The third and final installment of the annual Barron’s Roundtable instead deals with a seemingly increasingly arcane form of investing—the kind that draws upon rigorous analysis of company fundamentals and equity valuations. It was practiced in ancient times—say, about three weeks ago—when we convened our annual Roundtable of celebrated stock pickers to parse the outlook for the economy and financial markets in the year ahead. Integral to the gathering, which took place on Jan. 11 and Jan. 12 via Zoom, were presentations by each of our 10 panelists featuring their best investment ideas for 2021.
This week’s Roundtable package showcases the recommendations of James Anderson, Abby Joseph Cohen, Henry Ellenbogen, and Todd Ahlsten, whose commentary crackles with references to scale builders, network creators, and long-term compounders—in other words, companies in the vanguard of the digital revolution. Even storied enterprises like Deere (ticker: DE) now fit the new-age mold, thanks to technological advances that promise to enrich customers and shareholders alike.
James, head of global equities at Scotland’s Baillie Gifford, is a growth-stock believer with a long investment horizon and a stellar track record. He often ventures where others fear to tread. These days, that means China, as he eloquently explains in his defense of Tencent Holdings (0700.Hong Kong), the Chinese internet giant.
Abby, an advisory director and senior investment strategist at Goldman Sachs, technically doesn’t pick stocks; she picks the companies on Goldman’s Buy list that best reflect her investment themes and economic views. This year, her search for dividends and post-Covid recovery plays takes her to Germany, Japan, India, and China, along with the U.S., where stocks like Prologis (PLD), an industrial REIT, nicely fit the bill.
Henry, chief investment officer and managing partner of Durable Capital Partners, looks for companies built to last, as his firm’s name implies. Some he has owned and nurtured since they were pups in the private market. All are disrupters in their market segments, and, like digitally native used-car seller Vroom (VRM), could enjoy many years of potentially spectacular growth.
Todd, chief investment officer of Parnassus Investments and lead manager of the Parnassus Core Equity fund (PRBLX), marries stellar stock-picking with ESG, or a focus on environmental, social, and corporate governance issues. The union has produced a winning portfolio with eclectic names—including Applied Materials (AMAT), Booking Holdings (BKNG), and Deere.
Clobbering short-sellers might be fun for some. But investing in the underpriced shares of innovative, fast-growing companies could yield better returns in the long run.
Barron’s: James, where do you see the most inviting opportunities this year?
James Anderson: In listening to people speak here and elsewhere, I have detected a delightful whiff of fear and foreboding about a particular set of assets—namely, Chinese equities and technology companies. I think the fear is hugely overstated, so my first pick will be Tencent Holdings. Tencent is far more aware than Alibaba Group Holding [BABA] that there are lines they shouldn’t overstep [with regard to China’s government]. Tencent is stylistically a very different company, with deeply appealing aspects.
What they’ve done in the gaming business has been remarkable, and unmatched by their American peers. We would expect Tencent’s gaming revenue to go from a $20 billion run rate to a $50 billion rate over the next five years, and for profit margins to be at least unchanged at around 40%. The $730 billion market cap probably reflects the gaming business alone, leaving out the messaging app WeChat and other assets.
With the possible exception of Amazon.com [AMZN], Tencent has been the best capital allocator, reallocating its capital in the technology-platform world, from a 20% stake in Meituan [3690.Hong Kong] and a 5% stake in Tesla [TSLA], two of my picks last year, to a 12% stake in Snap [SNAP]. These are only a few examples. Tencent has also done a fantastic job in guiding the companies in which it is invested. The market cap hugely underestimates the value of the company, and the discount is underpinned by the deep fear and, I think, resentment of China’s success that currently exists in most of the Western world.
Henry Ellenbogen: How do you think about Tencent’s fintech opportunity, and about fintech regulation in China generally?
Anderson: First, we didn’t get the impression that Tencent was entirely surprised by what happened at Ant Group. [The Chinese government halted the initial public offering of fintech giant Ant in December, amid concerns about the company’s risks.] Second, Tencent’s fintech service is so intrinsic to the appeal and utility of WeChat that isolating it might be dangerous. I don’t think it will become dominant, or that it is frightening from the point of view of the state.
Next, ASML Holding [ASML] is also one of the stocks I recommended at last year’s Roundtable. It is the only one for which the case has gotten considerably stronger relative to the share price. ASML is probably the most important company in the world to the development of the internet, big data, autonomous driving, and much else. [ASML makes lithography systems used in semiconductor manufacturing.] Without it, Moore’s Law wouldn’t exist. ASML is an earned monopoly.
James Anderson’s Picks
The central problem of Intel’s [INTC] several problems is that it didn’t follow its road map for EUV [extreme ultraviolet] technology. It also made the mistake of walking away from a deep involvement with ASML, and is now seeking help from TSMC [ Taiwan Semiconductor Manufacturing (TSM)], an acknowledgment of that error. Second, China regards ASML and TSMC as the only two companies it can’t replace. Demand for semiconductors is growing in both the short run and on a secular basis. The industries of the future, from AI to autonomous driving, are going to have much more semiconductor intensity. Prices will rise as it becomes clear that ASML is an essential company for the working of the world.
