Jan 26, 2023
Paul Harris' Top Picks: January 26, 2023
Paul Harris' Top Picks
Paul Harris, partner and portfolio manager, Harris Douglas Asset Management
FOCUS: North American and global stocks
The U.S. Federal Reserve and other central banks reiterated that the priority remained the fight against inflation rather than the support of economic growth. On the inflation front (a lagging indicator), pressures moderated somewhat over the last few months. Nevertheless, core inflation generally remains well above central bank targets in most countries, which is why rates will continue to increase into 2023 albeit at a slower pace.
We continue to believe that S&P 500 earnings have further to fall despite the recent downgrade. Our expectation continues to be that this wave of negative earnings revisions will ultimately push the S&P 500 lower before the bear market is complete. Meanwhile, we continue to see a lot of complacency in the market, with the VIX in the 20s. We think you need to see the VIX closer to 35 before you can start discussing a capitulation bottom and the end of the bear market. Nevertheless, this is an opportunity to analyze and purchase some great companies that you wish to hold for the long term at reasonable valuations.
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In our view current headwinds are transitory. A number of issues have led to the stock’s worst year so far since 2008. Apple shares have tumbled 23 per cent so far in 2022, steeper than the Index which is down 18 per cent.
One setback has been a series of shipment delays for Apple’s iPhone 14 Pro and Pro Max, stemming from COVID-19-related lockdowns given manufacturing disruption issues in China. We see these headwinds as transitory and investors should remain focused on the long-term opportunity.
We remain focused on other areas of revenue growth for Apple, including its wearable products, such as watches and AirPods and its services segment. New product launches should also help the company down the line. Services have a clear path to $136 billion in revenue by full year 2026, which will drive margin expansion and help smooth out the cyclicality inherent in the hardware business. Wearables also have a robust growth outlook, with a path to $70 billion in revenue.
Shares of Amazon have struggled this year, down almost 45 per cent, as the stock has been swept up in a broader tech selloff. We recognize the demand challenges facing Amazon’s retail business given macro slowing, AWS growth and lower operating income. We also believe Amazon can gain wallet share during these uncertain times and the adoption of AWS can accelerate through improved operating efficiencies and hiring freezes can deliver improving operating income.
In November, the company announced plans for a staff cut of about 18,000, due to macro challenges and a previous flurry of hiring. It also paused corporate hiring in November. The online retail giant saw an uptick in its market share since the pandemic and has since roughly levelled off to about 45 per cent of U.S. e-commerce.
Furthermore, Amazon, along with Alphabet‘s (GOOGL) Google and Meta Platforms (META) have dominated the share of new ad dollars brought into the ecosystem within the global digital ad market. With valuations near trough levels, and estimates already dialled back, we see much of that negativity as priced-in and see a favourable risk/reward among many internet stocks. This is a high-quality company, well positioned to outlast the near-term macro challenges and should come out ahead in the new landscape.
Alphabet is a top search destination on the web and provides a leading search marketing platform for advertisers and merchants. The company continues to see growth in YouTube and its ability to monetize advertising. The stock trades at 18 times earnings. It will generate 50 billion in free cash flow in 2023 and has no debt. It has significant secular growth from internet advertising and a strong market share in search and other internet advertising segments. Google has a 30 per cent share of U.S. digital ad revenue and global ad revenue is expected to reach well over 400 billion in 2024. Digital advertising accounts for more than 50 per cent of total ad spend. The restrictions that Apple has put on iPhone help Google.
PAST PICKS: March 16, 2022
FirstService (FSV TSX)
- Then: $178.51
- Now: $191.00
- Return: 7%
- Total Return: 8%
Zebra Technologies (ZBRA NASD)
- Then: $401.65
- Now: $308.74
- Return: -23%
- Total Return: -23%
Stryker (SYK NYSE)
- Then: $262.16
- Now: $253.86
- Return: -3%
- Total Return: -2%
Total Return Average: -6%