3 Stocks to Sell and 3 Stocks to Buy Before 2024

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar Research Services’ chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead.

On your radar this week, Dave, is of course Thanksgiving. The U.S. stock and bond markets are of course closed on Thanksgiving Day. But remind us, are the stock and bond markets open on the Friday after Thanksgiving?

Dave Sekera: Good morning, Susan, and happy early Thanksgiving to you and all of our viewers as well.

Both markets, stocks and bonds, are closed on Thanksgiving, and then they both have an early market close on Friday. I think it’s a 1 p.m. Eastern close for stocks, and then a 2 p.m. Eastern close for the bond markets.

Dziubinski: We’ll likely be hearing late this week about retail sales during Black Friday and the long holiday weekend. What’s the market expecting? And if sales come in below or above expectations, is that going to have much of an impact on the stock market?

Sekera: Probably not, and let me just walk through some of the reasons here.

Over time, Black Friday sales have just become increasingly less important to retailers, and there’s a number of reasons for that. One, we’re seeing a lot of sales that come in even before their traditional Black Friday as retailers try and capture that share early in the season. Consumers have been trained to watch for sales throughout the entire holiday season. It’s no longer just the Black Friday sales and then the couple of days before Christmas. And we’ve also seen as inventories need to get destocked before Christmas, a lot of the best deals are now actually coming just those couple of days before the holiday.

Now, we also see consumers waiting until after Christmas. There’s a lot of clearance sales, but there’s also the impact of gift cards. Over the past number of years, we’ve seen a lot more people give gift cards instead of actual gifts. So, that ends up shifting that spending until the beginning of next year.

Now, the other shift that we’ve seen too is that the internet has made price comparison extremely easy. People can be out shopping, check their cellphones and see what prices are on the exact same item at a number of different other retailers. So, I think consumers have a much better idea now of as far as which sale prices really are good versus which sale prices are just kind of marginal.

Again, it’s just a long-winded answer really to say no, I don’t think Black Friday sales in and of themselves will really impact the market. I think it’s going to be the entire holiday season as well as early January that we’ll see the impact on the retailer stocks.

Dziubinski: We do have a couple of companies of note reporting earnings on this shortened week of trading. One is of course Nvidia NVDA. What do we think of the stock ahead of earnings, and what are you listening for?

Sekera: I think Nvidia is really going to just be the most highly anticipated, most closely watched earnings report this season. I think it’s going to be bigger than Alphabet GOOG or Apple AAPL or even Microsoft MSFT. The only thing though that’s going to surprise me here is if we don’t see a huge swing in the stock price in either direction after we see the report.

It looks like they report Tuesday after market close. I think first you’re going to see probably a huge swing in the price just as the news and the earnings report hit the tape. And then we have the conference call afterward. I think during that call, depending on what kind of guidance management may give or what they talk about, we could see a big swing in the price thereafter. And then on Wednesday, I think a lot of traders are probably going to start off the Thanksgiving holiday season early, so we may see less participants in the market. That also could increase the volatility as well.

Now I know our focus is really going to be on the revenue and the operating margin this past quarter. And as far as the guidance, what the demand is going to be not just for next quarter but the next couple of quarters out. Because I think the real question in this story is how long can this extremely rapid growth rate keep up?

I downloaded our model, took a quick run through that. I noted that our revenue growth forecast for the fiscal year ended Jan. 31, 2024, is 100%. So, we’re looking for sales to double this fiscal year, and then we’re looking forward to increase another 38% in fiscal 2025. Just some huge growth rates.

Essentially, we’re looking at $27 billion of revenue last year for fiscal 2023, growing all the way up to $120 billion by fiscal 2028. Now, we’re also looking for a very large expansion in the operating margin. So kind of pre-AI, the operating margin was 21% in 2023. We’re forecasting that to more than double to 50% here in fiscal 2024 and increase all the way up to 58% in 2028.

Based on those assumptions, the stock right now is trading right above our fair value, puts it in the 3-star territory. I’d also note that we do rate this company at the Very High Uncertainty Rating. In my opinion, I think it’s probably nearly impossible for people to really have that much confidence just as far as how fast and how much AI is going to continue to grow not only just the next couple of quarters, but much less, how it’s going to grow over the next couple of years.

