Plus, economic news and a preview of bank earnings.
On this week’s episode of The Morning Filter, Dave Sekera and Susan Dziubinski catch up on tariff and economic news and preview bank earnings. They also discuss what to watch for when Johnson & Johnson JNJ reports this week, whether Constellation Brands STZ remains a stock to buy after earnings, and if former stock pick Fluor FLR is still attractive after its recent price gains.
Plus, they review Dave’s Q3 2025 Stock Market Outlook and reveal which of Morningstar analysts’ top picks for the quarter he likes best.
Episode highlights:
Tariffs & Jobs & Inflation, Oh My!
Bank Earnings Preview
3Q 2025 Stock Market Outlook
Great Stocks Getting Overlooked Today
Read about topics from this episode.
Read Dave’s 3Q Stock Market Outlook: https://www.morningstar.com/markets/q3-2025-stock-market-outlook-after-rally-whats-still-undervalued
See all of Morningstar’s analyst picks for 3Q 2025: https://www.morningstar.com/stocks/33-undervalued-stocks-2
Learn more about Morningstar’s approach to stock investing: https://www.morningstar.com/stocks/morningstars-guide-investing-stocks
Here Are the Sectors and Industries That Are Vulnerable if Reciprocal Tariffs Come Back https://www.morningstar.com/stocks/here-are-sectors-industries-that-are-vulnerable-if-reciprocal-tariffs-come-back
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 and Dave:
Susan Dziubinski https://www.morningstar.com/people/susan-dziubinski
Dave Sekera https://www.morningstar.com/people/david-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’s chief US market strategist Dave Sekera and I talk about what investors should have on their radar for the week, some new Morningstar research, and a few stock ideas.
Now, before we get started this week, we wanted to let viewers know that in a few weeks, we’ll have a special guest on The Morning Filter, and that’s Morningstar’s director of personal finance, Christine Benz. Christine is author of How to Retire, 20 Lessons for a Happy, Successful and Wealthy Retirement. Christine is also co-host of The Long View podcast, and she’s a weekly columnist for Morningstar.com. The reason we’re telling you this is that we plan to include some viewer and listener questions in our conversation with Christine. So start sending us those questions at themorningfilter@Morningstar.com. Of course, you can continue to send Dave your questions at that same email address, too.
All right, Dave, well, it’s been a couple of weeks since you and I sat down for a new episode of The Morning Filter, so we have some catching up to do. Let’s start with tariffs. President Trump’s initial reciprocal tariff extension that was set to expire on July 9 has gotten pushed out to August 1. So in general, the stock market kind of seems to be shrugging off tariff concerns. Is that right?
David Sekera: Hey, good morning, Susan. Yeah, the market’s really just become especially complacent over the past couple of weeks. To be honest, I’m really kind of surprised that stocks are back to new highs once again. This morning, I double-checked our systems here, and as of last Friday’s close, the market is now trading at about a 2% premium to our fair value. That tells me the market is just not really giving investors any potential margin of safety to account for any of the risks that are out there today. I think now is a good time for investors really to ask themselves the question, is now a better time to be putting new money into the market or is now a better time to be taking some profits? In my opinion, I prefer some harvesting of profits today.
But either way, I think it’s definitely time to go back to your portfolio allocations, take a look at where they are, and if any of them have started to drift away from your targeted levels, definitely a good time to rebalance, which is naturally going to have you take some profits out of some areas and put it back into those areas that have lagged behind.
Dziubinski: Now we also had nonfarm payroll numbers come out in early July, and the numbers were better than expected. What did you make of the numbers, and what does that mean for investors?
Sekera: You know, to be honest, at this point, I’ve really kind of forgotten what they were and what the commentary was about all of those numbers at this point. Yeah, they came in, they were slightly better than expected, but I don’t think it was really a market-moving event. I think it’s just more evidence that the economy is slowing, but not necessarily falling off of a cliff. I know the Morningstar US economics team is still expecting that slowing rate of economic growth over the course of this year, but we’re really not looking for a recession or anything like that.
We’ve talked about this a number of times over the past couple months. Personally, I just really haven’t been watching the economic numbers all that closely. I think with everything going on, all the economic dislocations out there, there’s just too much noise to try and read too much into any one economic indicator. I’m just watching the trends more than anything else, and I’d also note, too, that you have to remember economic metrics are often restated; oftentimes it can be by a pretty significant amount thereafter.