The U.S. is trying to keep even companies that make technology tools from working with China. Can ASML avoid getting pulled into this conflict?
Anderson: ASML is fighting hard to avoid it, but the world can’t function without the magic of advanced semiconductors. The fight between the U.S. and China won’t destroy the power of ASML’s market position.
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ASML is based in the Netherlands. I’ll stick with Europe for my third recommendation. Henry talked yesterday [during the first Roundtable session on Jan. 11] about the meal-delivery company DoorDash [DASH]. I’ll throw you Delivery Hero [DHER.Germany]. It is the largest delivery company in the world outside of Meituan. Delivery Hero has a market cap of about 27 billion euros [$33 billion] and operates in almost 50 countries. It is the dominant player in most of them. It is run from Berlin, which is more tech-knowledgeable than most of the traditional German manufacturing centers. That allows for greater autonomy, which has allowed them to make a good series of acquisitions at very low prices, including, most recently, in South Korea.
Delivery Hero is also pushing into the delivery of groceries and other essential services, which will be very important in coming years. The geography of distribution will favor both people getting goods at home and from small, local centers. We have great admiration for the management, including the CEO, Niklas Östberg. The company has the ability to compound growth in the next 10 years at 30% to 40%, and eventually get to at least 50% gross profit margins. Relative to DoorDash [with a market capitalization of $60 billion], Delivery Hero looks extremely undervalued.
Ellenbogen: Can you talk about what they are doing in grocery, and how they are using their delivery apparatus to access other local commerce, and how important that is to your thesis?
Anderson: It probably doubles their potential market. They now have grocery delivery in 41 countries. Their model is different from that of Amazon; everything has to be delivered within an hour, a skill compatible with restaurant-food delivery. Effectively, getting there first gives you a better chance of enjoying a local oligopoly.
Ellenbogen: We are thinking along the same lines. The mental model that U.S. investors had about the food-delivery space was driven by their understanding of the car space— Lyft [LYFT[ and Uber Technologies [UBER]—as opposed to what Meituan had done in China. But when you realize the importance of food as a frequency asset to drive scale in the offline world, you realize how that can move into groceries and other local goods. Over time, people will realize that this is an even better business model, with a bigger end market than they thought.
Anderson: Delivery Hero says it has learned some tricks from Meituan, but that it is working in markets with just as much inherent growth and urban concentration as Meituan itself enjoys. Over half of its business is now in Asia; South Korea is possibly the most attractive market. The geography in which Delivery Hero has become dominant is very appealing.
Ellenbogen: I’ll make just one more comment: If I ask a local merchant in Washington, D.C., how much it would cost to ship me something overnight by FedEx [FDX], it’s $20. DoorDash can get it to me within an hour for $8. The network DoorDash is building doesn’t exist in the physical world.
A year ago it seemed DoorDash might never be able to go public. Then its IPO was a massive success. Was it simply Covid that changed the opportunity and value of these companies, or did we not fully understand the business model?
Anderson: Meituan proving it could be profitable, which came about before Covid, was very important.
Ellenbogen: We led a private fundraising round for DoorDash in the first half of 2020; the company raised around $15 billion. What market commentators didn’t realize is just what James is talking about: Meituan had gained a 50% market share in first-party delivery, and had the ability to broaden into other delivery areas. DoorDash is basically the same story. It has topped a 50% market share in the food-delivery marketplace business, and also has a big and fast-growing business doing third-party delivery for other companies. The long-term competitor to DoorDash is Amazon, but for a whole bunch of reasons, many retailers don’t want to give Amazon their data. Thus, DoorDash is in the pole position.
Anderson: Now I will come to America, where health-care investment opportunities are more appealing than what we find internationally at the moment. At some point, it was inevitable that two exponential trends—genome-sequencing costs collapsing and machine learning and AI being applied to health care—would finally begin to have an effect. They are just beginning to translate into real outcomes for the benefit for patients.
Illumina [ILMN] has been a frustrating stock to own. The business hasn’t exploded in the way we would have hoped early on. Last fall, Illumina announced it was buying Grail, a pioneer in liquid biopsies for cancer detection. Testing started with Britain’s National Health Service [NHS]. We have reached the extraordinary point where the combination of gene sequencing and machine learning is giving us insights that run well ahead of our understanding of human biology. This will give Illumina access to vast new markets. It is also making the company run itself more aggressively. This will push it to gradually move away from giving quarterly earnings guidance and maintaining optically higher returns in the short term. We feel very strongly about the outlook for the next 10 years.
“ People aren’t grasping Moderna’s ability to keep replicating what it has done in the one-off Covid saga, and not only in vaccines. Moderna is the most culturally different and identifiably ambitious company that I have come across in health care in a very long time. ”
Moderna [MRNA] is the second version of this. The way Moderna has developed a vaccine without even having the virus in their lab is astonishing. But there is a big misunderstanding between the wonders of the company’s Covid vaccine and its long-term opportunities. Moderna has the potential to lead the world in treatment of the four big killers: autoimmune disease, cardiovascular disease, cancer, and infectious disease. The CEO, Stéphane Bancel, seems to have realized that the traditional biotech model, let alone that of Big Pharma, simply doesn’t work. He is determined to make improvement not marginal, but tenfold. He has brought a Silicon Valley-type attitude to drug development. He wants to prove that success in biotechnology is replicable and abundant.
