Plus, stocks in the news that investors should dump.
On this week’s episode of The Morning Filter, Dave Sekera and Susan Dziubinski unpack Fed Chair Powell’s comments after the Federal Reserve’s 25 basis interest rate cut last week and preview the upcoming PCE reading. Dave explains why he’ll be watching the earnings reports for AutoZone AZO and Costco COST this week—and why he disagrees with President Trump’s suggestion that companies do away with quarterly reports.
They also cover what investors can learn from last week’s earnings reports from Lennar LEN, FedEx FDX and Darden Restaurants DRI. Tune in to find which stocks in the news last week look like stocks to sell today. And Dave’s stock picks this episode are all undervalued stocks to buy from a part of the market that’s often overlooked: mid-caps.
Episode Highlights
Interest Rate Cuts: What’s Next?
Should Companies Do Away with Quarterly Reports?
Which Stocks in the News to Sell
Stocks to Buy While They’re Still Off-Radar
Read about topics from this episode.
Read Dave’s latest stock market outlook: https://www.morningstar.com/markets/stock-market-outlook-where-we-see-investing-opportunities-september
Are Mid-Cap Stocks the Sweet Spot for Investors Today? https://www.morningstar.com/stocks/are-mid-cap-stocks-sweet-spot-investors-today
Got a question for Dave? Send it to themorningfilter@morningstar.com.
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Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning 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. All right, Dave. Well, let’s kick off today’s episode talking about last week’s Fed rate cut of 25 basis points. The market finished the week up. What do you make of the market’s response?
David Sekera: Good morning, Susan. Initially, I think the market was just a little confused by the really wider range that they had of the dot plots. But on Thursday, the market just got past caring, and just everything moved up on Thursday. Everything was in the green. The only thing that mattered to the market at that point is that we’re on an easing path again. We’ve got two more cuts expected by the end of the year. So, everything was up and to the right. Friday was a little more interesting. I did see some indications of people taking some profits here and there on some specific stocks. But all of the “momo” stocks, the momentum stocks, they just continued to keep climbing higher on Friday. So again, markets looking to just keep going to higher and higher levels at this point.
Dziubinski: Did anything stand out to you in Fed Chair Powell’s comments after the rate decision?
Sekera: Well, first of all, I’ll admit I only really listened to the first two-thirds of the press conference, and then I had some media calls thereafter. I took a quick look back at the notes that I had. To be honest, nothing in particular really stood out to me. I mean, I would say there was no surprises, really nothing unexpected. Nothing all that noteworthy, I think, was just a lot of what you would expect for him to say in such a situation.
Dziubinski: I think you said earlier that the market’s expecting two more rate cuts for the rest of 2025, but what about 2026?
Sekera: The market’s pricing in that 25-basis-point cut in October, another one in December. Looking toward 2026, it gets to be a little bit more cloudy. I mean, the market’s definitely pricing it over the course of the year. Several more cuts. It’s just going to be dependent on inflation and the economy as far as how fast those cuts come, probably going to be more front-loaded toward the first half of the year. But we’ll see how that all comes to fruition. At this point, though, from now until the end of the year, the only thing that could stop those additional cuts from coming is if, for whatever reason, we see inflation really start to surge higher.
Dziubinski: Let’s pivot and start looking ahead. This week, we have the PCE coming out. Now, we had some mixed messages from the PPI and CPI numbers earlier this month. Do you think we’re going to get any more clarity on inflation from the PCE, given that is the inflation metric the Fed watches most closely?
Sekera: We’ll see. It’s kind of a yes and a no answer. I took a look at the consensus number. Core PCE, they’re looking for that to increase 0.2% month over month. That would be slower than the three-tenths of a percent that we had last month. So, that’s good news. However, headline PCE, they’re looking for that to increase three-tenths of a percent, which is slightly faster than the two-tenths of a percent from last month. Overall, on a year-over-year basis for headline PCE, we’re looking that to come in at 2.8% versus 2.6%. Overall, I’d say as long as we don’t have inflation spiking higher, the Fed’s going to continue to keep easing. They’re certainly more concerned by what’s going on in the economy and a slower labor market than they are by inflation at this point. So, I don’t think it’s really going to give us that much more clarity, per se. I think as long as it’s just kind of still on that same track, the Fed’s going to keep cutting.
Dziubinski: What about earnings, Dave? What earnings reports are you looking forward to this week?