For example, 2024 nonfarm payrolls were restated early this year. I think they were revised down by like 800,000 jobs. I mean, that averages to like 70,000 per month, which, of course, last year, if those monthly numbers were coming in 70,000 lower per month, that would have been a much different story last year, put a much different spin on what those monthly payroll numbers would have been as compared to what was actually printed. And with so many economic dislocations going on out there over the past couple months, I really wouldn’t be surprised to see a lot of the economic metrics that are coming out today revised, in many cases maybe revised pretty substantially, over the next couple months.
Dziubinski: Then we have the June Fed meeting minutes came out last week, and it looks like Fed officials agree that there should be some reduction in rates this year, but there seems to be no consensus on by how much or when. So, any takeaways from the minutes that investors should be aware of, Dave?
Sekera: Again, to be honest, I have no idea. I didn’t read the minutes. Personally, unless you’re a Fed watcher or if you’re trading interest rate futures or something like that, I don’t think trying to read through those minutes is necessarily a useful way of spending an investor’s time. A lot of other things to spend your time on as opposed to trying to read through those.
I looked through all the news stories afterwards. I didn’t see any headlines that really sounded all that meaningful. Skimmed a couple of stories, and it just sounds like what we’ve already known going on. The Fed still sees indications that tariff-induced inflation really hasn’t come through yet. They still expect inflation will show up at some point. However, they don’t know if/when inflation comes through from the tariffs, whether that will be just a one-time inflationary impulse or whether or not it could lead to longer-term inflationary pressures.
Either way, they’re going to be data-dependent, they’ll adjust monetary policy as needed, yada yada yada, so at the end of the day, Morningstar’s US economics team is still looking for two rate cuts starting this year, more rate cuts next year; they’re looking for the first rate cut now at the September meeting. We’ll see.
Dziubinski: Now, speaking of inflation, we have June inflation numbers coming out this week. What are you expecting?
Sekera: So it just gets back to the same question, whether or not inflationary numbers are really being impacted by the tariffs or not yet. It looks like people are expecting some of that to start to come through. If I look at the consensus numbers, CPI headline on a year-over-year basis, people are looking for 2.6%. That’d be an increase from 2.4% last month. Core CPI on a year-over-year basis, looking for 2.9%. That’s an increase from 2.8%.
Then for PPI, on a month-over-month basis, looking for two-tenths of a percent. That’d be an increase from one-tenth of a percent last month. So if it is showing an increase in inflationary pressures, that could push back the Fed from being able to cut rates anytime soon. However, if the numbers come in better than expected, maybe that does give the Fed some room to start cutting if the economy, and the job market is slowing, so we’ll see where the numbers are coming out. But again, I’m not putting too much emphasis on the numbers here in the short term.
Dziubinski: Right, we also have earnings season kicking off this week with the big banks, including J.P. Morgan JPM, Bank of America BAC, and some others. Is there anything in particular you’re going to be listening for, Dave, either from specific banks or more broadly?
Sekera: More broadly, I just want to listen to what their economic outlooks are, what their commentary is on the economy. For example, I think like last quarter, if I remember correctly, I think Jamie Dimon, CEO of J.P. Morgan, was a little pessimistic last quarter. I want to listen to whether or not he’s changing his tune or if he’s still pessimistic or not.
Overall, I mean, banks really should have the best view as far as what exactly is going on with the economy, when you think about their loan portfolios, they watch the credit quality of the underlying people that they loan money to very closely. They have a view as far as, what’s going on with the entire economy, whether it’s large corporate, middle market, retail. So right now, it seems like large corporations still appear to be doing just fine.
So I want to listen if there’s any deterioration more in like the middle markets or small business or with retail. Let’s see what’s going on with loan loss reserves, whether or not they’re increasing loan loss reserves. If so, that means that they’re expecting more defaults and bankruptcies. If those are unchanged, that would mean really no change in their economic outlook. If they were to decrease those loan loss reserves, that would indicate that the economy would be running better than expected in the second half of 2025. I’d be very surprised if they release loan loss reserves at this point.
Then lastly, more from a fundamental point of view, what their outlook is for net interest margins. Overall, when we look at the valuations of the big megabanks, we think the market is pricing in too much long-term growth in net interest income overall.
Dziubinski: All right, we also have one of your favorite core stocks, Johnson & Johnson JNJ, reporting earnings this week. How’s the stock look from a valuation perspective ahead of earnings? And what are you going to want to hear about from J&J?
Sekera: I mean, it is still, I think, a 4-star rated stock, but it’s only at a 5% discount, so not necessarily a huge margin of safety from our long-term valuation. But it is a wide-moat company, low uncertainty, 3.3% dividend yield. As you mentioned, I still think it’s a core holding type of stock. We’ll just be listening for whether or not there’s any updates in its research and development pipeline. I want to hear if any changes in some of the government regulation may or may not negatively impact their business. I know President Trump has talked more about trying to re- or onshore more drug manufacturing. He’s talked about most favored nation drug pricing. So we’ll see if they have any commentary as far as all of that goes.