Dziubinski: Now, we have Lowe’s LOW reporting this week too. What do we think of that stock heading into earnings, and what are you expecting to hear given what Home Depot HD had to say last week when it reported?

Sekera: Yeah, Home Depot stock did have a nice little pop after earnings, but I think it was really just because the earnings were less bad than a lot of people had feared. Now, Home Depot did update their full-year guidance. They narrowed their range for the drop in net sales. They’re now forecasting a 3 to 4% decline, whereas before it was a 2% to 5% range. And then they also reduced or narrowed the range of what they expect for their decline in earnings per share. They’re looking for earnings to constrict by 9% to 11%. The range before was 7% to 13%.

I think this is just one of those cases where Home Depot is a good company. We do rate it with a wide economic moat. Meaning, we do think they have long-term, durable competitive advantages. But our view here for the long-term investor is that the Home Depot stock is just overvalued at this point. It’s rated 2 stars, trades at a 17% premium to our fair value. Whereas, Lowe’s is a 3-star stock that trades right at fair value. So I’d say in that case, we do expect that for long-term investors, they would be able to earn the company’s cost of equity over time.

As far as Lowe’s earnings, I think we are looking for somewhat of a similar story here, looking for slightly lower sales as same-store sales likely have declined this past quarter. Now, looking at the charts here, Lowe’s stock has performed much better than Home Depot over the past year or so. So, in my opinion, I think it’s less likely to see a stock pop here if results are less bad like what we saw at Home Depot.

Dziubinski: Got it. Now let’s move on to some new research from Morningstar. We’re going to begin with our analyst takes on the earnings reports from a few retailers that reported last week. You just talked about Home Depot. But Target TGT also reported last week. The stock was undervalued ahead of earnings, the company beat, and the stock soared. What happened, and is the stock still undervalued today?

Sekera: Target, the earnings did beat expectations, but, in my opinion, I would consider that to be what we call a low-quality beat. As you mentioned, the stock definitely surged, but it’s really because there’s more coming off of such low levels. It had fallen enough that it really got to the point where it was trading at a significant discount to our fair value. In fact, the stock price was trading all the way back toward prepandemic levels.

A lot of people ask, well, what is a low-quality beat? What does that mean? In this case, I would say that this was the second quarter that they had comp-store sales declines. It dropped 5% this past quarter. The earnings beat came from an increase or an improvement in their gross margin. I think the company noted better inventory control, reduced promotional destocking, is a couple of reasons. And from having covered retailers in the past, I would say it’s really not all that hard for a retailer to manage their margins on a short-term basis in any one individual quarter, and my gut is that’s probably what was going on here.

Looking forward, we do forecast that the operating margin will continue to slowly improve, that we’re looking for it to rise up to 6.0% by 2026 over the next couple of years. It was 5.2% this past quarter. Again, we are looking forward to continue to improve getting up to about a 6.6% over our longer-term forecasts, which is still lower than our historical margin that we’ve seen here of about 7.0%. So, after the stock surged 18%, it’s now in that 3-star territory, so where we consider it to be fairly valued.

Dziubinski: Now, Walmart WMT reported last week, too. Its stock fell after earnings. The company’s third-quarter numbers came in as expected, but management gave a slightly lower-than-expected forecast for the rest of the year. What do we think of the stock today?

Sekera: This is really interesting. So, Walmart, I would actually consider that story to be the opposite of what we heard at Target. Whereas, Target was very undervalued coming into earnings, Walmart was, in our view, overvalued. Now, Walmart stock had just risen pretty steadily over the two and a half years, whereas Target stock has dropped quite a bit over that same time frame.

Over the past couple of years, when I look at what the story here is, I think this shows why we think Walmart has a wide economic moat as opposed to Target, which we rate with no moat. While Target’s comp-store sales this past quarter fell 5%, Walmart’s sales actually rose by about 5%. So the opposite.

Now, Walmart sales increased mainly on higher volumes, and I think that indicates one impact of inflation on consumers who are now shifting a lot of their spending patterns to the low-price retailer such as Walmart. Now, Target’s operating margin did expand. Whereas, operating margins at Walmart contracted by about 30 basis points.

The operating margin contraction at Walmart wasn’t for a bad reason. I mean, what we saw here was a mix shift, a higher amount of sales in groceries, which are lower-margin but higher-revenue. And then Walmart also noted that they were spending some additional capial expenditures on store remodels. Again, that helps keep the Walmart stores looking better. Again, it entices consumers to continue to keep coming back.

As you noted, the Walmart stock, it did fall. I think traders were looking for better than what we saw, and I think investors were probably slightly disappointed by that margin contraction. But from a fundamental point of view, I think Walmart is a better story than Target. Having said that, looking at the stock, we do think that that’s priced in. So even after Walmart stock did take a bit of a fall, it’s still trading at a 7% premium to our fair value, putting it in that 2-star territory.

Dziubinski: Let’s pivot over to some new additional research for Morningstar and this time on lithium stocks, which we talked a little bit about in last week’s show. Exxon Mobil XOM announced that it was planning to get into the lithium production industry. Is that good or bad news for current lithium producers and their stocks?

Sekera: Yeah, I think this is one of those instances where you can read the news however you want to read it, and I think you can read it both ways.

I do think it could be bad news from the perspective that there is more supply that will be coming online over the next couple of years. However, I’d point out, I think Exxon said they’re only planning on producing 100,000 tons by 2030. In comparison, our forecast is that the demand out there for lithium by 2030 will be 2.5 million tons. So again, more supply coming online, but in comparison, really probably not that much to move the needle here.

Now, from the good news perspective, if Exxon is getting into this business, which is getting away from their traditional energy business of oil and gas, I think that means that the management there sees enough of a business case to get involved in a new area such as mining lithium.

The news did take a little bit of air out of the stock. All of the lithium stocks were trading very well at the beginning of the week, but even after a little bit of a pullback in the latter half of the week, as a group, I think generally they were still up for the week. Then taking a look at Exxon, again, the company is just so large that this really isn’t anything that could possibly move the needle on that stock at this point.

Dziubinski: Let’s move on to the stock picks portion of our program. This week, you’re focusing on three tax-loss swaps investors might consider making before 2024 begins. Dave, explain to viewers what a tax-loss swap is and why they might want to engage in one or more of them before the end of the year.

Sekera: First, even before that, I do have to recommend that investors check with their own tax advisors first before taking any actions here. Taxes are very difficult, and trying to make sure that you’re not doing anything to run afoul of any wash-sale rules or making sure that you actually have capital gains and capital losses that you can offset before you make those changes in your portfolio.

Essentially, what we’re looking here for are those stocks that I think investors may own that likely have embedded losses based on the trading patterns of those stocks over the past couple of years. We look for those that we also think are overvalued, those that are rated 1 or 2 stars. So, hopefully not only can you capture those losses in order to offset some of your sales, hopefully by selling now you could dodge any potential additional losses that may still be yet to come.

Essentially, at the end of the day, what you want to do is sell those stocks that you do have those capital losses in and use that in order to offset the capital gains that you may have elsewhere. And then the other part to that is then reinvest those proceeds in stocks that you do think are undervalued that have similar characteristics as the stocks that you sold in order to really keep the same balance in your portfolio that you had before taking any of these actions.

Dziubinski: Just a reminder for investors, the two things to really keep in mind before engaging in this is A), make sure you really have a loss on the security, and B), make sure that you’re not running afoul of any wash-sale rules. Is that right?

Sekera: Exactly. Again, you want to double-check your account. Pretty much every brokerage account is going to have your cost basis in there, although sometimes you have some stocks that are in your account that are so old, you might have to go to your own books and records if it’s not in your account. But again, make sure that you have those losses to take. And then depending on how much stock you sell, if you don’t sell out of the entire position, then you also need to decide whether you want to use your average cost basis in that stock, or if you want to identify specific stock cost basis that you have that you’re going to sell in order to take those losses.

Dziubinski: Now, in a recent article on Morningstar.com, you outlined 10 tax-loss swaps that investors should consider making this year, and viewers can find a link to the article beneath this video. We’ll talk about three of those swaps this morning.