People aren’t grasping Moderna’s ability to keep replicating what it has done in the one-off Covid saga—and not only in vaccines. Moderna is the most culturally different and identifiably ambitious company that I have come across in health care in a very long time.
James, Tesla has returned 700% since you recommended it last January. What do you think about the stock now?
Anderson: I wasn’t expecting that sort of return, but what it is telling you is that, whether in electric vehicles or primary energy, electric and renewables have won. We are still owners of Tesla, but one has to be cognizant of what has happened to the valuation.
Have you taken profits?
Anderson: In some cases, yes. This is mostly because clients have risk guidelines that limit the percentage of any one stock in their portfolios.
Aside from those guidelines, how do you decide to sell a stock?
Anderson: We try to have a rigorous probability-adjusted upside, and rank our holdings in relation to that. We try to be fairly disciplined about developing an upside view over the next five to 10 years.
Ellenbogen: We invest primarily in durable growth companies, which have modest growth and high competitive advantages. Those usually have a narrower range of outcomes. We also own early-stage growth companies, like DoorDash. We have probability-weighted scenarios for all. The further out the growth, the larger the discount rate we apply.
All that said, it is important to remember that returns come in a very small number of companies. Hendrik Bessembinder [a finance professor at Arizona State University] published a study in 2017 showing that only 4% of stocks were responsible for the market’s gains since 1926. My partner teaches a class at Columbia Business School on the great compounders in the U.S. stock market. Fewer than 40 companies compound over 20% on average for 10 successive years, and they account for all excess returns. Increasingly, as earnings revisions and short-term data points are “owned” by quants, the advantage that fundamental investors have is understanding the quality of the management team’s ability to scale an enterprise and drive human and financial capital to extend and expand the moat. If you aren’t willing to let your winners run, you are probably going to underperform the market.
Well said. Now, let’s hear from Abby.
Abby Joseph Cohen: To recap my view, equity valuations aren’t particularly attractive. They are attractive only relative to low levels of inflation and interest rates. I also see valuation risk in the credit markets. Much of last year’s stock market performance was concentrated in a small number of stocks. That is especially true in the U.S., where five technology companies dominated the market in 2020, not just in stock performance, but also in earnings and cash-flow growth. Some of my selections performed well last year, and I expect that to continue. Others are perhaps misunderstood, and their valuations suggest opportunity. I am interested in dividend yields, and I am looking for diversity geographically and with regard to sector selection.
PulteGroup [PHM] reflects one of my themes. If the U.S. economy improves in 2021, as we expect, housing starts and sales will continue to rise. Residential construction did well during the recession of 2020, and in many communities home prices rose. This was a function of people who were still employed having mobility and looking for extra space outside of urban areas. Our analysts expect this trend to continue. Pulte sells a mix of starter and move-up homes. It also has geographic balance, with exposure to states such as Florida and Texas, which are seeing a population influx, and California. Net debt to capital is about 10%; the company has low leverage, with ample cash flow for growth and dividend increases.
Lumber prices have been rising, but Pulte has sufficient pricing flexibility to keep profit margins robust. Construction wages are also rising. We think Pulte ended last year with earnings of about $4.90 a share. [The company reported 2020 earnings Thursday of $5.18 a share.] In 2021, it could earn about $5.25. The stock sells for eight times earnings. Return on equity is 20% or better, and the valuation reflects the risks.
Ellenbogen: Abby, at what point do you worry about real estate affordability slowing housing growth?
Cohen: Normally, I would have been concerned by now, if not for the unusual developments we saw in 2020. Many families improved their balance sheets dramatically. The savings rate went up. I would also have been concerned about interest rates starting to rise, but monthly interest payments, relative to disposable personal income, are at the lowest level ever. We expect the Federal Reserve to keep financial conditions very easy. There could be a modest move up in intermediate and long-term interest rates, but that is more of an issue for the valuation of financial assets than in terms of holding down economic activity.
My next idea, Prologis, is an industrial REIT [real estate investment trust] based mainly in the U.S. It owns about a billion square feet of property, so it has a number of scale advantages. It also has less leverage than the average REIT. The typical ratio of net debt to Ebitda [earnings before interest, taxes, depreciation, and amortization] in this sector is about 6.3%; at Prologis, it is 4.3%. The dividend yield is 2.5%. In 2020, there were enormous disparities in REIT underlying-company performance. Prologis’ funds from operations rose 9%. FFO for some mall REITs was more like minus-20% to minus-30%. Prologis believes it is well positioned for the deurbanization trend. Among its most important customers are Amazon, Home Depot [HD], FedEx, and UPS [UPS]. Risks include a possible slowdown in e-commerce. We estimate that Prologis earned $3.76 a share last year. Goldman’s 2021 estimate is $3.92. Revenue growth exceeded 30% in 2020. It could revert to more normal rates of 8% to 10% in 2021-22.