Then lastly, just listening for any indications of changing in their pharmaceutical business, of course, most of their drugs are for immunology and for cancer. That’s about two-thirds of their revenue. But then also any commentary in the medical device business, that’s a third of their revenue, so really just ongoing fundamentals and whether or not there’s any changes that could be a catalyst.
Dziubinski: Now we have a couple of tech companies that we’ve talked about before on The Morning Filter reporting in this week, and those are ASML ASML and Taiwan Semiconductor TSM. So what are you going to be listening for with these two?
Sekera: I’m going to be looking at these two as potentially being indicators or early indicators for artificial intelligence buildout, what we might be seeing for capex spending going on with the big hyperscalers. Of course, ASML, they’re the company that makes the equipment that actually manufactures the very high-end semiconductors for companies like Nvidia NVDA. We’ll find out where they came in, whether their numbers were at consensus or better than expected. If so, that’s probably pretty good for artificial intelligence stocks at this point. Any kind of miss, of course, would be concerning that maybe the chip manufacturers are looking for a slowing rate of growth in AI chipsets at this point.
And TSM, they’re the ones that actually manufacture the GPUs and the other components for Nvidia for their AI GPUs. Now, I think we’re expecting just more of the same. Nvidia has been supply constrained. They’re selling everything and anything that they can make. I suspect that’s probably still the case at this point in time. Any deviation from that would actually be probably pretty negative for the market.
Dziubinski: Now, does either ASML or Taiwan Semi look attractive from a valuation perspective heading into earnings?
Sekera: Both of them still look attractive at this point. Of course, not nearly as attractive as they were a month and a half ago when the market was falling. But they’re both 4-star rated stocks. ASML at a 16% discount, Taiwan Semi at a 12% discount. Looks like both of these stocks are up about 16% year to date.
Dziubinski: Let’s move over to talk about some new company research from Morningstar, and we’ll start with Constellation Brands STZ. Now, the stock edged up a bit after earnings. What did management have to say?
Sekera: A little bit of a relief rally, I think, in the stock price that things weren’t any worse than where they came out. Revenue was down 4% overall. That’s really in the spirits division that they’re having the toughest time. That was down 21%. The beer division, which is really the preponderance of their business, that was only down 2%. With the lower top line, we did get a little bit of operating margin contraction. I know management is working to try and overcome some of the short-term declines in consumption we’ve seen for alcohol overall. They’ve introduced a couple of new products, so we’re hoping that those might help increase the amount of shelf space that they’re getting at the stores.
Otherwise, I would say that we are still seeing that short-term top-line contraction. We’re expecting a decrease in the top line overall by about 1% this year, but over the next couple years when i look at our model, we would expect that to normalize getting back to more of that midsingle-digit growth that they’ve had over the past, and i think we work our way up over the 10-year time frame that our analyst has those forecasts, so again not looking for anything necessarily like a big hockey stick upwards but looking for things really to bottom out this year and start improving thereafter.
Dziubinski: Now, Constellation Brands stock is up about 8% from its lows in June, but it’s still down more than 30% over the past year. Do you still like the stock today?
Sekera: Yeah, we do. Warren Buffett also is involved in the stock today. I think that’s a good indication for the valuation here, but I think management also thinks that their own stock is pretty undervalued here. It looks like they bumped up their share repurchase program pretty significantly. I think we’re expecting the company to buy back a total of over a billion dollars worth of stock over time. And because it is trading at a discount to our fair value, the more stock that they buy back, the economic value of that discount should accrete to existing shareholders over time. So, trading at a 30% discount to fair value puts it into 5-star territory by our ratings.
Dziubinski: Let’s talk about another former pick of yours, and that’s Fluor FLR. You recommended this stock on the May 19 episode of our podcast, and since then, stock’s up 38%. So, you’re looking pretty savvy on this one, Dave. Now, what drove those returns, and do you still like the stock today?
Sekera: Sometimes better to be lucky than smart! No, so in all seriousness, that is by far the best performance of the five stocks that we highlighted on that episode. That was the episode that we talked about stocks that we thought would benefit from the Trump trade deals that he had already been negotiating. From that episode, it looks like the market overall, if you look at the S&P 500, is up 4%.
Taking a look at some of the other stocks that we recommended, Boeing BA is up 11%, Wesco WCC up 15%, ASML is up 7% since then. The real laggard here has been Lockheed LMT. That stock is unchanged, maybe slightly down from when we talked about it on that show.
