“In business, I look for economic castles protected by unbreachable moats.” – Warren Buffett
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With most non-US markets crumbling, the resilience of a still-expanding US economy coupled with a strong greenback may make US stocks relative outperformers. Screen: Economic castles with a high percentage of revenue generated in the US that are trading at a large discount to our estimate of their intrinsic value.
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The see-sawing action in the US markets has not let up, with the latest wave of the upward variety. The S&P 500, however, remains nearly 8% off its all-time highs, as global markets continue to ebb and flow with news of negative economic data followed by the prospects of an ever-easing monetary environment and so on.
Several major economies across continents are in technical recession (Brazil, Canada, etc), while others continue to face a slowing pace of economic expansion, not the least of which are Australia and China. The global economic outlook is growing meeker by the day, even if a longer-run outlook still holds promise.
Recent news has offered hope that the “Asian Contagion” of 2015/16 won’t spread, but it appears to be false hope. Reports showed that German exports hit a record high in July, but we know historical economic data has limited usefulness when it comes to assessing the forward outlook of global equities. After all, the shock of the collapse in China’s stock market and the crash in Dow Jones Industrial Average were primarily mid-to-late August events, even if China’s markets have been under pressure for some time.
It is our view that Germany, which lists China as its fourth-largest export market, has not avoided the follow-on impact of China’s equity market collapse and slowing consumer spending in the Communist country, but instead, it is our contention that the repercussions haven’t fully reached Europe’s largest economy…just yet. We believe the ripples of August won’t be felt until the fourth quarter at the earliest, but we’re most concerned about global economic performance in 2016. July data is “old” news, in our view, untouched by the pause in economic activity prompted by the US market crash.
In any case, despite all of its shortcomings, the US continues to be a relatively more attractive market for equities, if only because the threat of recession is not imminent and the prospect of rate hikes has made the greenback the strongest it has been in some time. US investors may find that ideas in their very own backyard may turn out to be the most interesting, particularly ones that aren’t exposed to foreign recessionary environments and weakening currencies.
Below, we showcase 5 highly-rated Economic Castles that generate a large percentage of revenue in the US and that are also trading at a wide discount to our estimate of their intrinsic value.
AbbVie
Pharma giant AbbVie has one of the strongest late-stage pipelines in the industry, with developments in HCV, oncology, immunology, and neuroscience. This gives the company a sound platform for continued profitable growth. Its blockbuster drug remains Humira, but recent acquisitions have helped to further diversify the firm’s portfolio. The solid performance of multiple branded drugs (and the potential of its pipeline) give AbbVie one of the best Economic Castles around, and the IRS axing its deal with UK-based Shire ensured that the majority of the company’s revenue will continue to originate in the US.
Capella
Capella is an US-based online post-secondary education firm; over 70% of its learners are enrolled in a master’s or doctoral degree program. We think the firm has one of the best business models in the for-profit education space by a large margin, and it is one of a few in its industry where enrollment is actually expanding. Some of the company’s innovative programs could help break the mold of traditional post-secondary education and provide significant potential for growth, in our view. That it is primarily online-based, translating into an asset-light business model, is a large reason for its impressive Economic Castle rating. Capella has a healthy dividend, an ongoing share buyback program, strong free cash flow, and a pristine balance sheet.
Corporate Executive Board
Corporate Executive Board combines the best practices of thousands of member companies with research and analytics to provide senior leaders with insight and solutions. The firm has a loyal blue-chip client base, consisting of ~97% of the fortune 100, yet its top 50 clients account for less than 10% of combined revenue; we like the diversification and growth potential of its revenue base. The firm’s business model is aligned to key long-term trends, including increasing corporate complexity, rising knowledge work and workers, multiplying information flows, and heightened connectivity and empowerment. The fact that its product is largely advice-dependent allows it to have a high return on invested capital, and the company is one of the highest rated Economic Castles in our coverage universe.
Deluxe
Deluxe is one of the top check-producers in North America, and it also provides small business solutions such as web services and search-engine marketing. The firm expects to wane its revenue from checks as a percentage of total revenue from its current level of 55% to ~40% by 2018 due to the reduction in customer demand for paper checks. The company’s ‘Direct Checks’ division boasts the highest margin of its businesses, helping it to have one of the highest rated Economic Castles in our coverage universe. A key goal for Deluxe moving forward is maintaining a high customer retention rate in its ‘Small Business Services’ division. Free cash flow generation has been solid in recent years, and the firm has strong dividend growth prospects as a result.
EMC Corp.
EMC manages its business in two broad categories: EMC Information Infrastructure and VMware Virtual Infrastructure. The firm helps organizations store, manage and protect information, while its majority stake in VMware makes it a leader in virtualization infrastructure solutions. It is focused on riding the wave of transition to cloud computing. The fact that the company is growing at a pace several times that of global IT spending speaks to its strong positioning. EMC is incredibly profitable, and its cash-flow generation is amazing. We think it is one of the best businesses in our coverage universe. EMC invests a good chunk of revenue in R&D each year, which should support its fortress-like Economic Castle to remain standing for the foreseeable future.
Kris Rosemann contributed to this article.
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