Black: Prologis is a good company. The implicit cap rate [capitalization rate, or expected rate of return] is 3.7%. The question is whether the valuation is full.
Cohen: It depends on the type of REIT. Industrial REITs are trading at higher valuations than other REITs, reflecting greater confidence in their business models.
The Japanese economy has underperformed for a long time, but selected securities might be able to generate reasonable gains from the digitization trend. Japanese companies haven’t invested in making themselves competitive in the digital age, but correcting that is a focus of the new prime minister’s economic policies. We expect to see increased expenditures by businesses and the government, which might be a very big spender. Japan is emphasizing productivity, and it must. Japan has no labor-force growth or inflation, so it will have to grow the economy through productivity growth.
Abby Joseph Cohen’s Picks
Trend Micro [4704.Japan] is a mid-cap based in Japan. It will likely benefit from the policy moves toward increased digitization. It is No. 1 in Japan in endpoint security. Its products provide protection against viruses, online fraud, email spam, and the like. Last year, the company had a big increase in expenses and we think earnings declined about 5% from 2019. We expect Trend Micro to be back on track this year. About 40% of the business is in Japan and 16% is in the rest of Asia, mainly China. North America is 22%, and Europe, 18%. The company could benefit from a cyclical upturn in various regional economies, and more IT [information technology] spending. Goldman analysts forecast that Trend Micro will earn about 243 yen [$2.33] per share this year, up from about ¥190 last year. Earnings next year could be ¥260. We estimate return on equity at about 17%.
Infosys [INFO.India; INFY] is the fastest-growing large-cap IT firm in India. The stock, which trades on the BSE [formerly, the Bombay Stock Exchange], was up 68% last year—72% with dividends. This is very much a bet on India, one of the nations most adversely affected by the pandemic. The reported disease numbers probably tell only part of the story. Once vaccine distribution becomes more widespread, however, India may become one of the greatest beneficiaries of the post-Covid recovery.
What are the company’s strengths?
Cohen: Our analysts expect some margin improvement. Ebit [earnings before interest and taxes] growth looks strong. For the fiscal year that ended in March 2020, Infosys earned 38.51 rupees [53 cents] per share. We estimate they will earn about INR45.40 this year and INR53.11 in fiscal 2022. These estimates are above consensus expectations. We believe Infosys will use its cash flow to enhance the dividend yield, which will be approximately 3% in the 2022 fiscal year, which begins this March. Revenue growth will be about 9% in the current fiscal year, going up to about 13%. This isn’t an undiscovered stock, but it could continue to do well.
Deutsche Post DHL Group [DPW.Germany] is a way to participate in the postpandemic recovery and that of a somewhat structurally depressed Europe. Like much of Asia, Europe would benefit from enhanced digitization, and this company would participate. It is the global leader in express deliveries. Deutsche Post has been a repeat underperformer, but now looks increasingly promising. Standard postal volumes in Germany aren’t good, but global postal volumes are increasing, which will help the company. Last year, Deutsche Post was also hurt by a reduction in ocean and air freight. One risk for the stock is further pandemic-related lockdowns; that’s also a risk for Trend Micro in Japan.
Deutsche Post has about €4 billion in excess cash that it can use to enhance share buybacks. We expect that the company earned €2.20 a share in 2020, and our 2021 estimate is €2.72. The stock is trading for 15.3 times expected 2021 earnings. Revenue growth was in the 1% to 2% range in 2020, but could pop up to the 5% to 7% level this year.
In the U.S., we like Fiserv [FISV]. The most poorly performing market sectors in 2020 were energy and financial services. If there is a cyclical rebound in the economy this year, financial services will be among the biggest beneficiaries. But I selected this company because it has one of the most defensive business models. It will provide downside protection should the macro backdrop disappoint.
What exactly does Fiserv do?
Cohen: Fiserv provides support services for bank operations. It is less sensitive to the macro environment. The company acquired First Data in 2019, which owned Clover, a point-of-sale system for smaller businesses. Fiserv’s core financial-transaction processing business is solid. One reason our analyst likes Fiserv’s stock is because the impact of the First Data merger on free cash flow hasn’t been fully understood by investors. KKR [KKR] owns about 15% of the company.
“ We think [Yum China Holdings] will benefit as China emerges from the Covid crisis. ”
Fiserv has a market cap approaching $80 billion. We estimate that the company earned $4.41 a share last year, going up to $5.42 in 2021. That puts the price/earnings ratio at about 21 times earnings. Annualized revenue growth could be on the order of 7% to 10%. Expenses associated with the First Data merger will decline precipitously, resulting in earnings growth of roughly 22% this year. The stock has been flat in the past year, but has performed somewhat better in recent weeks.
Ellenbogen: How much of a challenge do fintech providers pose?
Cohen: Fiserv’s willingness to buy new products and services suggests it is trying to be responsive to changes in the industry. Also, Fiserv has the advantage of scale.
