De-teasing Kramer’s “The No. 1 Value Stock for 2020”

What's the new stock being teased by Value Authority?

By Travis Johnson, Stock Gumshoe, February 12, 2020

Growth stocks get all the attention these days, what with talk of a final “melt up” in the market before things finally return to rationality, and “value stocks” have been floundering for years as they’ve failed to capture the attention of investors… so last fall we saw a lot of predictions about the “turn,” the point when value stocks would finally begin to outperform again (as they generally have over much longer time periods), and the beginning of some hints, from the few value stock newsletters still out there, that we might finally be primed to see some “buy it cheap” opportunities.

There is, of course, no hard and fast definition of what “value” or “growth” means — usually folks just refer to things like below average price/earnings or price/book valuation when they use the term “value,” and talk about top-line growth (revenue growth, especially), when they migrate to “growth stocks.” In reality, of course, every stock you might invest in today has some element of growth and some element of value — “value” just means, to me, that you pay attention to the valuation of the stock and the actual fundamentals, and think about what the downside risk might be… “growth” means you take into account the fact that most of us are buying because we hope the company we’re buying will grow, sometimes extraordinarily fast but always at least at a fast enough clip to justify the risk you’re taking by buying shares. A real valuation of a stock always has to incorporate some notion of how much the company has grown, and how much it might grow in the future.

But anyway, value stocks are super unpopular because they haven’t generally been rising by 50% a year like the sexy growth stocks… but at some point they’ll probably return to favor, maybe during the next crash when growth stocks fall by 20% and the value stocks fall by only 2%. So when I saw a teaser pitch about the “number one value stock for 2020,” well, I thought we might want to figure out what it is.

The ad this time is from Hilary Kramer, who’s been peddling her ideas in newsletterworld for quite a while (this pitch is for her entry level newsletter, Value Authority ($77 for the first year)), and has some books and TV appearances to support her “brand” — she’s had a few good picks and a few terrible ones over the years that I’ve covered her teasers… the last two were both in retail and have suffered, At Home (HOME) and Big Lots (BIG), but let’s see what she’s got for us today.

Here’s a little taste of the ad, to get you started:

“Riding the Wave of Unstoppable Earnings Growth, a 14 P/E, and Making Money Hand Over Fist…

“This is One Stock That’s Set to Soar….

“Today I’m going to give you an inside look at my No. 1 Value Stock to buy now… and why it could triple your money or more in the next 12 months.”

And she sort of makes an argument for value stocks in general to surge, though it’s a little light on data…

“For the past 10 years, as the markets rose, hedge funds and institutional investors accepted higher multiples as momentum pushed prices even higher.

“Not for much longer.

“As one analyst at Goldman Sachs puts it, ‘Elevated valuations suggest low long-term returns.’

“This is why value plays like Weight Watchers jumped 389% in 2017 as tech stocks slowed… and why institutional investors and hedge fund managers are now looking at value stocks with low P/E ratios and incredible fundamentals that have yet to have their run.”

Weight Watchers (WW) was certainly a lively story from 2015 to 2018 or so, as they tried to rescue the brand and do a bit of a turnaround, with a massive dose of help from Oprah that did give the stock a serious jolt. I guess it counts as a value stock, it was trading at a PE of about 12 in early 2017 and surged dramatically higher to a PE in the mid-30s as the stock peaked in 2018, thanks to dramatically improved growth expectations — but it also then became a “growth stock” cautionary tale in mid-2018 as the stock foresaw the fact that earnings were about to be cut in half and the share price tried to beat the earnings down to the bottom of the chart. I don’t know whether Kramer recommended WW at the time or not.

Kramer’s “#1 Value Stock for 2018,” by the way, was also covered by yours truly — that was the aforementioned Big Lots (BIG), which definitely didn’t work out but certainly looked better at the time than it does in retrospect — and at the time Kramer was making a similar push for 2018 being the year that “value beats growth”, and also using that same comparison to Weight Watchers in her pitch for BIG.

But if we assume that yes, some stocks that perhaps look a bit “undervalued” might have appeal these days, for those of us who can’t stomach chasing growth stocks… or at least can’t stomach it with all of our portfolio… what’s the idea she’s touting now?

Here’s where she gets into talking about her #1 value stock more specifically:

“My No. 1 Value Stock Could Easily Match Weight Watcher’s 389% Gains and Then Some!