Sekera: There’s really two that I’m going to be focused on. The first one’s going to be AutoZone AZO. Now that company’s business has been doing very well for several years now. I mean, overall new cars, just way too expensive. What we’re seeing is that the average age of automobiles on the road continues to keep climbing. I think just more and more people are repairing their cars and keeping them for longer before they’re scrapping them. However, when you take a look at the company’s stock, it’s pretty expensive. I took a quick look at our model this weekend. Our top-line five-year compound annual growth rate is looking at 5.6%. It’s a combination of a little bit of inflation, a little bit of additional volume, some net new store openings. I would say that’s probably a pretty good expectation as far as like the top line. We’re looking for a little bit of margin expansion, some share repurchases.
So, between those two, earnings growth should average 11% to 12% over 2026 to 2029. But that stock trading over 40% premium to our fair value puts it well into 1-star territory. I mean just that exceptionally strong growth that they had, especially in the first couple years of that pandemic. I think the market’s overextrapolating this short-term growth too far into the future. I mean, when you look at that stock, it trades at 28 times forward earnings. I don’t know, that just kind of seems high to me for an auto parts retailer. And then we’ve got Costco COST. Costco stock just continues to keep defying gravity. We’ll see if we continue to still be wrong on this stock here in the short term. Again, taking a look at the assumption in our model, I’m not going to say they’re aggressive, but certainly pretty full.
Our top-line expectation for revenue, five-year compound annual growth rate of 8%. We’re looking for same store sales to grow 5%, looking for net new store openings, new increases in memberships. All of that put together then leads to earnings growth of a little bit over 11%. But the stock trades at over a 50% premium to our fair value, well into 1-star territory. When you lake again, we don’t use price to earnings or forward PE multiples to come up with our fair values. But I don’t know, it’s over 50 times this year’s earnings. I just don’t necessarily see how a retailer like Costco can justify those type of earnings growth rates.
Dziubinski: Now speaking of earnings, President Trump suggested last week that he’s in favor of doing away with quarterly earnings reports in favor of semiannual and annual reports only. First of all, Dave, how likely do you think this is to happen?
Sekera: Well, we are talking President Trump here, so who knows? My own personal opinion, I think this is probably just noise for now. I just don’t see why this would be a significant issue to him that he would necessarily look to spend his own time and resources on it to pursue pushing this through. Now, having said that, if I remember correctly, going back to the 1990s, a number of his different gaming companies that were public, I only ever listened to like a couple of their earnings calls. But I don’t ever remember him actually being on any of those earnings calls. I think he always left it to like his CFO and some of the other people to do those earnings calls. I don’t think that you, it’s necessarily important from him from back when he was in the industry.
So, I could see why he doesn’t think that it’s necessarily to do quarterly. Having said that, the financial industry thinks that it is necessary for the market to have. I actually got in one of my email inboxes an institute survey from the CFA Society. So, CFA standing for Chartered Financial Analysts. And in their survey, they noted that 91% of investment professionals agreed with the statement that quarterly reports provide critical information and disclosures and has a structured and reliable data that affects how they view companies. They also noted that in the UK, they shifted to semiannually over a decade ago. And according to the CFA Institute, they failed to achieve one of those intended goals back then, which was to enhance long-term capital investment. And they also noted that there was a study that the CFA Institute Research did that significant increase in corporate investment did not increase when they reported semiannually instead of quarterly.
Dziubinski: So then, Dave, what’s your hot take on it? Do you think it’s a good or a bad idea? And why?
Sekera: My own personal opinion, I think it’s a bad idea. I mean personally I’m in favor of keeping quarterly earnings reports. I started off in the business and finance in 1991. I moved into an analytical role in 1993. Mostly, I’ve covered US companies, but I’ve certainly covered my share of European and other international companies as well. And my view, I think quarterly just provides better transparency. It’s better for valuing stocks, but not just stocks. Better for valuing the credit quality of the companies as well. So, it has implications not only for the equity market but the credit markets as well. And I don’t necessarily think that by going to semiannual from quarterly really ends up opening up that much opportunity for managements to spend that much more meaningful time on the business as opposed to quarterly reports. I don’t think that really makes a difference.