Yum China Holdings [YUMC], which operates restaurants such as KFC in China, really suffered as a consequence of Covid. Much of its business depends on transportation and tourist hubs, and people stopped commuting and traveling. Also, different parts of China were on lockdown at various times. We think the company will benefit as China emerges from the Covid crisis. Yum China is opening 800 new locations, many designed for takeout and delivery, and most of them smaller than existing locations. This is a less expensive way for the company to build out the footprint, and something they think customers want. They are also going to move into so-called lower-tier cities, and create localized menus at lower price points. Our analyst estimates Yum China earned $1.74 a share last year, and sees $1.88 this year. Revenue fell 5% to 7% last year, but could rise by more than 20% in 2021.
Thanks, Abby. Sounds yummy. Henry, it’s your turn at bat.
Ellenbogen: I have four picks. Three are competitively advantaged companies, two of which have been long-term compounders. One is an early-stage growth company with great potential.
Boston Beer [SAM] has all the ingredients of a strong stock over the next couple of years. Returns were driven over the company’s first two decades by its namesake craft beer, Sam Adams. More recently, growth is being driven by Truly, the No. 2 brand in hard seltzer, introduced in 2016. Our investment thesis is based on Truly’s ability to continue to grow. Hard seltzer has the potential to become this generation’s light beer. It now accounts for 3.5% of the alcohol market and, similar to light beer, it could become five times its current size.
The category’s success is rooted in what it takes to be a successful consumer product today. The product has to have a health and wellness component; it has to taste great and have variety; and it has to be worth a premium price, relative to where the category traditionally sat. Hard seltzer meets all these requirements. It has less than 100 calories and one gram of sugar. It has a unique light taste that customers like. Truly has a 26% market share, and is a strong No. 2 to White Claw, with a 50% share.
Long term, we believe these two brands will maintain around a 70% market share because of the importance of national scale and distribution and brand advantages. Truly gained share in 2020 despite competitive offerings launched by Anheuser-Busch InBev [BUD], Constellation Brands ’ [STZ] Corona, and Molson Coors Beverage [TAP]. Yet, at year end, the new entrants were declining from their peak. The top two brands had defended their competitive advantage.
How’s the rest of Boston Beer doing?
Ellenbogen: SAM has been public for more than 25 years, and the stock has compounded at well over 15% annually, or twice the rate of the market. Underlying this performance is an ownership mind-set. Controlling shareholder Jim Koch still owns 23.8% of the company and has driven a culture of innovation. He has the perfect CEO in Dave Burwick, the former chief marketing officer of PepsiCo [PEP].
We believe SAM, led by Truly, will have strong revenue growth and operating leverage over the next two years. Revenue could double and earnings per share could triple. The company could earn around $40 a share in 2022. At that point, Truly could be 70% of the business, and the whole company would still be growing by more than 20% per year. The stock could trade for 30 to 35 times 2022 estimates, closing in on $1,500 a share, compared with a recent $1,000.
How important are bar and stadium sales to the hard-seltzer market?
Ellenbogen: In the short term, the company is indifferent to the on-premises business coming back. Longer term, they are advantaged by it. Unlike White Claw, which doesn’t have a relationship with bars, SAM has overinvested in distribution. Burwick is key to the story. He made Pepsi’s Mountain Dew a great success. He was on SAM’s board in 2016 when Truly was launched. He became CEO in 2018. He really understands the CPG [consumer packaged goods] business and the seltzer category.
“ Fewer than 40 companies compound over 20% on average for 10 successive years, and they account for all excess returns….If you aren’t willing to let your winners run, you are probably going to underperform the market. ”
My next pick is Intuit [INTU], which has two durable franchises. TurboTax, a consumer tax-preparation offering, accounts for 40% of revenue and serves 43 million tax filers. QuickBooks, a record-keeping system for small businesses, contributes 55% of revenue and serves 6.5 million users, out of 48 million small and midsize businesses and self-employed workers. Both businesses have roughly a 70% market share in their segments. Intuit has benefited from continuous innovation and customer obsession, which has allowed the stock to compound at 19% a year for 27 years. The company is poised to accelerate revenue growth because it has invested in a multiple-year transition to the cloud.
Henry Ellenbogen’s Picks
How will the cloud benefit Intuit?
Ellenbogen: It has unlocked the ability to integrate a greater suite of services, including a video platform that brings a network of accountants to consumers’ fingertips. Intuit launched TurboTax Live in December of 2017 for the 2018 tax season, providing consumers live video assistance with tax preparation. Video-as-a-platform has come of age, and investing in existing durable businesses that take advantage of this will be a good way for investors to make money in coming years.
QuickBooks grew 31% last year, despite a challenging environment for small businesses. An improved product and tighter integration of services like payroll and third-party applications has resulted in greater customer retention and faster growth. QuickBooks Advanced is priced at $1,500, 4.5 times the typical offering, yet is growing at four times the rate of the rest of the business. QuickBooks Live, a separate product from QuickBooks Advanced, also costs $1,500 and provides video access to accountants, which helps lower churn and retain higher-value customers. Finally, we believe QuickBooks will soon be able to offer valuable banking services to its small-business customers via its QuickBooks Cash product, which it launched in July.
