It's a new year, and the holiday season is officially over. But that won't stop us from continuing to shop for the best stocks our market has to offer.
To that end, we asked five top Motley Fool investors to each pick a stock that they believe you would be wise to buy in the month of January. Read on to learn why they chose Under Armour (C Shares) (NYSE: UA), