to last week’s US government shutdown, we didn’t get a jobs report last Friday. And if the shutdown persists, we won’t be getting some other key pieces of economic data this month, including inflation figures. So what impact of not having those reports could there be on the Fed meeting at the end of this month?
David Sekera: Hey, good morning, Susan. You know, first of all, I don’t know why, but for some reason I’m feeling it today, it’s the Halloween mug. I know it’s only Oct. 6, but for whatever reason, that was the mug I went with this morning. Yeah, the government shut down, but we are still getting a lot of other alternative data out there. For example, there’s the PMI reports, PMI standing for Purchasing Managers’ Index, and the ISM reports, that’s the Institute of Supply Management.
Now, both of these indexes also have subindexes that do measure price increases. And in fact, a lot of economists will use that as a leading indicator for CPI. And both of those are reporting that prices are still edging up. And then both do have subindexes for labor data as well. I know the ISM report showed that the labor markets were still weakening as well. And of course, there’s also the ADP, the nonfarm payroll report, I believe last week that showed that private payrolls fell by 33,000 in September. That’s now the third decline over the past four months. So when you wrap up what’s going on with the alternative data, that still points to the Fed should be cutting once again.
Dziubinski: So then, on the economic front, what do you have on radar this week?
Sekera: Really not all that much, I think. We have Federal Reserve Chair Powell speaking this week. He’s at the community bank conference. Personally, I’m not even gonna bother listening. I highly doubt he’s gonna say anything of any significance while he’s there. If he is, we’ll see it in the headlines. There’s a number of other Fed officials out there giving speeches as well. So they’ll probably try and update the markets on their own personal thinking as far as the federal-funds rate. And depending on when the government finally reopens, we may have payroll data coming out. End of this week, we’ll see if that comes out or not. Otherwise I think it’s gonna be a pretty quiet week. So I would just say with earnings coming up the week thereafter, enjoy the quiet this week. You know, enjoy the quiet before the storm.
Dziubinski: Yeah, it’s not a huge earnings week this week, but are there any earnings reports you’re watching for and why?
Sekera: Probably really just two. First one is Pepsi PEP. Now Pepsi, of course, is a 4-star rated stock. Trades at a 13% discount to our fair value, has a nice dividend yield at 4%. We rate the company with a wide economic moat and a low uncertainty. And this is of course a stock we’ve recommended in the past. Stock is trading a little bit higher than the most recent recommendation this summer, but a little bit lower than when we first recommended that stock in July of 2024. So the two things I’m really gonna be listening to most closely will be any remarks about the Elliot activist campaign, what if anything they might be doing to try and help unlock shareholder value, and then just any kind of general commentary they have regarding consumer spending.
The other one I think will be important to listen to is Delta DAL. Now Delta is very overvalued. It’s a 1-star rated stock, trades at an 85% premium, 1.3% dividend yield. And like all of the airline stocks, we rate it with no economic moat. When I look at the US airlines, all of them actually are trading above fair value to some degree. I think Delta is the one that trades the most above our fair value. So I just say that when you look at the airlines today and you look at the underlying business, yeah, it all looks great right now. Demand for travel is still very high. Oil prices have kept their prices or kept their own costs low. So of course you’ve had very good near-term margins. But when, long term, you think about this sector, you think about the airline industry overall, it’s just an industry that has very high fixed costs, no economic moats. So it is one that I’d be very concerned that when you see any kind of downturn, these stocks could sell off pretty hard when they start to fall.
Now, yes, we did recommend Delta several years ago. That was just when we were starting to come out of the pandemic. But at this point, I think the market’s really just pricing all of these stocks to perfection today. So I’ll listen for any changes in consumer behavior. We’re not hearing any as far as travel goes just yet, but I do think that once travel starts to slow down, for whatever reason, the stock is at downside risk.
Dziubinski: All right, let’s pivot over to some new research from Morningstar about a couple companies that were in the news last week, starting with Carnival, which is ticker CCL. What did Morningstar make of the company’s earnings report, and is there opportunity in the stock today?
Sekera: Generally, the results were pretty good. I mean, the company talked about having once again higher net yields, lower net costs. In fact, they increased their earnings guidance up to $2.14 a share, up from $1.97. Leisure travel demand as far as they’re concerned is still holding up. In fact, they noted that customer deposits are up once again, another 4%. Overall, cruises are still cheaper than land-based vacations. So from a demand point of view, everything looks good here. I would just talk about how I think to some degree the cruise lines are also a little bit like the airlines, as it’s one of these stocks where you really want to be buying these stocks when the outlook is at its ugliest, not when the outlook is all looking pretty good. So, similar to some of the airlines.
Yeah, we recommended Carnival and some of the other cruise lines just as we are emerging from the pandemic as kind of that reopening play. I think that is back all the way in early 2023. Back then, the stock was I think at a 10 handle. It’s now at 28 and a half. So depending on where you bought it, I mean, you might be up almost 3 times at this point. So technically, it is still a 4-star rated stock. Trades at a 17% discount. That really just puts that barely in that 4-star range. At this point, you’re really no longer picking up the knife off the kitchen floor. So I would say this is one where technically, yes, it is a 4-star rated stock, but it’s no longer trading anywhere near the margin of safety personally I’d be looking for.
Dziubinski: All right, well, we also had Nike, ticker NKE, report last week. It was up 6% after earnings, and Morningstar held its fair value estimate at $104 per share. So, Dave, unpack these results and tell us whether Nike is an attractive stock today.
Sekera: I think you really need to look at the stock performance here immediately after earnings and thereafter to try and gauge how you think the stock might be reacting over the next couple months and years to come. So they had a very nice run, very good pop after earnings were initially released. But then later in the week, they gave back some of that pop. In fact, a pretty good amount of it. So fundamentally, on the one hand, to the downside, sales in China are still pretty disappointing. China represents about 13% of their overall sales. That was down 9%. But on the other hand, they had a pretty good increase in sales elsewhere. That was up enough to be able to bring total sales for this past quarter up 1%. So I think the market was pretty happy about seeing that.
Now, they did note that they’ve had higher marketing spending that led to an operating margin contraction. So the operating margin fell down to 7.7% from 10.9%. So for this current quarter, the company was guiding to another small sales decline, looking for that general or the gross margin to contract by another 300-375 basis points. And they broke that down. They said 175 basis points of that contraction would be coming from tariffs, but the remainder coming from higher marketing spend. As they’re really trying to get their market share back up again. Overall, there was no change to our fair value. It’s still a 4-star rated stock at a 28% discount. But I think that this is going to be a much longer story for them to really get to the point where the stock can move up toward our fair value. Overall, they really need to get a lot of that market share back that they had lost to some of the other running shoe brands out there.
Dziubinski: Yeah, seems like this one will require some patience. All right, our question of the week comes from Aaron. Aaron says, “love the show and love the Morningstar investment process and methodology. My question is, with the Federal Reserve cutting the federal-funds rate, how does this impact the valuation drivers and capital structure of companies under Morningstar’s coverage universe?”
Sekera: Well, first of all, I have to also then break this down into two parts. First, there’s an impact for the banks and the financials versus the corporates. So when we look at financials and look at banks, it’s going to be much more important to their valuations than it will be for the corporates. I would just note that our bank valuations already incorporate our forecast for interest rates and changes in interest rates. So unless at this point the federal-funds rate comes out differently than what we’re currently forecasting, it’s not gonna have much of an impact at this point.
Taking a look at our corporate coverage, the synopsis here is it’s really not gonna change the valuations in the short term by all that much. So when you think about, what is a stock worth, it’s worth the present value of the discounted cash flow of all the future free cash flow that that company is gonna generate over its lifetime, which you then discount at the weighted average cost of capital. So when you think about the free cash flow of a company, in our view predominantly that’s all gonna be driven by your long-term assumptions for both revenue and for your costs. Interest expense generally for most companies is gonna be a pretty small portion of your overall costs. As far as the weighted average cost of capital goes, that’s gonna be your blended cost of equity and your cost of debt. And of course, that’s then going to be pro rata based on the capital structure of the company, how much they have of each.
Now, when you break down the cost of equity, generally that’s pretty sticky over time. In fact, our cost of equity is really gonna be geared toward our uncertainty rating, and then you have the cost of debt. The cost of debt being that risk-free rate plus your corporate credit spread. So our long-term view is we don’t really revise our federal-funds rate or our risk-free rate all that much every time the Fed cuts or raises that federal-funds rate. We want to have a much longer-term view going through an entire economic cycle. So right now the risk-free rate in our model is 4.5%. We didn’t raise it up as much as what the Fed had raised the funds rate up to. And at this point, we’re not cutting it.
Although I’d note depending on where it goes to, if it stays lower for longer, then maybe we have a slight decrease next year on that risk-free rate. And I’d say from what I can tell that’s how most institutional investors also think about the risk-free rate. So, for example, when we had several years of zero interest rate policy, no one ever lowered their risk-free rate down all the way into that 1% or 2% area. I think everyone kind of kept it up at more of a longer-term view as far as like when the Fed would start raising rates once again.
So of course that gets back to our initial question. Where might we see the impact? First, I would say for those companies that have a very high degree of short-term debt on their balance sheets, you could see some valuation increases. Just as the companies refinance that debt with lower cost, that of course bolsters earnings, which could lead to some increases in valuations. And then if interest rates do fall enough that companies change their capital structure, that is that they could issue a lot of debt and then use that debt in order to repurchase stock. I would say that with those companies, those that we think trade pretty far below their long-term intrinsic valuation, that of course could bring those companies up closer to our fair value over time.
So I’d say from a broad market impact, it’s really not going to be that much. And I don’t really think it’s going to be that much. I don’t think it’s going to meaningfully change our economic outlook as well. And then lastly, just talking about how that may change market sentiment, that actually is probably going to be the greater impact that you would see in the markets over the short term. I’d expect a lot of those undervalued stocks, those trading below our intrinsic valuation, probably should move up as investors are looking more for bargains. Might make high dividend stocks look more attractive than fixed income. So you could see some rotation out of bonds and into those high-dividend stocks.
Then last, just a couple words of caution. So I think as those risk-free rates and interest rates come down, you might hear in the mass media a lot of people talking about how that might make growth stocks look much more valuable. Of course, the reason that would be is because growth stocks, when you think about their earnings stream, it’s really gonna be earnings much more in the future than earnings today. So they’re gonna be longer duration stocks. So as you decrease that discount rate, the present value of that cash flow stream is going to be greater. Theoretically, yes, that’s true, but that’s really not what I’ve seen in practice. I think especially with the really high-growth stocks, investors are much more concerned about the assumptions and forecasts going into earnings and their earnings rate of growth than anything else. So at the end of the day—I’m sorry, it’s a very long-winded answer—to say from a fundamental point of view, the changes in the federal funds rate probably don’t have that much of a meaningful impact on our long-term intrinsic valuations overall.
Dziubinski: All right, well, viewers and listeners, please continue to send us your questions. You can reach us via our email address, which is TheMorningFilter@morningstar.com. Well, we are at the start of the fourth quarter, which means it’s time to get Dave’s take on what may lie ahead for the rest of the year.
Before we dig in, I’d like to invite our audience to register for Dave’s upcoming in-depth webcast, where he and Morningstar economist Preston Caldwell will share their fourth-quarter outlooks for the stock market and the economy. The webinar will be held on Wednesday, Oct. 9, at 11:00 am Central Time, and you can register for the event using the link in the show notes. Now, Dave, you say in your fourth-quarter outlook that the stock market is walking a tightrope today. Expand on that.
Sekera: Yeah, and actually talking about the webinar too, I do have a couple of new graphics this quarter, which I think are gonna help really illustrate just how concentrated the market has become. Because when you look at the market performance, it’s all about artificial intelligence at this point in time. Returns very highly correlated and really concentrated in those mega-cap stocks, specifically those mega-caps that are most tied toward the AI build-out boom and expected growth that we’re looking for in artificial intelligence. Yet I’m also seeing more indications from the real economy stocks that the underlying economy in the US is still weakening once you get away from artificial intelligence.
So, looking forward, I think the market’s right in this balancing act. We’re walking this tightrope between just how much the AI build-out boom spending, as well as the Fed easing, is enough to offset other macrodynamic factors in which the economy is weakening. I know from an economic point of view, we are looking for slowing consumer consumption growth. The housing market has remained relatively stagnant here over the next couple of quarters, and a lot of the government stimulus measures that we had over the past couple of years are really fading fast at this point. So, in my opinion, I think there’s just no margin for error in the market right now. There’s no margin of safety. In fact, the market is trading at a slight premium to our fair values at this point in time.
So on the one hand, the AI build-out boom has been enough to offset the weakness we’ve otherwise seen in the rest of the economy. But if that AI spending growth starts to slow, I think that could hit the economy and the market valuations pretty hard. On the other hand, we also don’t wanna have too much growth. We don’t wanna see inflation really start to kick up. If that were to happen, that of course would keep the Fed from being able to ease the federal-funds rate as much as we currently model in. And of course, on top of all of that, we still have the trade negotiations and tariffs ongoing. So that’s still a wild card as far as when and how that’s going to play out through the economy and through the markets.
Dziubinski: So Dave, be specific. At the start of the fourth quarter, just where is the market from a valuation perspective?
Sekera: Even before I get to that, just a quick reminder for those of you that are new to Morningstar’s valuation methodology, we do take a different view in how we look at the market valuation compared to what you might hear from a lot of other market strategists. So in the US, we cover over 700 stocks that trade on US exchanges. I mean, that’s almost all of the S&P 500. So what we do is we take a composite of where all of those stocks are trading in the marketplace on a market-capitalization-weighted basis, and we’ll divide that by a composite of the intrinsic value of all of those companies that we cover. So that gives us this bottom-up view based on our equity analysts’ views of the individual companies as to where the market broadly is trading. So right now, when you make that calculation, you come up with a price/fair value metric of 1.03, essentially meaning the market is trading at a 3% premium to a composite of our fair values. Doesn’t sound like that much. Certainly not unprecedented to be up here. But I would just note, since 2010, only 15% of the time have we traded that high of a valuation or more.
Dziubinski: So then given that valuation, should investors maintain their target allocation to US stocks or do you think it’s time to take some chips off the table?
Sekera: Well, of course, it always depends on the type of investor you are, depends on where you might be with some of your investments and where they’re trading compared to the long-term intrinsic valuation. But the shorter answer is yes. I still think that we probably should maintain that market weight rating for your equity allocation. Right now, we are at the upper end of the range that we consider to be fairly valued, but it is still in that fair value range. I think right now it’s just with this balance between the AI build-out and the economy slowing, I think it’s much more about positioning overall within the portfolio than trying to overweight or underweight equities as an asset allocation.
Dziubinski: Now, you did touch on concentration in the US stock market today. Talk a little bit more about that in terms of the stocks that are really driving the market’s return this year.
Sekera: Well, we’ve seen a bit of a broadening out here in the third quarter compared to the first half of the year. If you did a market attribution analysis for the first half of the year, the top 10 stocks accounted for 74% of the market return. But year to date through the end of the quarter, those top 10 stocks now only account for 53%. So I think it shows a good broadening out across the market of those returns.
So, for example, in the first half of the year, Apple AAPL had been a detractor to the returns. Apple rose 24% in the third quarter. So that really ended up becoming one of those top 10 stocks. Alphabet GOOGL was up 38% just alone in the third quarter. Tesla TSLA, I think, was up 40%. Johnson & Johnson JNJ, one of our favorite stocks here on The Morning Filter, was up 21%. So it’s just when you look at the market overall, the 10 largest stocks still account for 40% of the market overall. That’s double the amount that they were as recently as 2018. So I also have to note, too, even if you’re an investor that’s broadly diversified in a lot of broad market indexes, whether it’s the S&P 500 or whatever, you’re still very heavily weighted in those top 10 stocks.
Dziubinski: All right, break the market’s valuation down for us, Dave, by investment style, looking at both large versus small and then value versus growth.
Sekera: So the large-cap category, which of course has all of those mega-cap stocks within it, that’s trading at a 4% premium, puts it right at the very top of the range that we still consider to be fairly valued. Mid-cap stocks essentially fairly valued today. But it’s that small-cap area that we still see a lot of value for investors. That trades at a 16% discount to fair value. To me, that’s attractive not only on an absolute valuation basis, but on a relative valuation basis compared to the rest of the market. Taking a look by category, value stocks are at a 3% discount. Core stocks moved up a bit, especially because of Apple, that’s now at a 4% premium. And growth stocks are still at a 12% premium. And when I look at growth compared to where it’s traded as far as a premium or discount, going back to 2010, again, the growth categories only traded at this much of a premium, I think about 5% of the time.
Dziubinski: All right, let’s pivot over to sectors. Which sectors look the most overvalued at the start of the fourth quarter?
Sekera: Right now, the utilities sector is actually the most overvalued. Trades at a 12% premium. Of course, we’ve talked about this multiple times in the past. The utilities sector is really being looked at as that second-derivative play on artificial intelligence. But it also just looks attractive to a lot of dividend investors as they’re seeing interest rates in the bond market come down. Those utilities are starting to look better to them. But we think that’s already played out both from a fundamental perspective with the demand for electricity going up and interest rates coming down. Financials are next up at 11% premium. Yes, they will benefit from easing and interest rates coming down and the steepening of the yield curve. We just think that that’s already more than priced into that sector.
Taking a look at both the consumer sectors. Consumer defensive at a 9% premium, consumer cyclical at an 8% premium. I would just note both of these sectors appear to be somewhat barbell-shaped. For example, in the consumer defensive sector, the reason it’s overvalued is because Walmart WMT and Costco COST stocks are just trading at such high multiples. We think that those are both significantly overvalued. So that’s actually skewing the valuation of the entire sector. A lot of the food stocks within consumer defensive we think are very undervalued.
And then somewhat the same story with the consumer cyclical. Tesla, such a large market cap, 1-star rated stock, is skewing the valuation of that sector overall. Then lastly, just want to highlight industrials, that’s trading at an 8% premium. So I think that’s going to disappoint a lot of investors going into this economy that’s going to be slowing over the next four quarters.
Dziubinski: And then which sectors look the most undervalued today?
Sekera: Not much, as the rally has brought up a lot of the rest of the market. Really only three. Real estate, that’s trading at an 8% discount. We’ve talked about this on The Morning Filter a couple of times. We think that real estate will benefit over the long term, especially with easing monetary policy, bringing interest rates down. Energy’s at a 7% discount. In fact, I’d note we actually just increased our price forecast for oil. Our midcycle price forecast for both West Texas Intermediate and Brent, bringing those up by $5 a barrel over the long term. So I see a lot of value in that sector. Then lastly, healthcare is trading at a 5% discount. The names in there that I look toward the most are gonna be the device makers, the medtechs and the consumables.
And then before we move on, I also wanna talk a little bit about the communications sector. So it’s actually now moved up enough; it’s trading at fair value. It was one of the ones that we highlighted as being undervalued at the beginning of the year. And in fact, I’ve gone back through some of our other annual outlooks. At the beginning of 2024, it was the most undervalued sector. And going back to 2023, it was trading at a 43% discount to fair value, a sector that we’ve been very constructive on for quite a long period of time. In 2023, the sector was up 54%. In 2024, it was up 39%. Year to date, it’s up 24%. So unfortunately, it’s kind of run its race at this point in time.
But I really wanna congratulate the analysts on our communications team for the last, call it two and a half to three years, really sticking with their analysis and the fundamentals all the way through a couple of very tumultuous years. Communications, again, unfortunately, it’s run its race. But again, I just wanted to highlight that one.
Dziubinski: Well, then, given valuations today, how should investors be thinking about their stock allocations in terms of style, market cap, and sector?
Sekera: Just running through each of these, based on their valuations, we’d advocate to overweight the small-cap space. And in order to do that, you probably have to have at least a small underweight on the large-cap space. We’d look to overweight value, underweight growth. We’d overweight each of the real estate, energy, and basic materials sectors. And to pay for those overweights, you probably want to be underweight utilities and financials.
Dziubinski: All right. Well, Dave and I have a special guest joining us this morning, Michael Field. Michael is Morningstar’s chief Europe market strategist, and he’s here to talk about investment opportunities in Europe today. So welcome to The Morning Filter, Michael.
Michael Field: Well, thanks, Susan.
Dziubinski: Now, European markets have experienced a good deal of volatility this year. Recap for us, what’s been going on and what you’re expecting for the rest of the year.
Field: So, yeah, they certainly had a big year. You know, it started off quite well, and then we had the “Liberation Day” tariffs, which sent European markets, like US markets, into a bit of a tailspin. And then strangely, they recovered really strongly out of that and have been performing pretty well since, I think the third quarter lost a little bit of momentum. But we think the structure that’s there, the fundamentals are there that they can kind of close out the year strongly and move into 2026 quite strongly as well.
Dziubinski: Now, you know, Dave pointed out that US stocks look fairly valued on that upper end of fairly valued at the start of the fourth quarter. How about European stocks? How do they look from a valuation perspective today?
Field: So I was happy to hear Dave outline how the methodology works for us to get to these numbers. That saves me going through all of that as well. But, yeah, the US market’s trading at about a 3% premium. Europe’s slightly more attractive. It’s trading at about a 3% discount at this stage, which might not sound like a whole lot, but for investors looking to invest at the margin, that kind of difference could make a big thing for them.
Dziubinski: Now, within Europe, which countries have more attractive valuations, and then of course, on the flip side, which countries maybe have less attractive valuations today?
Field: So that’s a good question because when we look at the chart of all the countries in Europe currently, the valuations actually do differ quite strongly, surprisingly, given that it’s the same essentially macroeconomic backdrop in some ways. You have countries like Spain and Italy, surprisingly, given the troubles these countries had maybe 10 years ago, macroeconomically, they’re the most expensive markets in Europe currently, they’re trading at about a 10% premium, both of them. And that’s a function of the macro economy in those lower European regions doing quite well, number one. But also some of the big stocks that make up those market indexes are performing quite strongly as well.
And then on the flip side of that, in Northern Europe, you have the Netherlands and Denmark, which actually are currently the cheapest countries in Europe at the moment. And that again, that’s somewhat of a bit of a freak of nature in that if you look at the big stocks in those countries, some of the biggest stocks in Europe, actually. So Novo Nordisk NVO in Denmark and indeed ASML ASML, the company that makes the machines that make AI chips essentially in the Netherlands, both of those stocks have had a pretty bad run of late. And generally, the components of those indexes have just been dragged down. So that’s kind of what’s making them cheap at the moment.
Dziubinski: Now, again, as Dave mentioned, here in the US we’ve seen a lot of market concentration with 10 companies driving more than half of the market’s return this year in the US. Is the same true in Europe?
Field: To some degree, but less so, I would say is the quick answer. I think if you look at it by market cap, the top 10 stocks in the US comprise like 36% of the market, essentially. Right. It’s lower in Europe, it’s almost half that level. And indeed, in terms of returns, Dave mentioned that the top 10 stocks in the US have driven over half the market. Right. And that’s less so in Europe. It’s more about a third. But I would say that figure kind of belies the diversification of the top 10 stocks in Europe, that unlike the Magnificent Seven, which comprise most of the returns of those top 10 stocks in the US, in Europe, it’s a bit more diversified. You do have ASML, which I mentioned is essentially related back to AI, but you have many other stocks like Novo Nordisk in healthcare, some of the consumer names also generating those gains. So from that perspective, yes, certainly it’s more diversified.
Dziubinski: Michael, you mentioned sectors here. Are there any sectors in Europe that look especially overvalued or especially undervalued today?
Field: Certainly. So I think overvalued sectors you have financials, which has done phenomenally well. Strangely, I don’t think anyone would have expected gains of almost 40% over the last 12 months in a sector that’s comprised of large European banks. But there you go, that’s what it’s done. And now valuation has kind of caught up with it to some degree. And then communication services, which Dave mentioned, has rallied in the US. Similar situation in Europe, but now that’s overvalued by around 8%. And then on the flip side of that, the sectors that are looking cheap at the moment, you have healthcare, which is the cheapest sector in Europe.
Strangely enough, at the moment it’s trading at about a 15% discount to our fair value estimate. A sector that’s supposedly defensive in a time that we have a lot of volatility, but again, valuations just aren’t reflecting that. And then you have the two consumer sectors as well, both defensive and cyclicals. They’re trading at quite large discounts for quite a while in Europe, actually. And I would say that’s pretty broad-based. You’ve got a lot of moaty names, big names in Europe, but also some of the lesser well-known names in different areas as well, like autos, are driving those valuations down again. So I think plenty of opportunity in Europe at the moment.
Dziubinski: All right, so name some names, Michael, give us a few stock picks, some European stocks that you like that US investors can pretty easily buy.
Field: Yeah, absolutely. So I would say, look, three stocks for you. The main kind of common factor these have is that they’re all actually wide-moat stocks. So that just shows you the depth of opportunities that we were able to actually find those really moaty names that are still trading at a discount.
So the first one up is SAP, and ticker SAP also, very easy one. It’s one of the largest stocks in Europe, essentially based on software, cloud software, essentially the migration to the cloud. So structurally, that’s been a driver of the stock for quite some time now, and it’s been performing really well up to earlier this year. I think it got caught up to some degree in the US tech wobble, but unlike Alphabet and other US stocks, SAP just hasn’t really recovered yet to the same degree. So we’re actually seeing a lot of upside in that one. At the moment it’s a 4-star stock.
The next one on the list then is slightly related but again slightly different is RELX, RELX is the ticker, and again this is originally a Dutch company, but essentially, it’s global these days. IT services, one of these businesses that people don’t know a whole lot about until you start describing it. And then it triggers a few memories for them. So they’re involved in legal and risk software, things like this. So LexisNexis, people might have heard that name. Essentially, an oligopoly in some industries. And again, it’s one of these stocks that kind of got caught up in the tech wobble earlier this year and concerns around AI and just hasn’t really recovered yet. And another 4-star stock name there.
And then last but not least, certainly not least, is Diageo DGEAF, a company that again might trigger, the name might trigger something for people. It’s actually a 5-star stock at the moment, and it’s the global leader in liquor and beer sales. So brands like Johnny Walker, Smirnoff, and then in beer in terms of Guinness, which I’m sure people are familiar with. So this has been one of those consumer stocks that’s been really dragged down over the last while. It used to trade on a pretty large premium, and now the discount is wide open on this one.
And ultimately, what that comes down to is inflation has been high in Europe like it has in the US for quite some time. It’s simmered down, but these companies are really trying to recover volumes, and consumers just haven’t been going out and spending those volumes like they used to, and it’s essentially a slow burn in that regard. But what we’ve seen with companies like Diageo is they’re increasing their market spend over the last while, and we think the turning point has come where they are going to drive those volumes again over the coming months. We would recommend taking advantage of those opportunities while you still can.
Dziubinski: All right, well Michael, it was great to have you here. Thank you for joining us this morning.
Field: Thank you.
Dziubinski: All right, we have Michael’s picks. Now it’s time for Dave’s picks of the week. This week, Dave has brought us four brand new stock picks for the fourth quarter. And he’s called all these stocks from our analysts’ new list. These are all stocks that haven’t been picked before. So everyone pay attention! This is fresh! First up is LPL Financial, which is ticker LPLA. Run through the numbers on this one, Dave.
Sekera: So LPL Financial is a 4-star rated stock. Trades at a 38% discount to our fair value for dividend investors. Not much of a dividend yield here. Only four-tenths of a percent. A company we rate with a high uncertainty and a wide economic moat. And in fact we just raised that economic moat from narrow up to wide. And that’s really why this one caught my eye this quarter. That wide economic moat is based on two different things. First being switching costs and then second based on their cost advantage based on their size and scale.
Dziubinski: All right, so unpack Morningstar’s thesis on LPL and how that thesis differs from that of the market.
Sekera: I kind of like the stock from two different perspectives. One, there’s just the fundamentals of the intrinsic valuation in and of itself. And secondly, I kind of look at it as almost being a little bit of a leverage play just on the growth of the market, just as the market seems to continue to keep moving up every single day. So LPL itself is the largest US independent broker-dealer. Has over 29,000 advisors on its platform, over 10 million accounts. So I think in the short term it just benefits from existing assets under management increasing. So the more the market goes up, that increases their assets under management, which then just leads to higher fee income and faster earnings growth.
And then over the longer term, from a fundamental point of view, we think that they’ll be able to capture a lot of new assets under management. Overall, our analyst team has noted that the percentage of advised assets continues to keep growing every year. So new assets under management then just leverages even higher management fees over time.
Dziubinski: Now, your next pick this week is Idex, ticker IEX. Tell us about it.
Sekera: So it’s a 4-star rated stock, 21% discount, 1.7% dividend yield. Also has some share buybacks going on. It has a medium uncertainty rating and a wide economic moat, with the wide economic moat being based on switching costs and intangible assets.
Dziubinski: Now, Idex’s stock is down about 20% this year. What’s the case for it today?
Sekera: Well, the first thing that really caught my eye was the title of the last stock analyst note that the analyst put out, and that is, “Idex is a cash compounder with an impressive record of capital allocation and margin expansion.” So that, in a nutshell right there, tells you what’s going on. So they own a collection of what we consider to be pretty moaty businesses. Typically, these businesses are leaders in what we consider to be niche end markets with number-one or number-two market shares in those individual niches.
Historically, this company uses its free cash flow to acquire other businesses. So, of course, that first leads you to the concern about whether or not they overpay for those businesses. Our analyst has gone back and notes that they consistently generate returns on invested capital in the upper midteens percentage area. So, in our mind, that’s pretty good evidence that they have very good acquisition parameters and they’ve not been paying for those acquisitions over time. So this stock did fall last quarter, and really the reason for that were tariffs and macroeconomic uncertainty really weighed on demand for the past quarter or two. So that then led to much weaker operating margins. In fact, management cut their guidance.
Overall, we think the market is probably overreacting to the downside. Our analyst teams noted this is a stock that really doesn’t trade at much of a discount very often. So I think this is a rare opportunity to take a look at this one. I opened up a model over the weekend, took a look through that. We do forecast the operating margin to eventually normalize over the next five years. From a top-line perspective. We’re looking for 7% top-line growth, compound annual growth, over the next five years. It’s a combination of 5.5% organic growth sales, with the rest of it coming from additional acquisitions; that, with the operating margin expansion, gets you to a little bit over 11% compound annual growth rate over the next five years. Trades at 21 times this year’s earnings but under 20 times next year’s earnings.
Dziubinski: All right, your third pick this week is a smaller company. It’s Freshpet, ticker FRPT. Give us the highlights.
Sekera: This one’s a 5-star rated stock at a 50% discount. However, they don’t pay any dividend, and it has a high uncertainty. I’d also have to point out this is a no-moat stock. It’s a small-cap stock in that growth category, which I think will benefit from the rotation into small-cap stocks. But this is gonna be a little bit more of a risky situation. Probably better for people. They can take some additional speculation in their portfolio.
Dziubinski: Yeah, the stock is really down this year. I think it’s about 60%. So why do you like this one, Dave?
Sekera: Well, it’s down this year, but if you take a longer look at the chart here, Susan, that stock soared in 2024. I mean, in fact, it was kind of bouncing right between 1- and 2-stars for much of the years before it sold off. And I think this is just a great example of oftentimes how the market just overpays for growth when growth is accelerating at an accelerating rate. But then once that rate of growth starts to decelerate, you can see these stocks just crater thereafter. So at this point, if you take a look at the chart, the stock has actually round-tripped all the way back to where it was in January of 2023. So this is a growth stock. So you’ve really got to believe the story here.
Our top-line growth forecast—actually, even before I get that, taking a look at the model, this top line grew at an average of 32% over the past three years. Now, we’re looking at pretty strong growth here, but compared to that, I think we’re probably pretty conservative. So our forecast is for that growth to moderate to 14% over the next five years. We are looking for additional operating margin expansion as you get that fixed cost leverage on those higher sales base. You know, we’re looking for 40% earnings growth over the next five years on a compound annual growth rate. So it is an expensive stock. It’s trading at 53 times our earnings estimate this year of $1. But it’s only 28 times next year’s earnings estimate of $1.87. And that drops down to 18 times our 2027 earnings estimate of $2.90 per share.
Dziubinski: All right, your final pick this week is GE Healthcare Technologies, which is ticker GEHC. Walk us through the key metrics.
Sekera: So it’s currently rated 4-stars at a 14% discount, only offers two-tenths of a percent for that dividend yield. We rate the company with a medium uncertainty and a wide economic moat, that economic moat being based on intangible assets and switching costs.
Dziubinski: Now, there are a lot of undervalued stocks in the healthcare sector today. So why is GE Healthcare Technologies specifically your pick?
Sekera: Well, within healthcare overall. I like a lot of these medtech firms just with what’s going on in a lot of the rest of the healthcare area. Now this company sells imaging and ultrasound equipment. It has some leading market shares in both. In fact, I think the industry overall is a little bit of an oligopoly. Now, this stock was hit pretty hard early in April. Looks like it’s kind of working its way back up. Management at that point in time had guided to an $0.85 per share hit to account for potential tariffs. This past quarter, they reduced the amount of the negative tariff impact.
Fundamentally, the company has a very large backlog of orders. I think part of the weakness here is just because people are concerned about weak Chinese demand. But we think that’s already incorporated into the valuation. Overall, I think our assumptions look relatively conservative to me. Our top-line forecast for revenue is 3.7% compound annual growth rate for the next five years. Looking for that margin to rebound as the company figures out how to work around any potential tariff issues, that should lead to a 5.5% earnings growth rate. We’re currently looking at $4.53 per share. So it puts it under 17 times the midpoint of their current guidance. So looks like a good, strong value stock to me today.
Dziubinski: All right, well, thank you for your time this morning, Dave. Those who would like more information about any of the stocks Dave talked about today can visit morningstar.com for more details. We hope you’ll join us next Monday morning for The Morning Filter at 9 am Eastern, 8 am Central. In the meantime, please like this episode and subscribe. Have a great week.