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Steven Cress talks to Kim Khan on using a safety/growth strategy amid this market selloff. The Stock market is beholden to Washington at present, which is prompting a rotation. (1:29) Fundamentals ultimately prevail. (2:47) Time for a barbell approach. (3:01) Using Quant Ratings for early warning signs. (20:18)
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Transcript
Kim Khan: Hello and welcome, my name is Kim Khan. I ‘m the senior executive editor of news at Seeking Alpha, and I’m joined by Seeking Alpha’s VP of Quant strategy Steve Cress. Steve, great to talk to you again.
Steve Cress: Thank you so much for having me back. Perfect timing.
KK: We’re talking about a market turbulence and how to navigate rough waters, and I don’t bandy the words prophetic or soothsayer around a lot, but I will say it in this case because you wrote this article February 25th on strategies to help the investors who are navigating a tough market, and it’s kind of only gotten worse.
When you wrote the article, we had fear on the greed and fear scale. Now we’re we’re in extreme fear. We have the VIX (VIX) at the high of the year. We’ve got the S&P (SP500) battling its 200-day moving average. We’ve wiped out all the gains since election day.
What are your thoughts on what we’re seeing right now in the market?
SC: Absolutely. Well, first and foremost, we’re likely at the beginning stages of what’s going to be continued uncertainty, and the market hates uncertainty. So, the market can normalize a bull period, the market can normalize a bear period, what markets really don’t like is uncertainty. And we know, historically when there’s uncertainty out there, that’s when we’re at maximum volatility and the maximum corrective phases.
So, what just adds to the uncertainty here is, we’re beholden to what’s happening in Washington. Up until this point, the economy was in fairly good shape. Earnings for most corporations were in pretty good shape, but a lot of policy changes, executive orders, are making it difficult to navigate the environment right now. And that difficulty is what’s giving the market pause, and it’s forcing a rotation to defensive sectors such as consumer staple, utilities, and real estate. And what people do, during those rotational periods is, they typically sell stocks that have given them the best performance.
So, they want to take some of their profits, especially if you’ve been in a stock for a couple years, it’s nothing to take a little bit off the table. Unfortunately, if you’re just buying into those stocks that have strong fundamentals, you’re caught with bad market timing. It doesn’t mean that the companies don’t have good fundamentals, it just means that many of the existing shareholders are taking some profits. And when they all do it at the same time, it has a big impact on stocks.
So, people shouldn’t let that market volatility scare them. They should keep calm. Carry on, really remain disciplined. One of my mantras is, for Quant is that it’s built on a belief that fundamentals ultimately prevail, and history shows that periods of market turmoil often create the best opportunities for patient investors. So, we’re going into one of those periods now. We don’t know how long this correction is going to last. We don’t know if it’s going to deepen.
So, in this environment, I’m recommending somewhat of a barbell approach. And in a barbell approach, we want to protect our portfolio. And to do so, we could rotate into stocks that pay dividends. So, dividends and their ability to generate income help provide some downside, I should say, to those stock prices because they’re supported by yields.
On the other hand, we also don’t want to ignore some of the incredible opportunities that we’re going to see. And, would say Quant Systems often perform like a Richter scale. Before, like, we started writing that article at the end of February, but even before the end of February, before you can even see a real rotation occurring in the markets, we started to see stocks that had really strong fundamentals weaken.
And, I can’t tell you how many times I’ve seen this over the last 30 years being focused on Quant when we have these portfolios that seem to have great fundamentals. All of a sudden, the prices just start coming off. And often, and I look back to the 2007 period, I look at what was happening right around the pandemic, how companies that had excellent momentum and really strong fundamentals just started in unison coming down.
So, I really feel like the Quant as a Richter scale. When we begin to see shakiness in the stocks, usually, there’s a long-term negative impact coming to the economy and the overall market. And I don’t think this was any exception because we really started to see this occur in late January and into February.
So, the guidance that we have is, it’s very much related about tariffs and the impact that that’s going to have on inflation and interest rates. We don’t know from day-to-day what’s going to happen with these tariffs. So, that’s why I think it’s really smart to approach this with that barbell approach. You want to give yourself some downside protection with stocks that generate income, but you don’t want to ignore companies with good fundamentals.
Because, really, and historically, these stocks that have these Quant Strong Buys, when a market comes off by 10%, 15%, 20%, the Quant Stocks actually come off before all the other stocks. So, at that point, they’ve already come down. And I usually find that, like, a great point to get into these stocks because the stocks with good fundamentals often rebound the sharpest to the upside, and it really, really pays off.
So, I think a barbell approach would be really smart here.