“The reason is simple.

“You see…

“Just like Weight Watchers, this company is also riding the wave of unstoppable earnings growth.

“But, unlike Weight Watchers, which profits in the diet sector, this company is making money hand over fist in the hottest sector on the planet: Artificial Intelligence (AI) — where thinking machines create new software, new hardware, and business applications in minutes — without human input.”

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So that’s just another way of saying, “it’s nothing like Weight Watchers, but I know you want me to compare this to something else that already did well.”

OK, so it’s somehow an “AI” stock and it’s also a value stock? That would be a little unusual, but I guess artificial intelligence is touching pretty much every aspect of business these days… let’s see what other clues she drops:

“My No. 1 Value Stock for 2020 is at the forefront of it all. They’re already harnessing this game-changing technology and turning it into profits….

“… Apple, Google, Baidu, Microsoft, and Amazon are investing heavily in AI technologies — and why you should, too.

“You see… thanks to AI, once you get ahead of your competition, there may be no way they can keep up.”

I’ll spare you all the talk about how big A.I. will be… there’s no end of quotes you could use, from Marc Benioff to Mark Cuban or Bill Gates, to exclaim the fortune-building potential of machine learning and artificial intelligence, but you’ve heard all that and it’s kind of like saying, “The internet will change the world” in 2000… it’s probably true, but that doesn’t mean all the companies who were building internet businesses were good ideas.

Then we start to get some idea of what sort of company this is she’s hinting at…

“There is no AI revolution without software that is driving the revolution. Artificial Intelligence and machine learning are the “picks and shovels” that bring the gold to market. That’s why companies that are at the forefront of this revolution will gain a superior advantage over those that don’t.

“Which is why, to paraphrase Dr. Domingos, ‘He who implements convergence the fastest, wins.’

“My No. 1 Value Stock for 2020 fits this description to a T.”

Then she describes what the company does:

“… the company’s AI learning applications, running over millions of computers, can solve numerous complex business problems across all industries.

“Improving predictions and forecasts by not only testing millions of potential outcomes then pre-selecting the best ones to implement. Outcomes that would have taken years to predict and test… yet can now be accomplished in minutes.

“What this company has created here is one of the most revolutionary technologies I’ve seen in my 30+ years of covering this sector: a predictive engine that helps business managers maximize business outcomes by recommending optimal decisions that apply directly to their goals.”

OK, that’s a lot of MBA talk but I’m not sure it means anything. How about some real clues?

“… the company generated $16 billion over the past 12 months.  All thanks to the corporate American and the world recognizing the advantage AI gives them over their competitors.”

OK, that’s at least some numbers. What else?

We’re told that…

“This is why Wall Street’s biggest institutional investors and mutual funds have gone all in to the tune of nearly $1 billion.”

Then we get the chart that copywriters love to throw out that shows the big institutions and the huge “bets” they’ve made on this company… though it’s pretty much meaningless, as it almost always is, any large company will be overwhelmingly owned by Blackrock, Vanguard, State Street and a few other major managers, because those managers control insane amounts of money, but that money is not “choosing” to go into this particular stock, that money is flowing into this stock because it’s in the S&P 500 and these are primarily passive investment managers who run index funds. The largest mutual fund holders cited by Kramer are the Vanguard Total Stock Market Index Fund and the Vanguard 500 Index Fund, which together own about 5% of the company but which have made no human judgement call about the prospects for this investment at all.

Which is probably good for investors in those funds, because the lack of human judgement means a lack of human mistakes, but that’s an argument for another day.

Interestingly, the only big “active” mutual fund manager that holds a meaningful stake in this stock, according to Kramer’s charts, is Dodge & Cox, a long-admired value fund shop (I have some money invested with them) that has done exceptionally well over time but has, you’ll be unsurprised to hear, trailed the S&P 500 for the past couple years.

But Kramer says that these institutions see the huge profits to come…

“Because they see, as we do, this company is grabbing the lion’s share of profits from the AI revolution.

“You need only look at the company’s $16 billion annual sales, winning business model, and 14 P/E to begin to see what the big money sees: an incredible value play on the forefront of the world’s leading technology that’s set to triple your money in the next 12 months.”

So do those holdings give us any clues that the Thinkolator can check? They do indeed, and that means our answer comes out nice and easy — don’t even have to get the Thinkolator fully warmed up to tell you that Kramer’s “#1 Value Stock” is the IT services and outsourcing firm Cognizant Technology Solutions (CTSH).

Cognizant went public as an independent company right before the dot com peak in the late 1990s, and they are primarily a consulting and business process outsourcing business, with roots as a fairly typical Indian outsourcing operation (though not much more than half of their employees are in India now).

What does that mean? Well, when Facebook wants to hire a thousand content moderators, for example, they don’t want to get saddled with all those employees and they outsource that work to a firm like Cognizant. This often leads to controversy or bad press, as you’ve probably seen with dozens of outsourcing firms over the years (Cognizant is winding down its content moderation contracts after some bad press about awful working conditions, for example). In a services-based world, there are some “technology” jobs that are generally white collar, but which are also really assembly line work, not so different than the folks who work in Foxconn’s cities assembling iPhones — the work needs to be done, but it’s not the “glamorous” tech work you imagine taking place in Silicon Valley. (Yes, I know Silicon Valley is not all glamour for the folks working at the mega-techs or their many suppliers and partners, but you get the idea).

And yes, to some extent Cognizant looks like a “value” stock — they have a very strong return on equity (17%), pay a small dividend (1.25%, growing about 10% a year), are growing revenues by a little bit but not enough to get you excited (probably 3-4% or so), and are in a bit of an earnings flat spot right now but are expected to grow earnings close to 10% in 2021 and a little less in 2022. Still, they can sometimes surprise and get investors a little excited, so they reported earnings last week and their “beat” quarter helped the stock to jump about 10% higher (despite guidance for 2020 earnings that fell below what analysts had expected).

So now we’re told by the company to expect earnings in the range of $3.97-$4.13 this year, which means that the stock at $69.25 is trading at 17X forward earnings. That’s not a “deep value” price, to be sure, but it is slightly cheaper than the overall market (the S&P 500 forward PE is 18.8 right now, with the tech sector at 22.6… so in the big picture the real “value” sectors are what they have mostly traditionally been, Financials (forward PE 13) and Health Care (forward PE 16) — that’s all according to the latest market brief from Yardeni Research).

I’d argue with the notion that Cognizant is really an “artificial intelligence company” — they’re a consulting company, with some of their business including the upgrading of customer systems and some higher-end technology work, but a lot of the business also being just “our people are cheaper than your people” contracts. I don’t have any particular insight to Cognizant relative to other enterprise software and technology consulting companies our outsourcers, but this is not really a leading edge artificial intelligence firm. That doesn’t mean they’re just a call center operator or a tech sweatshop operator, they also do higher-end work — they are consulting on data-driven projects, and running artificial intelligence initiatives for some of their customers (and their website reflects that AI consulting work they’re trying to get), it’s just that there shouldn’t be any expectation that the company will suddenly be able to get dramatic improvements in growth rates or margins.

Which is why, of course, it’s priced like a fairly steady and profitable company with low growth, good margins, a little boost from stock buybacks and dividends and some reorganization to cut costs, and probably a continuing stream of small bolt-on acquisitions that will let them continue to gradually increase their scale, as they’ve mostly been doing for 20 years. The challenges recently have been in declining margins, which I assume is because of rising labor costs in India, the U.S. and elsewhere for technologically savvy employees.

I have trouble with these people-driven outsourcing companies and consulting firms, because there’s not a real potential for margin expansion as they grow, unless they decide to use their balance sheet to rev up margins by doing some borrowing… so I’d probably insist on a bit of a steeper discount to buy a stock like this, given the lack of a huge upside potential in any near term timeframe — but it’s not a terrible idea, given what little I know about the company after an hour or browsing through their filings, and it’s probably pretty reasonably valued compared to the rest of the market.

But it’s your money at stake here, not mine, so it’s what you think that matters — do you see some potential for Cognizant? Is this an undervalued gem that will shine, or do you have other “value stocks” you’d like to urge your fellow Gumshoe readers to consider instead? Let us know with a comment below.

P.S. As always, we want to know what our readers think of the newsletters they’ve subscribed to — so if you’ve tried out Hilary Kramer’s Value Authority, please click here to let your fellow investors know whether you liked it.

Disclosure: of the companies mentioned above I have long equity and/or call option positions in Google parent Alphabet, Apple and Amazon, and I have money in the Dodge & Cox Stock Fund. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.

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