Intuit could earn in the mid-$12 range per share in calendar 2022. We expect the business to compound at around 20% for the next several years, and there is the potential for value-creating acquisitions. Our estimates don’t include much value from Credit Karma, which Intuit bought last year. We believe it could be meaningfully accretive, strategically and financially, to the business.
Cohen: Does the Intuit model work outside the U.S.?
Ellenbogen: For many years they struggled outside the U.S., but now they are doing well. QuickBooks’ online business is growing by more than 50% a year in Australia and the U.K. Transitioning to the cloud has increased the product’s agility.
Vroom [VRM] is an early-stage growth company that sells used cars online. It came public in 2020. We were private investors before the IPO. As with residential real estate, the way in which consumers are buying and selling used cars is fundamentally changing. About 40 million used cars are sold annually in the U.S. About half of one percent were sold online in 2019, but that could grow to 5% within the next four to five years. Consumers’ willingness to make high-cost, complex purchases has lagged behind some other e-commerce categories. Covid represents a de-risking moment for this type of transaction, which is beginning to go mainstream. We like Carvana [CVNA] and Vroom. The skills needed to compete online are fundamentally different from those needed in the traditional industry; the business favors digitally native companies. Specifically, selling cars online requires strong data and AI capabilities, and e-commerce capabilities. Vroom is the No. 2 digital player. It will gain share in the next few years and show improving unit economics.
Key to our thesis is strong management. CEO Paul Hennessy and Chairman Bob Mylod were part of the senior management team that took Priceline/Booking from a $1 billion market cap to $50 billion. We believe Vroom could sell 250,000 to 300,000 cars in 2024, when it will become free-cash-flow positive. Assuming the business trades at 30 times underlying EBIT, that yields a stock price of $55 to $75 in two years, up from a recent $40. With only 1% to 2% of the industry online, there is a significant runway for growth.
Anderson: Do you foresee a clash between Carvana and Vroom or some sort of deal between them?
Ellenbogen: Consumer demand for online car purchases far exceeds the capacity of Vroom, Carvana, and CarMax [KMX]. You need significant scale in this industry, somewhere between 40,000 and 60,000 cars around the U.S. to provide the selection and speed consumers want. Carvana is at relevant scale today, and Vroom will get there by 2024. Do I see the logic of a combination between Carvana and Vroom? There won’t be pressure on either management team to do anything for a number of years, although linking up now would be a take-the-hill strategy.
Mario Gabelli: If there is a 10% correction in used-car prices, you could have a real hiccup in earnings. We saw that at CarMax in the latest quarter.
Ellenbogen: If you are doing a good job buying cars, that should smooth things out.
My final pick is Black Knight [BKI], among the most durable franchises an investor will find. We believe it has the best business model in the mortgage market. Under CEO Anthony Jabbour, who joined in 2018, innovation and execution have meaningfully improved. At the same time, the digital age has arrived. Black Knight’s customers include the largest mortgage originators and servicers, such as Wells Fargo [WFC] and JPMorgan Chase [JPM]. Increasingly, borrowers expect a faster loan-origination process and real-time access to their mortgage statements, and Black Knight responds to these needs.
MSP, the company’s mortgage-servicing platform, contributes 65% of revenue. Black Knight is the system of record for 36 million of the 66 million mortgages outstanding in the U.S. Since the financial crisis of 2008-09, its market share has grown to 55% from 35%. MSP is the core technology platform for most of the top 25 mortgage servicers and their customers. New products, such as AIVA and Servicing Digital, have allowed for smart, AI-driven customer service, and led to new sales, which will show up in revenue in the next couple of years.
Mortgage originations represent 30% of revenue. The company’s success in this segment has been driven by a continued increase in regulation as a result of the financial crisis, and customers’ expectations for speed in the origination process. The cost of originating a mortgage has doubled to $9,000 in the past 10 years. That has forced banks and mortgage originators to adopt the services of the two leading players—Black Knight and Ellie Mae, which Intercontinental Exchange [ICE] recently bought for $11 billion. Black Knight bought Optimal Blue, the leading data asset in this space. The U.S. mortgage market is complex, but Optimal Blue drives meaningful efficiencies.
Give us an example.
Ellenbogen: Optimal Blue has the leading pricing information, which gives loan officers, real estate agents, and mortgage investors real-time insight into prevailing interest rates and the variable costs to insure and originate mortgages. In addition, they have the opportunity to build an electronic exchange in the secondary mortgage market. It is a $2 trillion market, larger than the corporate bond market in the U.S.
We expect Black Knight to accelerate its revenue growth to the high-single digits, and report mid-teens growth in earnings per share and free cash flow. Black Knight owns 13% of Dun & Bradstreet [DNB], which we also like. While the market is concerned about rising interest rates, less than 10% of Black Knight’s revenue is exposed to mortgage volumes. Our price target is in the low- to mid-$100s. The stock is $81 now.
Thank you, Henry. The last word goes to Todd.