KK: It’s important to note that we haven’t gotten a kind of an abandoned ship signal yet from the stock market. So this is a good time to put money to work because if you look at the AAII sentiment survey, so we have a big shoot up over 60% for bears. Recently that’s dropped down just a little bit down below 60%, but the equity allocation hasn’t dropped much at all. It’s still well over 65%. So people are fearful, but they’re not actually just dumping their portfolios, which you see in other places like other times like COVID and the financial crisis.
SC: Yeah. I think there’s a wait and see approach here. I think people want to have faith that the current administration, they’re making the right moves, but nobody’s quite sure. So, they want to give it the benefit of the doubt. And, I don’t think anybody is selling all their stocks. I don’t think they’re completely rotating into the defensive sectors as I mentioned before. So, it’s a wait and see approach, and I think investors are taking it day-by-day.
The last few days, though, the market, we’ve seen a lot of turmoil. So, I think increasingly, there’s no question about it. Over the last five days and even over the last month, the best performing sectors have been consumer staples, utilities, real estate, and healthcare. So, that drumbeat is getting a little bit louder day-by-day. And I think we might be 5% or 6% or 7% off the 52-week high. A lot of corrections, especially after Presidential election years, the corrections could be 15% to 20%. But what’s really interesting is, in those periods for the year after the Presidential election year, when the market comes down by that amount, it actually finishes higher by the end of the year.
And this might not be any different, especially since we have a very active President in the early days of his administration. People are going to want to see what’s happening. And I think, most economists and most investors are expecting the tariffs to be somewhat inflationary, but there are also other directives that are occurring that could help reduce that inflation. And, in the long-term, it’s yet to be seen what’s going to happen. So, that’s why I don’t think you’ve seen or this complete capitulation of people panicking and selling.
KK: You saw with Warren Buffett, people were criticizing his cash levels in Q4, and then all of a sudden they’re saying, hmm, maybe he was on to something. But again, Buffett always says he’d rather have his money in equities going to work than have it on the sidelines in cash.
So let’s talk about some of the dividends that we’re starting with for the barbell approach.
SC: Yeah. Yeah. Along the lines of what you’re saying with Warren Buffett, I think, he’s been there in the markets for a long time. Obviously, I’ve been in the markets for a long time as well. And we know historically what happens when tariffs are put forward, and then it escalates into actual tariff wars. So, we know from history how markets react, and that’s why you tend to be a little bit prudent when you hear somebody saying, we could be going into a period of tariffs.
And as I said, we take it day-by-day. Many people believe that the tariffs are being used as leverage for negotiations. So, that’s why there’s not that complete certainty that you abandon ship. So, raising some cash back in December, January, February is a good thing. Right now, I don’t know if I, – the markets are already starting to unwind a little bit. So, I think that’s why it really pays to rotate into certain stocks that have a little bit more of a defensive feature, not necessarily putting everything into utilities or consumer staples, but looking for those dividend stocks.
So, with that in mind, let me lead with a couple of stocks. So, this one is in the consumer staple territory. I like Clorox (CLX) here. Ticker symbol is CLX. It’s got a Quant Strong Buy. And within the consumer staples sector, it ranks 4 out of 183 stocks. And within its industry of household products, it currently ranks 1 out of 13. It’s got a really nice yield on it of 3.24%. And, they just had a double earnings beat for fiscal year 2025 for Q1 and Q2.
They also have a strong international platform, so we don’t know how tariffs are going to be impacting them, but being that they’re worldwide, they should be able to absorb and neutralize some of those hits. They also have a big digital transformation emphasis taking place in the company, which is helping to drive their business strategy. And also, I’m looking here, they’ve had about 60% of their ad spend being personalized in these digital formats, which is really touching consumers.
My second pick would be a property company Vici (VICI), VICI, is the ticker symbol. This is a very large property company. It’s got a market cap of about almost $34 billion. It’s a Quant Strong Buy. Within real estate in our Quant universe, out of a 173 stocks, it ranks number 4. And within specialized industrial REITs, it ranks number 1 out of 11. It’s got a sweet yield at 5.38%, and it’s actually one of the largest property owners on the Las Vegas Strip. So, people might pull back, but they’re still going to be paying their rental properties in Las Vegas.
So, I like that aspect to the company, a very strong revenue growth history. On an AFFO growth basis its compounded five-year CAGR is 8.84% versus the median for the real estate sector at 2.74%. So, really, really strong, revenue growth and AFFO growth. They have a FFO margin of 70%. That’s at a 71% premium to the sector, and they have a – and with equities, we usually use P/E. When we look at REITs, we use P/E over FFO, and the multiple there is 12x. So that puts it about a 12% discount to the sector. So, we had Clorox as a consumer staple, VICI as a property company.