So, my concerns here, first, I think changing to semiannually could lead to greater volatility around earnings season. If you think about it, if you’re only getting your updates every six months and instead of every three, the business can diverge a lot further from what expectations are between those reporting periods. I think you could have some differences between what companies provide to the marketplace. Even in Europe, while they’re doing semiannual reporting, a lot of companies will provide some update or some information still in between those semiannual updates. But they can provide whatever they want. There’s not a lot of consistency within sectors as far as what they provide. And then lastly, I think it actually would make things harder for management, and the reason is that it could be harder for them to relay information in between those reporting periods. I think it could actually lead to a lot of Reg FD issues where you could have the company providing some disclosure to some investors but not to other investors. And at the end of the day, and going back to the CFA Institute surveys and research, it just doesn’t seem like there’s any statistically significant advantage in those European companies providing semiannual versus quarterly. So, I don’t necessarily see why we should be going down that route.
Dziubinski: All right, let’s move on to some new research from Morningstar, starting with a few companies that reported earnings last week that you were watching for. The first is Lennar, ticker LEN. Now, you were keeping an eye out for this one for insights into the housing market. What did management say that you found useful?
Sekera: I’d say it appears that the housing market overall is still kind of working through a bottoming process at this point in time. Specifically, Lennar talked about how they still have to be very aggressive offering sales incentives in order to move those houses that they’re building. It led to a 12% increase in new order growth, but yet the company actually lowered its full-year delivery guidance to about 82,000 units from 86,000 units. That lower guidance still has them growing 2% from last year. But I think what’s going on here is I think that the company probably is looking to reduce the volume of what they’re selling in order to try and focus more on profitability.
So, gross margins are coming in at about 17.5%. In a normalized environment, our analytical team expects that they should be in that low-20% area. I think what they’re trying to do is make sure that unsold net new inventory out there doesn’t grow to be too much of the marketplace. Looking forward, even with the Fed lowering the fed-funds rates, our team still expects that 2026 overall will be a pretty challenging market for new home starts. They’re looking for single-family starts to be down 2% after a 5% decline this year. And that’s just based on our economic outlook. Looking for a pretty sluggish economy not only through the rest of this year but for the first half of next year until the economy starts to reaccelerate. Our team would really like to see mortgage rates fall below 6% to really think that’s going be a big boost to new-home sales. So, we think the rebound in new-home building probably doesn’t occur until 2027.
Dziubinski: And then what do you think of Lennar’s stock after earnings?
Sekera: It should be a long-term beneficiary of the Fed cutting rates. Now, the stock did slide after earnings just enough to put it into 4-star territory at a 20% discount. But I think it’s just one of these situations that it is a longer-term story. I think you’re going to need to see housing really start to reaccelerate to the upside before the stock starts to work.
Dziubinski: FedEx’s FDX earnings report was also on your radar last week for insights into the consumer. Any key takeaways from FedEx management about that?
Sekera: To me things are just still as clear as mud when I’m trying to really understand what’s going on with the economy. So, looking through our stock analyst note here, our analyst noted the top line did increase by 3%. So, the good news is that the company saw domestic package volumes increase by 5%. However, a lot of that strength was offset by weaker international activity, specifically a weaker volume from Asia to the US. And they also noted that industrial activity was weak, specifically the less-than-truckload sector was weak. That would indicate that the economy for small businesses isn’t getting any better anytime soon. Consumers are still continuing to spend but industry still continuing to slow, I would say would be the net-net takeaway. Now one thing that was positive here is management was able to provide updated guidance. If you remember last quarter, they said it was just too murky out there for them to be able to give full-year guidance. The adjusted EPS did come out to $17.20 to $19.00. It’s still a very wide range. But at least I do think it’s positive that they’re now able to at least give that guidance.
Dziubinski: So then, what do you think of FedEx stock, ticker FDX, after earnings? Dave, is there an opportunity here?
Sekera: I don’t think so. Taking a look at it, it’s pretty fair valued. Where it’s trading, the marketplace is almost right on top of our fair value. It’s a 3-star-rated stock, trades at I think just under 13 times forward earnings, which, compared to the rest of the market, actually seems relatively attractive. But when I talked to Matt [Young] on this one, who’s the equity analyst that covers it, he noted that historically the stock has traded in that 13 to 14 times area. So, really nothing to do. Doesn’t look like it’s really trading at much of a margin of safety from our long-term outlook.
Dziubinski: Now Darden Restaurants, which is ticker DRI, reported last week, and you were watching this one again for insights into the health of the consumer. What did management have to say?