Fluor is a company that specializes in engineering and construction, specifically large-scale, very complex construction projects. The theme here is that we thought that they would benefit from increased spending as we see more onshoring of manufacturing as those facilities are being built out. They require a lot more energy, they require a lot of the related infrastructure around that. We thought Fluor would be able to benefit from all of that over the next couple years because of course it takes a long time to be able to build out all of those projects.
But really what’s taken off here in the short term was the value of the equity stake they have in a company called NuScale Power SMR. NuScale develops small modular reactors, and the market’s really become very fixated on the nuclear business at this point in time. In fact, as that valuation of that part of their business continued to keep moving up, we’ve raised our fair value as well. We’ve raised it to $60 a share from $52. It’s trading right at like $52 and a quarter right now, which was the old fair value. With the new fair value at $60, it’s still at a 13% discount. It’s a 3-star rated stock. So, at this point, now might be a good time to lock in some of those profits.
I’d note we also did increase our uncertainty rating to very high from high because of that. NuScale does benefit from all the excitement surrounding nuclear energy right now, but there is a lot of execution risk in that business. So again, with as much as it’s run at this point, I do think now is probably a good time to at least take some of those profits off the table.
Dziubinski: All right. Well, Dave, you recently published your third-quarter stock market outlook, and viewers and listeners will find a link to that in the show notes. So let’s unpack some of that outlook. Now, when it comes to market valuations in 2025, you say they behave like a pendulum. Talk about that.
Sekera: So at the beginning of the year, the market was trading at a pretty rare premium to our fair value, especially a lot of those artificial intelligence stocks. Once DeepSeek hit the headlines in mid-January, that started a bear market in artificial intelligence stocks. In our view, at the beginning of the year, a lot of those stocks were rated 1- and 2-stars, they’re just overvalued and overextended, so they started moving down.
Then we had the “Liberation Day” tariffs announced that hit the market really hard, so the pendulum was swinging too far to the downside, so by April 4, stocks were trading at a 17% discount to fair value after starting the year at a premium. That 17% discount is pretty rare. You don’t see the market trading that much of a deep discount very often. In fact, we officially changed our market recommendation to overweight on the April 7 episode of The Morning Filter, as well as a special market outlook that I published on that same date.
Then you had the pause that was announced thereafter. Markets bounced. It kind of feels like we’ve been up and to the right ever since. Now it feels like we’re getting back to kind of that rare premium once again. We’ve swung from being at a premium all the way down to a big discount. Now back to a premium again. Market feeling just very complacent. Seems like they really don’t care about the trade and the tariff negotiations.
In my view, it’s still very unclear as far as when these are going to be concluded, what exactly the outcomes are going to be. We’ve got earnings season starting this week, and we’ll be listening for what guidance will be from the companies, just how much they’re seeing slowing economic growth, and what that might mean for earnings. With valuations being pretty high here, no margin of safety, I wouldn’t be surprised if things come out slowing that the market could take a hit.
Dziubinski: Now, you said in your outlook that the rising stock market tide in the second quarter lifted most boats. But from a sector perspective, there were two boats that didn’t rise: the healthcare sector and the energy sector. So, start with healthcare, Dave. Why did the sector lag, and do you think there’s an opportunity there today?
Sekera: With healthcare, it’s a combination of a couple of things. First, you know, the market’s just very concerned right now as far as what the potential impact and changes in government regulation may or may not do to a lot of the companies within this business. For example, the pressure to onshore pharmaceutical manufacturing, also the pressure out there in order to lower pricing. A lot of people are concerned exactly what that’s going to do to the big, large pharma companies.
But also a big detractor to the sector has been changes that are making in the Centers for Medicare and Medicaid Services, plans there to increase regulation on Medicare Advantage, and really trying to bring down a lot of the spending, a lot of the overpayments that they see going on there. And of course, that could hit a lot of the private insurers like UnitedHealth. That stock, UNH, is down I think over 40% in the second quarter alone. We’ve also lowered our fair value because of those changes by 20%. Overall, the healthcare sector is now at a 9% discount to fair value.
I’d note here, too, this is one where it is actually skewed by Eli Lilly LLY, large mega-cap stock, which is overvalued in our mind. If you were to take that out of the price/fair value valuation here actually makes healthcare even more undervalued than that 9% discount by a couple of percent.
Personally, the area that I’m most interested in in the healthcare sector right now is still a lot of the medtech companies, a lot of the device makers. Those are the ones that we think are undervalued, but we’ve highlighted several of those on different episodes of The Morning Filter in the past. Those are the ones that I think that even with some of the changes with regulation going on today, I’d still be the most comfortable investing in.
