What I am sharing with you are somewhat random observations about a topic that has been very importa...
Top Picks for a Watch List
09/16/2016 10:00 am EST
Although he is hesitant to add new long positions in the current market, Peter Staas is using the current period of uncertainty to develop his watch list of favorite growth stocks. Here, the editor at Capitalist Times discusses three stocks â€" a leader in educational publishing, a top cloud computing firm, and a lesser-known play on software for the insurance sector.
Steve Halpern: Joining us is growth talk expert, Peter Staas, editor of Capitalist Times. How are you doing today, Peter?
Peter Staas: I'm doing well. Thanks again for talking to me, Steve, I appreciate it.
Steve Halpern: In recent months you've turned more cautious on the stock market noting that lackluster economic growth could make the overall economy vulnerable to external shocks. What are some of the concerns here?
Peter Staas: Over the past several months -- for much of this year actually -- my co-worker, Elliott Gue, who handles our macro calls has grown increasingly concerned about the US economy.
You can pick out, of course, positive data points specifically the employment data, but even if you look at that average monthly nonfarm payroll growth has declined this year relative to 2015 and before that and 2014, so that's in a down trend.
You look at recent readings from the purchasing managers indexes for the manufacturing side of the economy. That retreated below 50 in August, which is a sign of contraction.
And if you look at the service side of the economy, that one slumped significantly last month to levels that would imply real GDP growth of 1% and the first half of the year the US economy grew at an annualized pace of less than 1%.
So I think that combination of economic growth that's definitely trending lower from an already lackluster pace and then you add in S&P 500 trading at 20 times roughly trailing earnings that's the 97% percentile of its four-decade range.
Those valuations, coupled with a challenging economic backdrop, make us a bit cautious on the market. We've been paring our exposure to riskier names and added some hedges to our growth portfolio and then also we're kind of building a list of structural stories that we like and we think will do well over the longer term with an eye toward adding to those positions in a pullback.
Obviously, timing a pullback in the market is tricky. In terms of near term catalyst you've got the upcoming presidential election, which always introduces some uncertainty to the market and then if you look at the pattern of quarterly GP growth over the past several years, the first quarter has been a period of weakness. That can also spook some people as well.
Steve Halpern: As you mentioned, you're using this period of uncertainty to build essentially a watch list of companies that you'd like to be increasing your positions in or added to your portfolios. Let's walk through some of those stocks and one of them is Houghton Mifflin Harcourt Brace (HMHC), which you call a long-term turnaround story. What's happening here?
Peter Staas: Yes, how Mifflin Harcourt Brace, they're one of the leading textbook publishers. They've also published a lot of classic literature over the years, but the real story here and the biggest part of their business is the textbook sales.
This is a longer term play and this is going to take time to play out -- probably over at least a three to five-year period. But what we see happening there is the transition from traditional physical textbooks to instructional material that is delivered more in line with the software as a service model.
We think that that transition should help to improve Houghton Mifflin Harcourt's profit margin. You're going to have lower printing and warehousing costs.
The subscription-based model is also going to lead to better revenue visibility. Instead of having these large chunks of revenue that are tied to upgrade cycles and when school districts upgrade their textbooks and that kind of thing, they're going to be getting more consistent revenue.
And from an instructional standpoint, I think the interesting thing here too is that they're developing solutions. That they're collecting data about how the students interact with the digital content and they can make adjustments to that that is delivered over a shorter timeframe than they would be with physical text books.
Again, that's something that we think is going to take time to play out so this is something that you might add to the portfolio and just kind of forget about it for a bit and wait for that story to play out. We think Houghton Mifflin Harcourt Brace is definitely the name that's best positioned to take advantage of what we see as a longer-term trend.
Steve Halpern: You also point to Salesforce.com (CRM), which you call the 800-pound gorilla in the cloud computing space. What's your outlook for this stock?
Peter Staas: Salesforce has delivered really impressive revenue growth over the past several years. They have multiple platforms, the largest of which is their sales cloud, which is a customer relationship management software.
And it just seems with every quarter they continue to make inroads with larger corporations. They're definitely taking market share from the likes of Oracle and SAP and other traditional players in enterprise software.
They recently acquired Demandware, which is another software, a service company, so again here you're paying a regular service fee for access to the software rather than one big upfront chunk to have the software installed on site.
Demandware provides solutions for retailers that includes e-commerce and sales, order management and other predictive analytics and the more solutions that Salesforce adds to their platforms the greater the opportunity for cross selling and I think that the growth trajectory is for the various product lines that they have.
The timing -- some might be adopted more readily, more quickly. Some may occur at a slower rate, but I think for the majority of their solutions it looks promising so this is a name that we definitely like to buy on pullback. We see a strong long-term growth opportunity.
Steve Halpern: Finally, we only have a minute left, but a less familiar name on your watch list is Guidewire Solutions (GWRE). Could you tell our listeners a little about this outfit?
Peter Staas: Yes, they know the insurance industry inside and out and they developed a suite of specialized software for property and casualty insurers; addresses really every point in that process.
The insurance industry, really they have not kept up with technology so there's a pretty sizeable upgrade cycle that will take place and I think that's going to take place over a longer time because they are pretty slow moving, but Guidewire has really gained some impressive traction.
They implemented their software solutions with 23 of the 55 tier one insurers that are out there and we see a long tail for them to gain further penetration in that space. There really aren't any other competitors that have their capabilities so we see that as another strong growth story.
Steve Halpern: Again, our guest is Peter Staas of Capitalist Times. Thank you so much for your time today.
Peter Staas: Thank you Steve, always appreciate it.
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