Your first tax-loss swap is selling Xerox XRX and buying Salesforce CRM instead. Let’s start with Xerox. Why is that a good tax-loss candidate for some investors?

Sekera: Well, as part of my screening, I noted that Xerox stock has dropped over every single time period that I checked. In fact, over the past 10 years, that stock has dropped at an average annual rate of 8.2%. Now it’s taken a bounce off its October lows, so at least you’re able to recapture a little bit of some of that decline.

But, in my opinion, when I take a look at Xerox, I think the company is really just a melting ice cube. Printing in and of itself is definitely in a long-term secular decline. And when I look at our financial model here, over the past 10 years, revenue has dropped from $20 billion all the way down to $7 billion, and we forecast that that top line will continue to deteriorate from here, and there’s really no upside growth trend in earnings. So, again, not a lot going on for this company.

Dziubinski: So then, why do you suggest Salesforce as the stock to buy as a replacement?

Sekera: Yeah, so Salesforce, in our view, is undervalued. It’s rated 4 stars. Trades at a 13% discount to our fair value. When we take a look at the technology sector, according to one of our equity analysts, Dan Romanoff, he thinks that Salesforce just has the best combination of top-line growth potential, the potential for operating margin expansion, has a strong balance sheet, and really just the best combination of those three aspects across the entire tech sector.

Dziubinski: Now, your next tax-loss swap is selling CrowdStrike CRWD and buying Fortinet FTNT. Why is CrowdStrike a sell, Dave?

Sekera: CrowdStrike stock has fallen an average annualized rate of 15.9% over the past two years, and that’s even after bouncing 40% this year. What we’re seeing here is increased competition from a number of other cybersecurity vendors. They’re expanding into the endpoint security space. That’s the same area that CrowdStrike focuses in. So, in our view, we do think that stock is trading at a 27% premium to our long-term fair value estimate, putting it in that 2-star category.

Dziubinski: And then why do you like Fortinet?

Sekera: Just looking across cybersecurity, and again, that’s a sector we’ve talked about that we do think has long-term secular benefits to it, Fortinet right now, in our view, just has the best combination of quality and value. We do rate that company with a wide economic moat. Now it’s trading at 3 stars, but within that 3-star territory, it’s trading near the bottom at a 17% discount to our fair value.

Dziubinski: And your last tax-loss swap that we’ll talk about this morning is selling American Airlines AAL and buying Norfolk Southern NSC. That’s an interesting swap, Dave. First, tell us why American Airlines is a sell.

Sekera: The airline industry in and of itself is probably one of the most competitive industries out there. When I look at American Airline stock, that’s fallen at 7.8% on average over the past 10 years, and a lot of that decline has actually occurred even more recently. In fact, over the past 10 years, it’s dropped at an average annualized basis of 23.8%. In our view, none of the airline companies have an economic moat. Airlines have really had a difficult time passing through inflationary cost pressures, higher labor costs, higher oil prices. So, it’s really squeezed the margins, not just of this airline, but really across that entire industry.

Dziubinski: Dave, can you clarify a little bit? You said what it had fallen over the 10-year period and then a shorter period?

Sekera: Sure. It’s fallen over the past 10 years at 7.8% as an average annualized loss, and then over the past two years, it’s fallen 23.8%.

Dziubinski: Two years. Got it. Then let’s move on to Norfolk Southern. Now, we’ve talked about that stock on the show before. Why should investors swap an airline for a railroad?

Sekera: Whereas the airlines have no economic moat, in our view, we rate all of the railroad companies with a wide economic moat, and that’s based on two different things. One, just the cost advantages that the railroads have versus other transportation methods and the efficient scale that we see within that sector. And rarely have stocks in the railroad sector traded at very much of a discount to our fair values. In this case, it’s currently trading at a 7% discount. And just because of the narrow uncertainty ban there, that does put it in that 4-star territory.

Dziubinski: Well, thanks for your time this morning, Dave, and given that it’s Thanksgiving week, Dave and I would like to thank our regular viewers for your feedback and loyalty. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis.

Dave and I will be back live next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel and have a Happy Thanksgiving.