And the third stock that I am recommending for dividends, I would go with Philip Morris (PM). So, that sometimes is a little bit more controversial, obviously, because of the tobacco aspect, but I think it’s proven many times in the past during these types of crisis is that it’s a really good place to park your money, and it usually has a really good yield as well. And on Philip Morris, the yield is currently about 3.4%, which is far higher than the S&P 500, which I think is a yield of around 1.2%. Again, this is in the Consumer Staples Sector. It ranks 10 out of a 183 companies in our universe for Consumer Staples. And within the tobacco industry, it ranks number 1 out of 8.
They have, with their smoke free products, they’ve been doing incredibly well. And in the fourth quarter, they made $15 billion in net revenues in their smoke free unit alone. The company has a 40% EBITDA margin, which is at about a 200% premium to the sector, and they have a 9.74% forward EBITDA growth rate, which is at a 97% premium to the sector. Interest rate coverage on this is 7.5x, so they have more than enough cash to cover their dividends. So, that would be the dividend stocks that we would be discussing here. Yeah.
KK: Well, Philip Morris going the smoke-free route. It was recently reported that they’re looking to sell their US cigar business, which they acquired in their deal for Swedish Match.
That would be another step towards their smoke-free plan and goals. Part of their cigar portfolio in the U.S. is Garcia Vega, which always reminds me of the Garcia Vega commercials that I’m old enough to remember seeing on TV constantly with the guy putting out a cigar – looking at his cigar and putting it out.
SC: Yeah. Don’t try to date yourself too much. I think we never see that really in the U.S. anymore, but there is news that, I think that hit just a couple days ago in terms of them, selling their cigar unit. So, I think that would be a nice sale for the company.
So, moving on to stocks that we think have good fundamentals, and I’d say are somewhat conservative in this environment too. These are not dividend plays, but again, stocks that offer strong fundamentals. We have Stride, Inc. (LRN), ticker symbol LRN. This is actually in the consumer discretionary sector. So, it’s getting a little bit out of what I mentioned before with those safe-haven sectors.
If you’re not familiar with the company, this is in educational services. And our Quant ranking within educational services, it ranks number 1 out of 25 tech-based learning companies. So, there’s been a number of positive developments. The stock has been stellar. It’s a Quant Strong Buy. When we look at Quant, we look at it from a Seeking Alpha perspective. We’re looking for what we call GARP, which is Growth At a Reasonable Price, but we also add momentum and analyst revisions into that.
So, Stride, Inc. has some really great grades for the valuation grade. And when we look at our factor grades, they’re always sector relative. So, it gives you an instant characterization of where the company is on a metric versus the rest of the sector. So, from a value standpoint, it’s in-line with the sector. It has a C grade, but the growth is a B, which means it’s a bit better than the sector. Profitability is a B, which makes it better than the sector. The momentum of the stock is an A+, and analyst revisions are an A+.
So, when you see that, that means that analysts, those revisions, analysts are revising their estimates up more for this company than other companies within the sector. They topped their EPS and revenue estimates for nine quarters in a row, which is incredible. And they’ve had very good revenue growth year-over-year of 13% versus the sector at about 2.5%.
The next stock that I would recommend would be Brinker International (EAT). I just read the other day, Goldman Sachs loves this company. Ticker symbol is, EAT. Their market cap is about $6.8 billion. It’s a Quant Strong Buy. This also is in the consumer discretionary sector, and it ranks number 1 out of 485 stocks in our universe for consumer discretionary stocks.
Within the restaurant industry, it ranks 1 out of 42. So, this is, I think you get a big bang for your buck at most of the restaurants, and the, notable restaurants would be Chili’s and Just Wings. The stock is up a lot in the last year. It’s about 200%, but, I don’t want people to approach this thinking I don’t want to buy a stock that’s up 200%. Because if you look at the valuation framework, it is exactly the same now that it was six months ago.
So, there’s been no change in that, but the growth of the company has actually picked up. And when we look at our factor grades, six months ago, the growth grade was C+, and now it’s B. So, growth is actually better than it was, but the valuation framework is exactly the same. Company is nice and profitable. It’s got a B grade. The momentum, obviously an A+, and analysts EPS revisions are an A+ for the stock as well.
And, the third stock, and it just came down sharply too, but they’ve had really good fundamentals is SkyWest (SKYW). It’s one of the smaller airlines, ticker symbol as SKYW. They have a market cap of $4 billion. It’s a Quant Strong Buy. This is within the industrials sector, and it ranks 22 out of 617 companies. Within passenger airlines, it ranks 6 out of 26, but they’re – number of positive catalyst why I like this.
The industry tends to show resilience during periods like this. I think one of the reasons why the stock has come down so much is it’s trading in sympathy when the number of the other airlines that have had accidents. So, you may recall, like, we’ve had a long period without accidents. And then over the last, like, couple of months, there’s been a number of accidents that have occurred.