Dziubinski: Then what about energy, Dave? Why the performance lag during the second quarter? Is it an attractive sector to invest in now?
Sekera: To some degree, I think it’s just as simple as the sector sold off with oil prices over the course of the quarter. Oil prices have fallen to $65 a barrel from $71.50 when you’re looking at West Texas Intermediate. Now, one of the reasons I like this sector and why I think that at a discount, it’s very attractive to be in today: We have kind of a bearish long-term view on the price of oil. So our midcycle forecast for WTI is $55 a barrel, so still well below where it’s trading today. We’re also looking for demand to start declining later this decade and decline sequentially thereafter.
Now, in our model, we use the market-implied two-year forward strip price, where it’s actually trading in the futures market. Then, we step down our prices in our model thereafter to our midcycle economic forecast. Even when you incorporate these bearish numbers into our valuations, a lot of these oil companies are still trading significantly undervalued from our long-term intrinsic valuation, as well as a lot of these services companies that they have to hire in order to be able to drill and service their wells.
I see a lot of value, and I still think it provides a good long-term natural hedge in your portfolio just in case inflation were to come back or for the expansion of any other kind of geopolitical risk.
Dziubinski: Break today’s market valuation down by style, Dave—you know, growth versus value and large versus small.
Sekera: So, at the end of the second quarter, value stocks were at a 12% discount, looked pretty attractive to me. Core stocks at a 4% premium, not necessarily that high up there but getting a little stretched at that point. But again, it’s now going to be growth stocks, which have moved way too high. They’re now trading at an 18% premium. Not necessarily the highest premium that they’ve ever been at, but the last time they were here was at the beginning of this year, before we saw the selloff start in AI stocks.
Other than that, the last time they were at an even higher premium was at the beginning of 2022. If you remember back then, I think we were probably one of the only people out there at the beginning of that year who actually recommended to be underweight US stocks. We all know what happened after that.
Taking a look at it by valuation here at large-cap stocks, 2% premium, mid-cap stocks, fair value. Small-cap stocks, still a very large discount, 17% discount to fair value. When you look at those small-cap stocks, not only are they undervalued compared to or on just an absolute basis in and of themselves, but compared to the broad market on a relative value basis, look very attractive here.
I would highlight going to the outlook, taking a look at the couple of the graphs that I have in there. For both value stocks as well as small-cap stocks, I graph what the valuation is relative to the broad markets. So neither of them are at the most historically undervalued levels compared to the broad market, but still on a relative value basis, both are very attractive according to our numbers.
Dziubinski: So then, given market valuations and how things break down by style, how would you suggest investors position their equity portfolios today?
Sekera: Well, again, it just gets back to it’s a good time to check the allocations, look at your percentage weights. When you have your overall portfolio allocation, a certain percentage in equity, and then within equity you break that into large/mid/small, value/core/growth, depending on what kind of investor you are, to get back towards those targeted type of allocation levels. Also, I just note that I would also position my portfolio to be overweight value and underweight growth because of the spread differential in the valuations there.
Then by capitalization, I would look to be overweight small caps and underweight large caps. Now, again, I will caution, and we’ve talked about this a couple of times with small-cap stocks, this is an investment, not necessarily a trade. I don’t necessarily think small caps are going to rally significantly here in the short term compared to the broad market.
Historically, small-cap stocks do better when long-term interest rates are coming down, the Fed is easing monetary policy. The rate of economic growth is either at the bottom or starting to reaccelerate. We’re not in that environment right now. That’s probably not going to be until later this year. But I just do think now’s a good time to be overweight those stocks because when small-cap stocks start to move, usually they move pretty quickly. It doesn’t take that much of a reallocation out of large cap by the market in the small cap to start seeing those stocks rally.
Dziubinski: So then broadly speaking, what do you think is the biggest risk or the biggest risks in the US stock market now?
Sekera: In my mind, I still think it’s all the negotiations as far as trade deals and tariffs. I know the market is very complacent at this point in time, but with stocks at highs, unemployment low, economy still kind of holding up better than expected. Inflation has been relatively tame. Interest rates are within a trading range we’ve seen for a while now. In my mind, I think that might embolden President Trump to take a much more aggressive stance on negotiations, maybe reinstating tariffs once again. If so, I think that would maybe not necessarily hit the market as much as it did earlier this year, but I do think that’s one of the bigger risks here in the short term.
More medium term is what’s going on with the economy. We think it is slowing on a sequential basis, but just how fast is it slowing? Now, again, this is a good time. You need to ignore exactly what’s going on with the headline print in economic numbers. In the first quarter, the GDP print came in negative, but that was really because of all of the purchases that people were making ahead of tariffs. The underlying economy was still positive in the first quarter, and we expect now the second-quarter GDP print to be pretty high, and I think that’s going to be higher than what the real economy is actually doing. Looks like the Atlanta Fed GDP print is 2.6% right now.
When we look at the fundamentals of the economy and start thinking about consumption and investment, it’s probably a lower run rate there. As the economy slows, what’s that going to do to earnings and earnings growth in the third and the fourth quarter? We could see some surprises to the downside that the market isn’t necessarily pricing in.
Long-term interest rates, I’m still keeping an eye on long-term interest rates, especially the longer ends of the curve, and not just the US, but internationally as well. A couple of weeks ago, like Japan, their 40-year JGBs started to plummet. That started pushing yields up pretty high. That spooked the market. We saw some selloff because of that. Looks like the Bank of Japan did intervene and started buying those bonds in order to bring yields back down. If they were to lose control of that, I think that could spook a lot of international investors.
Again, a lot of risks still out there, maybe like artificial intelligence, any kind of hiccup as far as what’s going on there, I think that would hit sentiment pretty hard as well, and of course geopolitically that’s always a wild card.
Dziubinski: All right, well, we’re going to get to your picks in just a minute. This week, there are a subset of the list that Morningstar’s analysts put together each quarter of their top ideas. We actually have a question about just how Morningstar’s analysts come up with those top ideas each quarter. The question is from our listener, Josh, who you and I actually met at the Morningstar Investment Conference just a couple of weeks ago, so hello there, Josh! So give Josh and the rest of our audience some insights into how that analyst picks list comes together each quarter.
Sekera: First and foremost, it’s always valuation. Even the best company in the world with the best growth dynamics, best trajectory, can be a poor return if you overpay for that stock. Second, I always prefer investing in companies that do have an economic moat, looking for companies that have long-term durable competitive advantages. In my mind, you know, the economic moat is probably the second most important factor. Take then a look at the uncertainty rating. I always prefer a company that has a lower uncertainty rating than a high uncertainty rating. Again, you want to make sure that you’re buying a company with enough margin of safety under its long-term intrinsic valuation such that you have that margin of safety to absorb that higher amount of risk.
Take a look at the technicals. Again, we’re not traders. We’re not trying to overdo it. But again, what’s the chart look like? I prefer not to try and catch a falling knife. Even if a company is undervalued compared to our long-term intrinsic valuation, more often than not, we’re trying to wait until when there’s a big change in the investor base. Maybe a lot of institutional investors that have large positions, while they’re trying to exit, I don’t want to get in front of that. So trying to look for when that stock looks like it’s going through a bottoming-out process.
I always like stocks that have a good story to it, a good investment thesis. Why do we think it’s undervalued? If that stock is moving up, why do we still think it has further to run to the upside? Or if that stock is selling off, why do we think it’s going to recover? What’s the story on maybe getting back towards long-term historical operating margins? Or what’s the catalyst that’s going to cause that stock to start moving up once again?
Then not only where do we have a differentiated view, but also where our analysts have conviction in their outlook. For example, taking a look at a company like HealthPeak DOC, that’s one that we’ve talked about for quite a long time at this point as far as why we think it’s undervalued. That’s one where I’ve talked to the analyst a number of times, and he just has a lot of confidence in why he thinks that company is undervalued.
For example, he’s noted to me several times he sees sales of similar types of properties that HealthPeak owns. Trading in the secondary market at prices higher than what the market implied price is based on where that REIT is trading today. Yet a lot of those pieces of real estate that he sees selling out there, he thinks aren’t nearly as good or high-quality as what’s in the portfolio at HealthPeak. Again, that’s one based on the confidence of the analyst and really understanding the fundamentals. Even though it’s been undervalued for a long time and the market really hasn’t caught up, I like those stories in which the analyst has that confidence behind their call.
Dziubinski: All right. And audience members can find a link to that complete list of our analysts’ high-conviction picks for the third quarter in the show notes. But Dave, today you’re going to talk about five of those stocks in that list that you’re especially fond of today. And the first is US Bancorp USB. Run through the numbers on this one.
Sekera: It’s a 4-star rated stock. Looks like it closed last Friday at an 11% discount to our fair value. Nice healthy dividend yield at 4.2%. It’s rated with a wide economic moat, and I think it’s the only regional bank we rate with a wide economic moat.
Dziubinski: Now, US Bank isn’t necessarily a screaming buy by any means. So why is it one of your picks this week?