Sekera: Again, just kind of surprised me as far as what it’s telling me. I was surprised at how strong the results actually came in. So again, trying to understand what’s going on in the economy today is as difficult as I think I’ve ever seen in the course of my career. Total same-store sales increased by 4.7%. Olive Garden came in at 5.9%. Longhorn Steakhouse came in at 5.5%. And when you look at these same-store sales numbers, they came in with a pretty good mix of both higher foot traffic and higher average increases in check size. EPS rose 13%. Management increased their guidance. So, their 2026 sales growth, they’re now looking for a range of 7.5% to 8.5%. That’s up from 7% to 8%. Looking for same-store sales increases of 2.5% to 3.5%. It was 2% to 3%. So, considering that eating out is probably one of the more highly discretionary purchases out there, either middle-income consumers are just not in that bad a shape. They’re not being as pressured by inflation as I think that what we are seeing in a lot of other anecdotal incidents, or maybe they’re just cutting back elsewhere and they’re still continuing to keep going out and cutting back spending in other places. But again, very strong results overall.
Dziubinski: Now, what about as an investment, Darden stock, it’s still really overvalued, right?
Sekera: Exactly. So, even with as good as these results were, the stock slid, I think about 12% coming into earnings. It was a 1-star-rated stock, fell enough that it’s now a 2-star-rated stock but still trading at an 18% premium to our fair value.
Dziubinski: All right, well, let’s talk about several other stocks that were in the news last week. Elon Musk invested a billion dollars in Tesla stock, ticker TSLA, and the stock was up on the news. What do you think of Musk’s big investment, Dave?
Sekera: Well, on the one hand, it’s always positive to see the founder of a company buy more stock for their personal account. But I ran through the numbers here to try and put some perspective on it, and hopefully my numbers here are right. Using some artificial intelligence over the weekend, but Elon’s net worth is reportedly give or take about $450 billion. Now, half of his net worth is already tied to Tesla. So by buying more stock, that’s just making his net worth even more concentrated in that company. So, obviously he sees a lot of future growth there. But $1 billion to him, if I’m doing my math right, is like only like two-tenths of a percent of his net worth. Putting that in context, for someone with like $10 million in net worth, it’s like having $5 million in one individual stock, but you’re only buying another $20,000. So, I think it looks good on paper, but I don’t necessarily know if this really is a big difference in his own net worth and his own personal account.
Dziubinski: Given the stock price today on Tesla, is the stock a sell even after Musk’s vote of confidence?
Sekera: Well, personally, I’d never bet against Elon with his track record. I know I’m going to get flamed in the comments by all the people who are Tesla adherents, telling us just how wrong we are on the stock. But yes, we do think the stock is overvalued. It’s a 2-star-rated stock, trades over a 60% premium to our fair value. And when I look at our valuation, it’s not just our projections for the electric vehicle part of their business. Our analysts noted that over half of the valuation of the company that we ascribe here is already tied to Tesla’s AI software and to the robotics. We are forecasting that full robotaxi rollout by 2028. Maybe there’s some upside if that full rollout comes out before then. But I just have to say that when you take a look at the stock, it is very volatile.
Over the years when I look at our fair value versus how much the stock has swung back and forth, we highlighted that the stock was overvalued you at the end of 2021 when it was in the $400s, it fell enough that by 2022 it was undervalued. I think the stock bottomed out somewhere in like the low $100 area. It was overvalued at the end of 2024 when it got back to over $400 again, and it hit fair value after the correction earlier this year in March and April. So, as high as it is up again, maybe it’s a good time to take some profits off the table and wait for it to correct and move back into position again.
Dziubinski: Intel, which is ticker INTC, soared more than 22% after Nvidia NVDA announced it would invest $5 billion in Intel as part of a deal to co-develop data center and PC chips. And this is, of course, after the US government took a 10% position in the company last month. What’s Morningstar’s take on the news?
Sekera: Our analyst team actually increased our fair value up to $28 a share from $21 a share. I did take a quick read through our stock analyst note. It just seems like our team is generally more optimistic now about the long-term support for Intel’s products. However, the stock analyst note didn’t actually specify what we changed in our assumptions. And to be honest, I just hadn’t had a time this weekend to kind of look through the new model versus the old model. So again, it’s really just much more of now having this general expectation that you’re going to see over time more people looking to do business with Intel, and that they should be able to use these investments to help build up and kind of catch up to how much they’ve fallen behind in the fabs, in the technology.
Dziubinski: After the rally in the stock, Intel is trading a bit above Morningstar’s new fair value estimate. Would you say that it’s a hold or a sell today?
Sekera: So, at this point, at that slight premium, it still keeps it well within 3-star territory. I just think this is going to be one where it’s just going to be a very long-term story to play out. It’s going to take multiple years of them using these new investments to build out new semiconductor fab facilities. They still need to catch up technologically to the rest of the semiconductor market. That will happen over a longer time period. So, this isn’t a stock that I would expect to really rally anytime soon.
Dziubinski: What about Nvidia NVDA, Dave?
Sekera: There was no change to our fair value with Nvidia. Our analyst noted it really seems like this is more of a way for Nvidia to get in the good graces of the US government, especially while the US government is negotiating trade terms and potential tariffs with the Chinese right now. And when you look at the actual transaction here, Nvidia didn’t commit to actually using any of Intel’s foundry to manufacture their own Nvidia chips. So, from an Nvidia point of view, really nothing has changed here in my mind.
Dziubinski: Let’s talk about Sherwin-Williams, ticker SHW. The company announced it was eliminating its 401(k) match. That can’t be good, right?
Sekera: I don’t know, that might be the understatement of the day. That news really surprised me. And this is just one of these anecdotes that just again, I’m trying to figure out what’s going on in the world. That announcement just kind of makes me wonder just how bad things could be going at that company if they’re resorting to eliminating that 401(k) match. The reports out there were saying the only other instances when they halted their 401(k) were back in 2009 and 2020. Of course, that was the global financial crisis and the pandemic. I think this is really going to hurt the morale of the company. So, I don’t know, we’ll see where they come out with earnings. But again, this to me really surprised me that they’re going to cut that. That’s telling me things are really going the wrong way at the company in the short term.
Dziubinski: Last time I checked, the company hadn’t announced its earnings date yet. But you know, looking at past reports, it’s probably going to be in about four weeks. Given that, is Sherwin-Williams stock a sell ahead of that earnings date?
Sekera: Well, even before that news came out, the stock was already trading at over 38% premium to our fair value. Puts it in 1-star territory. I took a look at the model here. We’re expecting a 4% top-line growth on average over the next five years, 8% earnings growth. I mean probably relatively conservative kind of numbers. But even modeling that in, the company was trading at 35 times earnings. Seems pretty high to me. So, I would say the stock is definitely overvalued in our mind, it isn’t one that we would recommend for investors. And maybe with the news here, I don’t know, maybe some traders want to go out there and buy some puts before the earnings report, and you ll see what kind of potential downside there could be here.
Dziubinski: Reddit, ticker RDDT, has come up in some news stories about the assassination of Charlie Kirk. And these stories say that the person accused of the killing was active on Reddit, among other online platforms. Now, Reddit stock is up more than 400% since its IPO about a year and a half ago. Given all of this, does Reddit’s stock look vulnerable, Dave?
Sekera: I think so. And the reasoning here is just I think all of these platforms, Reddit and the other ones, are going to be under a lot of government scrutiny here in the short term. And from an advertiser’s point of view, I think that’s going to cause a lot of people to think twice about whether or not they want to have their brand on those platforms and be associated with those platforms for a while at this point. But even before this came, Reddit was a 1-star-rated stock at an 89% premium to fair value. We thought the market was just way overestimating the amount of advertising growth. Looking at our model, I think we had some pretty high expectations here. Our five-year compound annual growth rate for revenue was 33%. We were looking for earnings this year of $1.67. That put the company at 158 times this year’s earnings. Even with that huge top-line growth rate in the revenue number, you’d still only get to $4.75 in earnings by 2029. So, the stock was still trading at 55 times 2029 earnings. We think the stock is significantly overvalued here.
Dziubinski: One of your picks, pretty recent picks, Workday, ticker WDAY, was in the news last week as activist investor Elliott Investment Management announced it made a $2 billion investment in the company. So, Elliott seems to like your picks, Dave. First, PEP a few weeks ago, and now Workday. The stock was up on the news. What do you think of Workday today? Is it still a pick?
Sekera: Well, it seems like you and I probably should reach out to Elliott and start charging them a fee for our investment picks here. Obviously, they’re watching our show. So, for those of you that don’t know, Elliott is what’s called an activist investor. They look for relatively cheap value plays. They look to build relatively large positions in those companies, and then use that in order to try and partner with management in order to help management unlock hidden shareholder value. One thing I do have to admit, a lot of times our valuation methodology may not necessarily work in the short term for high-growth opportunities, but it is usually pretty good at identifying value where we think the market is overly pessimistic, which also seems to be a lot of Elliott’s business models. I think that’s why there’s a lot of overlap here. Workday itself is still at a 22% discount, a 4-star-rated stock. Granted, we rate the stock with High Uncertainty, but it does have a wide economic moat.
Dziubinski: All right, well, it’s time for our question of the week. This one comes from Sid, who asks, “While watching Dave discuss Campbell’s CPB last week, I found myself wondering why he called it a small-cap stock. Campbell’s has a market cap of around $10 billion. And I remember when $2 billion was generally considered the upper limit for small cap. So, how does Morningstar decide today what is small versus mid or large cap?”
Sekera: Well, first of all, just starting off, whenever I talk the market, I’m actually talking about the Morningstar US Market Index. And that’s our proxy for the broad US Stock market. For the entire market, not just like the S&P 500 or some of those other indexes out there. So the Morningstar US Market Index is the top 97% of all investable companies know by market cap. It includes, I think, over 1,200 individual stocks. It’s then broken into the different categories. For example, large, mid, and small. I, too, can remember when the rule of thumb was small caps were under $2 billion. And then as capitalizations grew, it became, “Hey, they’re under $5 billion.” And then a lot of people now are looking at small caps being under $10 billion in market cap.
The way that we actually break it down into those ranges, if you look at the Morningstar Style Box, the top 70% of companies by market capitalization are defined as large-cap stocks. Currently, I think 155 are defined as large cap. The next 90% to 70% are going to be mid-cap stocks. There are currently 407 stocks that are within that range. And then those stocks in the 97th to 90th percentile are those that they be considered to be small-cap stocks. There are currently 639 of those in our market index. I think it’s just that when you break it down into ranges of market cap by percentages, that helps to adjust for when the markets expand and then the markets contract.
So, right now, if you’re looking at those breakpoints, there’s a little bit of movement in those breakpoints just with stocks that in between reconstituting the index might move up and down, but large-cap stocks generally are in kind of that low $70 billion and up range. Mid-cap stocks are $12 billion to $70 billion, on average. And then small-cap stocks are somewhere in that $12 billion and under range today.
Dziubinski: Well, thank you for your question, Sid. And just a remind the rest of our audience that you can send us your questions via our email address, which is themorningfilter@morningstar.com. It is time for everyone’s favorite part of the podcast, and that’s Dave’s picks of the week. During the past couple of weeks, Dave’s picks have been small-cap stocks, but today he’s climbing up that market-cap ladder and has brought us five mid-cap stocks to buy. Before we get to them, Dave, why mid-cap stocks this week?
Sekera: I think sometimes mid-cap stocks just kind of get forgotten about by a large part of the marketplace. We talk a lot about the large caps just because the large caps get all of the attention just because of the size and the nature of those companies. And then as you mentioned, we’ve also talked about small-cap names a lot just because they are so undervalued on both a relative value basis and absolute value basis. But I think the mid-cap names kind of get forgotten. They don’t have a lot of natural buyers. Most funds either are going to focus on large-cap stocks just so they have the liquidity that large caps provide to be able to move in and out of positions. Or if they’re small-cap funds, they’re very focused on small caps. But you don’t really have a lot of institutional investors out there focused in the mid-cap space. So, I think it does provide some opportunity because to some degree they are just overlooked.
Dziubinski: All right, your first pick this week is Fortinet, ticker FTNT. Give us the highlights.
Sekera: Fortinet stock is rated 4 stars, trades at a 22% discount to fair value. It is a stock that doesn’t pay a dividend, so not necessarily appropriate if you’re looking for dividend yield in the technology sector. Like most of these, we do rate it with a High Uncertainty, but it does have a wide economic moat rating, mainly on switching costs, but it also has some network effect as well.
Dziubinski: Now Fortinet stock is lagging its competitors in the cybersecurity space this year. Why is that Dave, and why do you like it?
Sekera: The stock was hit pretty hard after the last quarterly earnings results. We thought the selloff was overdone. Stock bottomed out. Looks like it’s been recovering nicely since then. I think overall our analyst noted that the market seemed to be pretty disappointed by slower hardware and networking cybersecurity sales than what we had expected. Now that is the foundation of the company’s business. But over the long term, we think the company has a very good runway of mid-single-digit growth coming from a couple of areas that they’re moving into, specifically what they call SASE, secure access service edge, as well as in sec opps, security operations. Both of those businesses are growing quite strongly but over a smaller base. But they will become a larger percent of the company over time. Our analysts noted that those two parts of their business did increase last quarter, 22% and 35%, respectively. Stock trades at times 32 times earnings. A lot of the tech companies are all kind of in that 30 handle right now.
But overall we’re looking for a compound annual growth rate of over 13% for the next five years. Looking for earnings-growth rate of almost 16% over that five-year period. So when we’re looking at not this year’s earnings but 2026 earnings, it’s only trading at 26 times. So, a lot lower than that 32 times number. Now, as a complete aside, I also want to note when you get into the fall and especially into the winter, you’re getting into that time of year where a lot of the sell-side street analysts will stop talking about the 2025 PE multiples and start moving into that next-year valuation multiple. I think we’re getting close to that time of year that you’re going to start hearing more and more of the market talking about forward PE multiples really being based on 2026 earnings instead of 2025 earnings.
Dziubinski: All right, your second pick this week is Becton Dickinson, and that’s ticker BDX. Run through the key metrics.
Sekera: It also is a 4-star-rated stock. Trades at a 31% discount to fair value, has a 2.2% dividend yield, a Medium Uncertainty rating. And this one we rate with a narrow economic moat based on its cost advantages and switching costs.
Dziubinski: Now Becton stock has really taken a dive this year, though it is up from its lows. What happened here and why is the stock a pick?
Sekera: Actually, I think this is the first time that we’ve recommended this stock. I would say the stock has been a disappointment for a pretty long time. Over the past couple of years our analyst team has highlighted a lot of management missteps that happened here, a lot of industry issues as well. I did touch base end of last week with Alex Morozov. He’s our analyst that covers it, and in his mind, he thinks this story has finally started to bottom out, which is what I think is providing the opportunity.
When I look at a long-term chart of this stock, it’s been a very wide range, but overall the stock has gone nowhere since 2018. The stock got crushed following poor earnings and a reduced guidance in May. Earlier this year, it traded down on huge volume at that point in time. So, obviously some institutional investor, or even more than just one, threw in the towel and they just puked the stock out of the portfolio, just hitting bids until they got out. Since then it looks like the stock has started to bottom out, maybe even kind of in a recovery pattern at this point. Longer term, our investment thesis here is that over time you will get back toward more normalized growth and margins. Really looking for the life sciences and diagnostics market to stabilize.
I think the takeaway here was that for this stock really to start recovering, you’re going to need to start generating a top-line growth in order to get that investor confidence back. Company is working through some strategic actions to try and unlock shareholder value. Recently, they announced a partnership with another company for their biosciences and diagnostic products. That way they can focus more on their core medical technology operations. This past quarter, revenue was up 3%. I mean not much, but at least it’s now starting to go in that right direction. Management did raise their guidance to $14.30 to $14.45 a share. That puts the stock at kind of that 13 times earnings PE at the midpoint of that guidance. I think the market’s still very skeptical. They’ve gotten burned on the stock for years now. I think market’s just going need to see that consistent performance by this company to get that sentiment back to start seeing this one move up. But again, over the long term, we think that as you have a more normalized environment for the company, you get to that mid-single-digit growth rate, and that would just lead to double-digit net income growth as margins improve as well.
Dziubinski: Your next pick this week is another stock from the healthcare sector. It’s Zimmer Biomet, which is ticker ZBH. Walk us through the metrics on it.
Sekera: Yeah. Zimmer Stock is rated 4 stars at a 23% discount. Not much of a dividend, only a 1% yield. We rate the company with a Medium Uncertainty but a wide economic moat. And that wide economic moat is mainly based on switching costs, but also on their intangible assets as well.
Dziubinski: Zimmer stock is in the red for the year to date, but it is up double digits since early August. What’s driving this bumpy ride this year? And what does Morningstar think the market’s missing on this one?
Sekera: So, unlike Becton, where that was the first time that we’ve recommended this stock, Zimmer is one that we’ve long recommended and to be honest, have been very disappointed by the performance here. I did talk to Debbie Wang. She’s the equity analyst who covers the stock, and in fact, she’s been an equity analyst at Morningstar since 2002. So a very experienced analyst. She noted here that Zimmer is, in her mind, just the undisputed king of large joint reconstruction. Our investment thesis here has been that the combination of aging baby boomers and improving technology for younger patients will just fuel solid demand over the long term for large joint replacements that over time would offset any price declines that we have seen here in the short term.
Taking a look at our model, a five-year compound annual growth rate of only 3.5%. So again, really not looking for any kind of heroic revenue increases to get to our fair value. Management’s operating margin goal is 30% over the long term. Yet, I think we’re conservative. We’re only modeling in 28%. This is just a value stock where it just has not performed like we’ve wanted it to perform over time but still models out very undervalued.
Dziubinski: Now, your next mid-cap pick this week is a REIT. It’s Crown Castle, which is ticker CCI. Tell us about it.
Sekera: The stock’s rated 4 stars, trades at a 25% discount. Nice healthy dividend yield at 4.6%. Medium Uncertainty, narrow economic moat with that narrow moat being based on switching costs and efficient scale.
Dziubinski: We’ve talked on prior episodes of, about just how undervalued REITs in general look. What makes Crown Castle in particular your pick this week?
Sekera: Well, first of all, I do have to caution that this stock is a lot more volatile than I think you would necessarily expect for a REIT, for a company in this business where they have wireless towers for cellphones. If you take a look at the long-term chart here, it kind of looks like to some degree investing in these wireless towers has just gone in and out of fashion. So back in 2020 and 2021, this was a 1-star-rated stock. We couldn’t figure out why the market was valuing it as highly as the market was. It then slid throughout 2022 and into 2023 into 4-star territory. We recommended this one on the June 24, 2024, episode of The Morning Filter. The stock then rallied 20% the next three months. And then, as interest rates started to rise, the stock started to sell off again. Looks like it bottomed out when the 10-year hit 5% and now it started to recover as interest rates have been coming down again. Now, it did sell off over the past two months. The most recent bout of selling, our analyst noted, was following EchoStar’s announcement that it’s selling spectrum to SpaceX. Our analyst noted that EchoStar is only a relatively small customer, so it’s not anything that he thinks impacts the value of this company overall. So, we’ve maintained our fair value on all of the tower REITs. This is our pick of the tower REITs today.
Dziubinski: And then your last pick this week is Devon Energy, ticker DVN, run through the numbers.
Sekera: Yeah. Devon stock is 4 stars at a 32% discount, has a 2.8% dividend yield. Now, it is in the energy sector. It is an oil producer, so we rate it with a High Uncertainty Rating. But it does have a narrow economic moat based on cost advantages.
Dziubinski: Recently, Morningstar raised its fair value estimate on Devon by 19%. So why? And why do you like the stock?
Sekera: Devon has been our go-to pick for domestic oil production for quite a while. Generally, it looks like the stock in the short term does trade really in line with spot oil prices. So, you have to remember the way that we value oil producers is that. But we don’t think we’re any better than the market trying to predict where oil prices are going to go in the short term. We use the two-year futures strip price in our model, but then we’ll take the price of oil and then either appreciate or depreciate to our midcycle oil price forecast by year five. So, one of the reasons that I like oil producers here is that the spot price is actually still higher than our long-term midcycle oil price forecast. And even when you forecast for oil prices to fall from here, a lot of these companies still model out cheap.
The reason I want to bring Devin up again here today is that we recently raised our midcycle oil price forecast for West Texas Intermediate to a barrel, and that’s up from $55 a barrel. As we’ve reevaluated the oil market, our team has noted that they think future supply constraints will drive those prices higher over the next five years or so. Now, as we see again just trying to think about how oil prices work out in our supply-demand model over the course of the next decade, we do model in demand declining, but it will decline at a slower rate than what we see supply declining at.
Just as a reminder, when we’re thinking about those supply-demand characteristics, our auto team forecasts at two-thirds. I too also need some more coffee here. This morning, we forecast that two-thirds of global new auto production will be electrified by 2030. But even with new auto production at that high of either hybrid or electric vehicles, there’s still going to be a lot of internal combustion engines on the road. The average age of cars is 14 to 15 years. So, we incorporate in our outlook the need for oil in a lot of other industries where you just don’t have other substitutes. If you think about shipping and transportation, aerospace, heavy equipment, chemicals industries, there is no substitute for oil. So, that’s why we are holding up our longer-term demand forecast for oil. Long story short, at the end of the day, we raised our fair value on Devon to $50 a share from $42. And just would note that Devon is among the lowest-cost providers in the US as far as where they are on the shale cost curve.
Dziubinski: All right. Well, thank you for your time this morning, Dave. Those who’d 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 a.m. Eastern, 8 a.m. Central. In the meantime, please like this episode and subscribe. Have a great week.