Todd Ahlsten: I’m pumped to talk about six ideas. First, you asked how we decide to sell a stock. As long as a company we own is still innovating and trying to solve important, complex societal problems, we will continue to hold the stock. I also agree with Henry about letting your winners run. Deere [DE], which I recommended last year, is an example of that. The stock is up 70% since then, but the party is just beginning.
Deere has a $94 billion market cap. Three-quarters of the business is agricultural equipment. The company also makes construction equipment. Since I last spoke about Deere to this group, the adoption of the company’s precision ag tools has tripled. That’s why I’d like to double down on this name again.
What are precision ag tools?
Ahlsten: I’m referring to combines and sprayers and planters connected to the internet. Deere’s operations center now has over 200,000 connected machines on 190 million engaged acres across the U.S. Again, I can’t emphasize enough that use has tripled in the past year. This is a really key point because it helps take the long-term cyclicality out of the business. Over the next decade, we think Deere is going to transform itself from primarily selling those iconic green tractors to being a connected software company. In the long term, it will see higher returns on R&D spending. An upgrade cycle lies ahead. A lot of equipment is aged, and we’re starting to see inflation in some commodities. In the next three years, not only the equipment cycle but demand for connected devices could take off.
Deere’s annual revenue is about $36 billion. We estimate about $2 billion of that is precision ag equipment, up 40% in the past 12 months. Over the next decade, the use of those tools will go up parabolically; this could become a very large franchise for Deere. Then, from an ESG standpoint, these tools help save water and reduce pesticide and fertilizer use. They also increase the value of acreage and help farmers make more money. Deere is one of the wider-moat companies we’ve seen, and has one of the most extensive dealer networks.
“ Applied Materials is a fantastic way to invest in the building blocks of all the things we’ve talked about in the past two days: AI, telehealth, online education, 5G, autonomous vehicles, and the digitization of many different industries. ”
We expect Deere to earn well over $20 a share in the fiscal year ending in October 2024. The stock has been trading around $300. It could run to $500 over the next three years.
Mario Gabelli: Deere just did something I have never seen Deere do: They bid on wireless spectrum in a license auction. I speculate they’re going to use that spectrum to connect their factories’ equipment, dealers, and the farmer.
Ellenbogen: What is also unique about Deere is that they are so trusted by their customers. Deere is a beloved brand because it helps its customers solve problems. ESG issues matter: If you are an extractive company, customers will want to transition away from you.
What is your next pick?
Ahlsten: James talked about ASML earlier today. Applied Materials [AMAT] is another way to play the same innovation trend, but with a little more of a value bent to the stock. The stock has had a pretty good run in the past 12 to 18 months, but we think there is a megacycle still ahead. Applied Materials sells semiconductor capital equipment to chip makers, such as TSMC, Intel [INTC], and Samsung Electronics [005930.Korea]. It helps them produce those physics-bending materials in semiconductors. Applied Materials is a fantastic way to invest in the building blocks of all the things we’ve talked about in the past two days: AI, telehealth, online education, 5G, autonomous vehicles, and the digitization of many different industries. Semiconductor intensity will likely go up, long term. The semiconductor industry doubled in size from 2000 to 2020, and it likely will double again from 2020 to 2030, to $1 trillion. The wafer-fab equipment area that Applied Materials and ASML compete in is about 12% of the industry’s revenue. It could be a $100 billion-plus industry by the end of the decade.
ASML is a monopoly, but AMAT, Lam Research [LRCX], and KLA [KLAC] are setting up to be an oligopoly. Each dominates certain markets and has some monopoly-like positions. Applied Materials could earn well over $6 a share within three years, and trades at an upper-teens multiple of earnings. Finally, Applied Materials is doing a lot to use more responsible materials, and making chip manufacturing and use more energy efficient.
Todd Ahlsten’s Picks
Our third pick, Micron Technology [MU], is a way to double down on the same trend, and an economic recovery. Micron makes memory chips; about 70% of revenue comes from DRAM, and 30% from NAND chips. We see the potential for tremendous earnings growth in the next three years.
Ahlsten: Micron isn’t the widest-moat company we own, but the DRAM industry has consolidated to three main players. Micron has about a 25% share; Samsung, 41%; and SK Hynix [000660.Korea], 28%. The NAND industry has six main players, and Micron has about an 11% share.
DRAM will be strong this year; NAND might have some oversupply, but we see strong demand in the back half of the year and into 2022. Micron is cutting costs at its fabs, and we see a cyclical recovery, as well as a strong earnings trajectory.
We expect Micron to earn about $3.80 a share in fiscal 2021, ending in August, and $7.15 in fiscal 2022. The company could earn $10 a share at the top of the cycle; they’ve done it before.
What is an appropriate price/earnings multiple on $10 peak earnings?
Ahlsten: Twelve to 15 times earnings would be nice, but we see upside to that number because they used to lose money in down cycles and now they make money. That gives us upside well past $100 a share. The stock is around $80 now. And, from an ESG standpoint, Micron is committed to clean manufacturing and is planning to reduce greenhouse gases by 40% from 2018 levels. There is also another power-efficiency angle in data centers.
What else have you got for us?