Sekera: It’s really more like a swap idea than anything else in order to buy that once you sell some of these overvalued mega-cap bank stocks. It has been a prior pick on The Morning Filter in the past. It’s really always been our pick among the regional banks, our go-to pick there. Overall, I think the investment thesis we just don’t think the market is correctly valuing the long-term earnings power as opposed to most of the US regional banks. US Bank is more like a larger or maybe even more like one of the megabanks, even though it’s not quite as large. They have pretty strong revenue coming from their corporate trust business, pretty strong deposit franchise, one of the better operating efficiencies compared to some of the other regional banks, pretty good return on tangible equity, over the past decade.
To some degree, I think this stock is just kind of orphaned in the marketplace. What I mean by that is, it’s not large enough to be one of the big megabanks, not one of the big four, but it’s also a lot larger than some of the smaller regional banks. To some degree, I think people are looking for one or the other. Either people are just comfortable in the big megabanks, the J.P. Morgans, the Wells Fargos of the world, and they don’t want to be involved in the regionals, or you have people that are more specialized in looking at the regional banks and not looking at US Bank because it’s bigger than really what they’re looking for.
Dziubinski: Your second pick this week is from the healthcare sector. It’s Baxter International BAX. Give us the highlights.
Sekera: It’s a 5-star rated stock, trades at a 48% discount to our long-term intrinsic valuation, 2.4% dividend yield. It does have a high uncertainty rating, but we do rate it with a narrow economic moat based on its switching costs and intangible assets.
Dziubinski: Now, Baxter, as you said, is 48% undervalued. That’s really undervalued. So what’s Morningstar see here that the market doesn’t see?
Sekera: This is one that we’ve talked about in the past. It has been a prior pick on at least one show, if not a couple of shows. For the people that don’t know the company, they make a pretty wide range of medical instruments and supplies. They make products for acute and chronic kidney failure, injectable therapies, IV pumps, a lot of other hospital-focused offerings. To be honest, I kind of feel sorry for this company when I look at what’s been going wrong with it over the past couple of years.
In 2022 and 2023, when we had those high-single-digit and probably even low-double-digit inflationary numbers, that hit their margins pretty hard; they have a lot of multiyear contracts in place, which I don’t think had the appropriate inflationary escalators in those contracts, so that inflation hit them pretty hard.
Then in 2024, if you remember, we had the outage from UNH’s healthcare reimbursement system. What happened there is a lot of healthcare providers, because they weren’t getting reimbursed by the insurance providers, pulled back on purchases of a lot of their capex, really the high capital-intensive equipment that is sold by Baxter’s Hillrom subsidiary. Now we’ve got the market being concerned about the tariffs and the impact of the tariffs on the company, as well as changes in government regulation.
So at this point, after the past couple of years of what this company’s been through, no one’s really willing to give this company any of the benefit of the doubt at this point. This is totally just a forward-looking story. As those longer-term contracts come up for renewal, we think they’re going to be able to better negotiate some of the pass-throughs to take care of the inflation that they’ve had, as well as any potential inflation coming up.
I opened up the model over the weekend, top-line growth, 5.5% on average for the next five years. Relatively strong growth, but again, nothing that I think the company won’t be able to meet. We’re looking for margins, operating margins to expand more towards historically normalized levels, and we’re really not even looking for that to get back to that area until 2028. Between top-line growth and some margin expansion, we are looking for average earnings growth of about 11% from 2026 and thereafter. Stock is only trading at 11 times our 2025 earnings estimate. So again, I think this is one where the market is providing an opportunity because it just has a checkered history over the past couple of years at this point.
Dziubinski: Now, your next pick is from a sector that’s been on a tear, and that’s the utilities sector. And your pick is Eversource Energy ES. Run through the numbers.
Sekera: It’s a 4-star rated stock, trades at a 10% discount, pretty good yield of 4.6%. Again, this is just one of these ones where it’s just not very undervalued, but taking a look at the rest of the utilities sector, it’s one of the few undervalued utilities out there. This is not necessarily a very exciting story, even within the utilities sector.
Now, a lot of people in utilities, and part of the reason we think utilities stocks are probably overvalued, is because people are pricing in a huge amount of growth in artificial intelligence demand. AI requires multiple times more electricity than traditional computing, so it’s looked at as being a second derivative play on artificial intelligence, but this is one that we don’t think gets nearly as much growth out of that demand for AI electricity as we see in other areas within the marketplace. I think that’s the reason this one’s been left behind.
Dziubinski: Now, I don’t think Eversource has been a pick of yours before. Could be wrong, but I just don’t remember it. Why is it a pick today?
Sekera: Well, to some degree, when we look at where all the data center growth is coming and we look at the needs for transmission, distribution, electricity demand, Eversource isn’t going to have nearly the same kind of growth that we see in a lot of the other utilities.
