5 Oversold Stocks to Buy Before They Rebound

The Morning Filter Podcast Summary – February 26, 2024

Key Concepts:

• Tariffs: Impact on market earnings, economic growth, and investor strategy.
• AI Disruption: Assessing the real vs. perceived threat to various industries and companies.
• Geopolitical Risk (Iran): Potential impact on oil prices and energy sector investments.
• Valuation & Fundamentals: Emphasis on focusing on intrinsic value over short-term market reactions.
• Economic Moat: Identifying companies with sustainable competitive advantages.
• Capex Spending: Analyzing the implications of significant capital expenditures by companies like Amazon.

I. Market Impact of Supreme Court Tariff Ruling & Future Tariffs

The Supreme Court’s recent ruling striking down some Trump-era tariffs has prompted discussion about future trade policy. Dave Sakara anticipates President Trump will utilize Section 122 of the Trade Act to implement new tariffs for 150 days without immediate legal challenge, potentially impacting future trade negotiations. However, Sakara argues that investors should focus on the impact of tariffs on future earnings growth for their holdings, rather than overreacting.

He points to economic data from the past year, despite the presence of tariffs, showing stronger-than-expected real GDP growth: Q2 (3%), Q3 (4.4%), Q4 (1.4% - potentially 2.4% without the government shutdown), and Q1 (currently 3.1% via Atlanta Fed estimates). Inflation remained relatively contained, ranging from 2.4% to 3% year-over-year, suggesting other factors like the “AI buildout boom,” increased net exports, and strong consumer spending are more significant drivers of the economy. Morningstar made few changes to fair values after the initial tariffs were announced and expects a similar response to future tariff implementations.

II. Investor Strategy in a Tariff Environment

Sakara advises investors not to overreact to tariff news, emphasizing the importance of fundamentals and valuations. He uses examples to illustrate this point:

• Nike: Initially popped after the ruling but quickly relinquished gains, suggesting company-specific competitive factors are more crucial than tariffs.
• Walmart: Surprisingly decreased after the announcement despite being a major importer, indicating investor concern over its high 45x earnings multiple.
• Apple: Experienced a significant drop upon the initial tariff announcements but showed only modest gains after the recent ruling, highlighting the importance of long-term intrinsic value tied to AI integration.

III. Geopolitical Risk: Iran & Oil Prices

Discussion turned to potential military action in Iran. Sakara referenced a note by Josh Aguilar (Morningstar’s energy sector director – available on morningstar.com, specifically by searching ticker DVN) which suggests the market is already pricing in a high probability of conflict. Brent futures are currently over $71 (up 20% since early January).

Morningstar maintains a mid-cycle estimate of $65/barrel for Brent, indicating a $4-$10 premium due to geopolitical risk. They believe a limited strike on military/nuclear targets would have minimal impact on oil prices, similar to past events. However, the severity and duration of any action will influence spot oil prices.

Top Picks in the Energy Sector: Devon Energy (DVN) for US domestic oil production and Nommo Energy Transfer for natural gas plays.

IV. AI Fears & Sector Rotation

Sakara acknowledges the recent market volatility driven by AI fears, initially impacting software, then financial services, and even trucking/logistics. However, he believes many of these fears are overblown in the short term. He notes that even Morningstar’s technology team admits the ultimate impact of AI is largely unknown, contributing to the prolonged software sell-off.

He emphasizes that the market is attempting to determine which services and products are susceptible to replacement by AI, leading to a “rotating target” of industries experiencing sell-offs. Sakara suggests focusing on rigorous analysis of actual risk rather than reacting to fear and uncertainty.

Industries at Risk vs. Resilient:

• At Risk: Roles involving repetitive, data-driven tasks (data entry, accounting), and low-end content creation.
• Resilient: Industries requiring human interaction, judgment, negotiation, and originality. Examples include wealth management, insurance brokerage (analysis augmented by AI, but relationship-driven), and trucking (transportation still needed, AI augmenting efficiency).

V. Stock Picks & Valuation Analysis

Sakara presented several stock picks, focusing on companies that have been oversold due to market anxieties:

• Microsoft (MSFT): Trading at a 34% discount, 5-star rated. Strong subscription business, potential in AI, and a 16% 5-year CAGR for earnings. Trades at 23x 2026 earnings, below its historical average.
• Palo Alto Networks (PANW): 4-star rated, 34% discount. Beneficiary of increased cybersecurity needs driven by AI-powered threats. Trades at 40x 2026 earnings, but with a projected 26% 5-year CAGR.
• Amazon (AMZN): 4-star rated, 19% discount. Stable retail business, strong subscription growth, and potential in AWS. Concerns about $200 billion capex spending are overblown.
• LPL Financial (LPLA): 4-star rated, 41% discount. Undervalued due to AI fears impacting wealth management. Human interaction remains crucial in financial advising. Trades at 12x 2026 earnings with a 26% 5-year CAGR.
• Thermo Fisher Scientific (TMO): 4-star rated, 19% discount. Beneficiary of rotation into value stocks and increased healthcare demand. Trades at 20x 2026 earnings with a 10% 5-year CAGR.

VI. New Morningstar Research Highlights

• Walmart (WMT): Beat earnings, but guidance was below consensus. Fair value increased, but still trades at a high 45x earnings. Advertising revenue growth is a positive factor.
• Craft Heinz (KHC): Scrapping breakup plan after Berkshire Hathaway signaled potential stake sale. Fair value cut, but still trades at a 40% discount, remaining in 5-star territory.
• Norwegian Cruise Line (NCLH): Elliot Investment Management took a 10% stake, pushing for change. Trades at a 23% discount (4-star rated). Potential for board changes, cost management, and refocusing on growth areas.

VII. Key Takeaways & Actionable Insights

• Don't overreact to headlines: Focus on fundamentals and valuations.
• AI is a complex issue: Assess the real impact on individual companies, not just broad sector fears.
• Look for undervalued opportunities: Market sell-offs can create buying opportunities in fundamentally sound companies.
• Consider economic moats: Invest in companies with sustainable competitive advantages.
• Utilize Morningstar resources: Access research reports and analyst insights on morningstar.com.