Ahlsten: Another double-down—from the 2020 midyear Roundtable—is Booking Holdings. It’s the largest online travel agency in terms of sales, web traffic, and rooms. It’s a play on pent-up demand for travel and a reopening of the economy in the second half of the year.
Booking has best-in-class margins, a great marketplace model, and a fantastic ability to optimize marketing spend, relative to peers. We also like the fact that a lot of Booking’s revenue is skewed to Europe, where there is a fragmentation of hotels. That makes Booking’s moat wider because of a strong network effect. Clearly, the pandemic has challenged their business, but their balance sheet is strong enough that they could survive three years with revenue at almost zero.
Booking stock trades for about 22 times what the company earned in 2019. We see a dramatic earnings recovery from here, to upward of $160 a share by 2024 from maybe $50 to $80 this year. If you put a 25 multiple on that, you’re pushing $4,000 a share, up from a recent $2,200.
Ellenbogen: It is a fine company, but what justifies a higher multiple than they had before the pandemic?
Ahlsten: Its moat is widening. Those small European hotels desperately need to reach out to travelers. That means greater relevance and value for Booking to its hotel customers. People are chasing ways to play a global travel recovery. You can do that by buying airlines, hotels, or other assets nearer to the epicenter of the damage, but people are also going to want to invest in a more digital, asset-light story.
What do you think of Expedia Group [EXPE]?
Ahlsten: We think Booking is a far better asset. Last spring, Expedia had to raise capital at around 10%, which was very dilutive. At the same time, Booking was raising capital at 3% to 4%. The cost-of-capital advantage speaks to the superior asset quality, network effect, and moat.
It seems like leisure travel will come back strongly, but corporate travel might take some time.
Ahlsten: I think it is going to explode higher. This year’s Roundtable has been great on Zoom, but it so much richer in person. People will realize that they’re at a disadvantage if they don’t show up in person to close that deal or get that job. We have a small investment in Southwest Airlines (LUV) to play a rebound in leisure travel, but corporate travel will bounce back, too.
In that case, we’ll hope to see you in New York next January.
Ahlsten: Now, I’m going to double down on a 2020 pick that didn’t work out, but I’m not backing away: CME Group (CME), the options exchange. It’s a way to play an increase in fixed-income rate volatility without taking credit risk. CME is also one of the widest-margin businesses in the S&P 500.
Last year the stock was down 6%. Trading volumes surged from February through April, but fell dramatically in May and remained subdued for the rest of the year. Interest-rate volatility was really suppressed once the Federal Reserve said it won’t raise rates until at least 2023. That put a pin in the balloon for my CME trade.
Ahlsten: We see a return of interest-rate volatility this year. CME’s business model benefits as volatility and trading volumes increase. With a 50% adjusted net income margin, we want to be there. Henry mentioned great compounding companies. Coming into last year, CME had compounded its earnings at a double-digit rate over the trailing three, five, and 10 years, and could do that again in the next 10. The stock trades for about 26 times forward earnings, roughly in line with the S&P 500. Historically, CME has traded at a 55% premium to the market; it has traded at this low of a premium only 5% of the time in the past 15 years. If you have a multiyear time horizon, put this one away and let it grow. Also, CME pays special dividends and has about a 2% dividend yield.
My last pick is Digital Realty Trust (DLR), a $37 billion data-center REIT yielding 3.1%. It provides the critical infrastructure for the digitization of emerging technologies—wholesale, hyperscale, co-location, interconnection—and it is truly global. We see revenue growth accelerating to the high-single digits in coming years, as they continue to diversify the business. They landed 130 new customers last quarter, with 48% co-location or interconnect, and 59% outside North America. We expect mid- to high-single-digit growth in AFFO [adjusted funds from operations] in 2021. This is a great way to own a digital asset in real estate that can benefit from the megatrends we have discussed.
Is the dividend likely to grow?
Ahlsten: Digital Realty is on a 14-year streak of conservative dividend increases, and we expect dividend growth in the mid-single digits in the future. The management team has made some good acquisitions over the past couple of years.
To close on an ESG point, they have a stellar track record there. Given the exponential increase in data usage, energy efficiency is key. By our math, data centers consume about 2% of all the electricity in the U.S. If we don’t do something about it, current estimates are they will consume 8% of the world’s energy by 2030. I’ve toured some of DLR’s data centers that are designed to be more efficient. They have a long-term goal of making 100% renewable energy available to their customers. About 30% of their energy now comes from renewable sources. They were also the first data-center REIT to issue green bonds, in 2015, and they issued about €1.08 billion in 2019.
What are its competitors?
Ahlsten: Equinix [EQIX] is the largest. It’s a great company, and in some ways has an even wider moat than DLR. But its dividend yield is less, at 1.4%. With DLR you get a bit more of a yield play and more ESG.
Black: Iron Mountain [IRM] is getting into that business, as well. It yields much more [7%], but data centers are just a fraction of the business.
Thank you, Todd, and everyone.
Corrections & Amplifications
The dollar amount of green bonds issued by Digital Realty Trust was about €1.08 billion in 2019. An earlier version of this article misstated the amount and the currency.
Write to Lauren R. Rublin at firstname.lastname@example.org