So, I believe the stock has really traded down with that, but the company’s doing well. Their projected fleet expansion is looking for a 12% increase in aircraft utilization in 2025. So, the fundamentals seem to be pretty robust for the company. And for the valuation framework, it’s in-line. Growth is very strong for them at A+ compared to the sector. Profitability is in-line with a B, a little bit better. Momentum and EPS revisions have been very, very strong. So, there’s our barbell approach where we’re using three dividend stocks. And, the hope is, with the dividend yield, that it provides you with a certain degree of, downside risk because you are getting that yield, you’re getting paid to wait, and then three stocks that have really good fundamentals.
KK: It’s so great you mentioned Brinker, a very interesting story, just with the Chili’s turn around, driven a lot by TikTok, driven a lot by Instagram, and the 3 for me and the challenges that they’ve done. It’s quite an interesting kind of seeing a brand like Chili’s just make a complete different move and the stock’s really responded to that.
I was going to ask with these strategies how much execution matters. I know that you were mentioning some companies were consistently beating earnings expectations, getting good revisions grades. So, are you drawn to strong management teams or is that something that’s completely out of the realm when we’re talking about quant.
SC: You know what? I don’t really look at it from a management perspective as much as looking at the data. Quant is a data-driven process. So, the money to us, it’s where they might say they put their mouth. We’re just like about the numbers. Have they been proving themselves out historically? Do analysts that cover the stock believe that it’s going to continue to pan out in the future? And with analysts, we don’t look at the analyst ratings, but we look at the consensus estimates.
So, our Quant models, both historical-looking and forward-looking, and the forward aspect to it, is that it takes consensus estimates from Wall Street Analysts, whether you’re looking at revenue growth or EPS growth or EBITDA growth. And if the analysts and their consensus show that they believe the companies will continue to earn money, which comes in their earnings models, that goes into our model.
So, it’s not really – the proof of management comes through in the numbers itself. So, we don’t listen to what they say. We’re looking at what they’re doing through the numbers.
KK:I also wanted to ask if you, as a person who gets to look at this entire universe of stocks they get a quant rating on Seeking Alpha, is there a way you can kind of get a sense of the overall market from the shifts in grades that you’re seeing maybe in the overall grades from Buys to Holds or just like or certain metrics within that such as maybe earnings that suddenly show red flags for market turbulence.
SC: Absolutely. I’d say, if you look at that EPS revision grade, if something’s going wrong, even if analysts are saying one thing, they’re going to do something else with their numbers. So, analysts really do want to have their earnings forecast as correct as possible. Even if they have a Strong Buy on a stock, they might have that Strong Buy because they’re doing investment banking or they have a roadshow. There could be any number of reasons why they won’t move their rating and they can maintain a Buy or Strong Buy, but they do like to get their numbers right. So, we take those analyst forecast and we take the consensus of it.
And what’s really unique about our EPS revision grade is, you could look at, when we look at the grade, we’re looking at the last 90 days, the number of analysts that have made changes. So, it could be really telling when all of a sudden you have, half a dozen or a dozen analysts within several days of each other changing in one direction.
So, you could see our grades go from literally, like, a D to an A very quickly or conversely, you could see it drop from, like, an A down to D. And often, sometimes, like, these analysts won’t even say anything and they’re making just these slight changes to their estimates fine-tuning them to the downside, but our system picks up to all the analyst changes at the same time.
So, you could literally have, like, 12 analysts each moving their estimates down by a penny. On the surface, that doesn’t look like it much, but when our system looks at it, it’s like, wow. 12 analysts have just taken their estimates down in the last 90 days. That’s pretty meaningful. So, I feel like in a way, our EPS revision grade, which is proprietary to Seeking Alpha, it’s very, very unique and very, very telling.
KK: Steve, final word?
SC: Yeah. I would just say, again, I would really emphasize it’s important for people to stay calm, stay disciplined. I often say, if I had a superpower, it would be to ignore the talking heads on TV and just approach this, like, every single month you’re making your investments, whether the market is up 20% or down 20% or down 30% or down 40%, continue to identify those companies with good fundamentals, particularly since we’re at the very beginning, an uncertain period, the barbell approach could certainly work really well.
On one side, for dividend stocks, you have defensive cash flow rich stocks for protection. And then on the other side, you have high quality growth stocks with strong fundamentals that offer upside potential when the fear subsides. And believe me, when the fear subsides, these stocks with strong fundamentals, they skyrocket.
So, you just want to be prepared for that. And, ultimately, as I mentioned earlier, fundamentals will prevail and history shows that periods of market turmoil often create the best opportunities for patient investors.
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