The major indices have been trading near all-time highs.
But a handful of mega caps and AI names are doing most of the heavy lifting.
Look past them, and one value investor sees plenty of solid businesses that are being overlooked.
In the latest episode of Ticker Take, I spoke with Lorne Steinberg, Co-President of Lorne Steinberg Wealth Management, the Montreal-based firm he founded in 2009. Steinberg has been investing for more than three decades, and has made his money the Warren Buffett way, by finding great companies trading at cheap prices. He says this is the kind of market where those stocks still exist, if you know what you’re looking for.
Steinberg’s definition of cheap starts with a number. Bonds yield 3 to 4 per cent over time, he says, and equities have to earn enough to justify the volatility. The long-term return of the S&P 500 has been roughly 10 per cent a year. So he looks for stocks priced where he can reasonably expect that same 10 per cent annualized return over the next five years. That, he says, will deliver a lot of wealth creation for investors over time.
Then come the quality criteria. The concept Steinberg keeps coming back to is free cash flow. The cash a business generates in excess of what it needs to reinvest. That is what management has to buy back shares, make acquisitions, and pay dividends. The trouble, he says, is that history is full of companies that wasted free cash flow on terrible acquisitions. So the bigger question is how the cash gets allocated, and whether that allocation will keep generating returns for shareholders over time.
With that framework in mind, here are the 8 stocks he highlighted.
Berkshire has been under some pressure since Warren Buffett stepped down and Greg Abel took over. Steinberg compares the transition to when Tim Cook took over for Steve Jobs at Apple. Cook was not a visionary, but he created a different kind of success by being the best Tim Cook, not another Steve Jobs.
Abel is not Warren Buffett either, but he was trained by the best and has had a spectacular track record. And Berkshire sits on roughly 400 billion dollars in cash. At some point the market will fall, Steinberg says, and that is where Berkshire shines. The way it did during the financial crisis, that cash position lets the company make great deals that pay off for years.
Steinberg points to an old article about McDonald’s that has stuck with him. The company has five times the number of quality control inspectors of its peers, checking that the cheese on a Big Mac is in the right place and the washrooms are cleaned every hour. Ray Kroc once said people do not come to McDonald’s because they have the best hamburgers. They come because the bathrooms are clean.
That obsession with consistency shows up in the financials. McDonald’s continually generates cash flow and uses it well. It has aggressively reduced its share count while growing revenue, more than doubled its dividend in the past decade, and is still opening stores, around 900 in the U.S. this year. Steinberg projects 10 per cent earnings growth a year over the next five years, with the stock trading at one of its cheapest multiples in years because investors are focused on AI.
Cisco is still number one in routers, but is increasingly an integrated software company. Steinberg points to its acquisition of cybersecurity company Splunk a few years ago as an example of strong capital deployment. Cisco’s equipment is also being used in data centres, and quarterly results have been taking off. The business is moving from mid single digit revenue growth toward double digit growth.
And the capital allocation has been consistent across CEOs. Cisco’s share count has fallen from over 5 billion to 4 billion in the last decade, while the dividend has more than doubled, and the company carries next to zero net debt. The discipline, Steinberg says, is in the company’s DNA.
Steinberg calls Adobe one of the cheapest and most compelling stocks he owns. The whole software sector has been under pressure from AI fears, but Adobe’s last quarter delivered double digit growth in earnings, revenue, and free cash flow.
The stock trades at roughly 8 to 9 times free cash flow. Steinberg’s math is striking. If Adobe’s earnings and cash flow do not grow at all, and the company simply uses the free cash to buy back shares, he says he will be the last remaining shareholder of Adobe in 9 years. Every major company still uses Adobe, and the company is incorporating AI into its products.
Microsoft is the one mega-cap AI name on Steinberg’s list. With the stock having pulled back, he says investors have a chance to buy what may be the world’s best technology company at a reasonable price. Microsoft sits at the nexus of software, cloud, and AI, and is the integrator for nearly every major company.
Last quarter, the company continued to grow revenue and earnings at 15 per cent a year, while spending 190 billion dollars on data centres to meet existing demand. Steinberg makes the point that this is not pie in the sky investment. It is funded out of free cash flow. Microsoft converts about 35 cents of every revenue dollar into net after-tax profit, and the stock trades at just over 20 times earnings.
Allstate (ALL)
All Allstate does is sell home and car insurance. Boring, Steinberg says, but the company has done it better for shareholders than almost anyone. Instead of chasing business when competitors lower prices, Allstate takes its capital and buys back stock and pays dividends.
Over the past 20 years, Allstate has repurchased more than 60 per cent of its shares outstanding. Over the past decade, about a third. In the same period it has doubled its dividend and tripled its earnings. Steinberg says he tells clients that at the current rate, there will be no shares of Allstate outstanding in 15 years. The total return to shareholders has been roughly 15 per cent a year over the past decade.
Disney has three businesses, and Steinberg argues investors are not paying for what they’re getting. The theme parks generate the bulk of profits and remain a growth industry, with new parks increasingly being funded by other investors while Disney leases out the brand. The networks business, including ESPN, is moving to streaming. And the content business now sits inside Disney Plus, which has grown into the third largest streaming service in the world with 200 million subscribers.
Disney Plus is now solidly profitable and the fastest growing part of the company. Yet the stock trades at 14 times earnings, with double digit earnings growth ahead. Steinberg’s math on the streaming business alone puts it at roughly two-thirds of the share price. By his valuation, Disney trades at about a 50 per cent discount to net asset value, and he thinks the stock is worth roughly double where it trades today.
A longtime Berkshire Hathaway holding, which Steinberg notes is no accident. Buffett described it this way at one of the Berkshire meetings. The company bought its last share of American Express in 1988, at which point it owned 11 per cent of the company. Berkshire has never purchased another share since. Today it owns about 22 per cent. That doubling of ownership without buying a single new share speaks to the buyback program.
American Express is also not particularly economically sensitive, Steinberg says, because of who uses its cards. A lot of the revenue comes from businesses paying merchant fees. The result has been a free cash flow machine with double digit earnings growth and roughly a 15 per cent annualized return to shareholders over a long period.
In addition, he does not see much competition for its core business.
The Ticker Take
What ties Steinberg’s framework together is the discipline to require both things at once. Quality AND price. Most investors lean on one or the other.
Across all eight of his picks, the through-line is what management does with the cash. The companies on his list are not the ones generating the most excitement. They are the ones quietly using their free cash flow to compound shareholder value year after year. In a market climbing on a narrow group of names, that is where Steinberg believes the opportunity lives.
Jon Erlichman is a BNN Bloomberg contributor and the host of Ticker Take on YouTube.