Having said that, our utility analyst has looked through their capital spending plan over the next five to 10 years. We’ve incorporated that into our model. We’re looking at an average 6% earnings growth rate, at least for the next couple of years. When we put that into our valuation model, that gets us to the point that we think that this stock is at that 10% undervalued level. But again, it doesn’t have anywhere near the same kind of story or excitement that the market is looking for in the other parts of the utilities sector.
Dziubinski: All right. Well, your next pick this week is Campbell’s—mm-mm, good! Give us the key metrics on this one, Dave.
Sekera: First of all, I’ve got to admit Campbell’s CPB was not necessarily going to be my pick for this week. We were going through and looking for our stocks, it was actually kind of the runner up. Originally, my pick was going to be WK Kellogg KLG. It’s a small-cap stock. We’ve recommended it several times on the show, going all the way back to the fall of 2023 when you had the breakup of the old Kellogg company into WK Kellogg and Kelanova.
However, last week they did announce it is getting bought out by a strategic buyer for $23 a share. That was a 33% premium from where it was trading prior to the news hitting the tape. Looks like it closed in the upper $22 range. I think it was like $22.89 last Friday. Now, we actually thought the company was worth $28 a share. With the buyout being announced, we’ve moved our fair value to that buyout price.
When I look at where that price is in the marketplace, and there’s such a thin spread between where it’s trading in the market versus that buyout price, and the buyout’s not going to take effect for a while, it has to go through a lot of the regulatory approvals by the government. So that tells me a lot of the risk. Arbitrage hedge funds are probably pricing in a somewhat stronger probability that you could see a competing price pushing that price up further. But having said that, we did move our price target to that buyout price.
Dziubinski: All right, so tell us why Campbell’s.
Sekera: Campbell’s, 5-star rated stock. Again, another one trading close to half of our fair value. So 50% discount, 5% dividend yield, medium uncertainty with a wide economic moat. It’s a wide economic moat based on its intangible assets and its cost advantages. We don’t necessarily foresee any inordinate impact from the tariffs here. It is in the value stock category. If we see that rotation into value, I think it would benefit from that as well.
Dziubinski: All right. Well, let’s skip ahead to your final pick, and I hope income investors are paying attention this week because this one has quite a yield. It’s LyondellBasell Industries LYB. Run through the numbers here, especially that yield.
Sekera: It’s hard to pass up that kind of dividend yield. In fact, I think they just increased their dividend a couple of cents per share. That’s one of those things that you wouldn’t expect a company would be increasing their dividend if they thought that there was any chance that they would need to cut that anytime soon, even if we were to have a little bit more of an economic downturn. It’s a 4-star rated stock at a 35% discount, provides an 8.5% dividend yield.
Now, it is a high uncertainty rating, but again, being in the basic materials sector for a chemical company, I don’t think that that’s something that I wouldn’t necessarily suspect anyways. We do rate the company with a narrow economic moat, which you typically wouldn’t expect for a commodity chemical producer. That’s going to be based on its cost advantages, mostly driven by a couple of segments that represent over half the overall business. This is one that if you are interested, I’d highly recommend going to the writeup, reading through the moat writeup, and getting into the weeds on this one, and I think Seth does a pretty good job outlining what those cost advantages are.
Dziubinski: Seth Goldstein is the Morningstar analyst on the stock. So why is this one so deeply undervalued? And it sounds like we think the dividend looks pretty safe. Is that fair to say?
Sekera: When I talked to Seth about this company last week, I did dig into what’s going on with the dividend payment, and he thinks that the company can maintain this dividend unless the US were to slip into a recession. Even then, I think it would have to be a recession that lasts for a while and would be relatively deep. He noted that the balance sheet looks pretty good, so they could use the balance sheet if needed to be able to support that dividend for a while. I think a recession would have to last for a while and be pretty deep before we’d be looking for any kind of dividend cut here.
When I take a look at the structure of the company and think about its economic moat with its cost advantage, we think a company should be able to generate positive free cash flow even during the expected economic downturn that we’re looking for right now. Stock is down 14% year to date. Looking at the chart does look like maybe it’s bottomed out over the past couple of months.
In my mind, it looks like it is already pricing in this expected economic slowdown. It’s trading at like the lowest price level we’ve seen since the emergence of the pandemic. I think this is an interesting one, but really only for investors that are going to have maybe a little bit higher risk tolerance in their portfolio where they can stretch, take on a little additional risk for that higher yield, because at the end of the day, the company still is a chemical—well, commodity chemical—producer.
Dziubinski: Alright, 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 for The Morning Filter at 9 am Eastern, 8 am Central. In the meantime, please like this episode and subscribe. Have a great week.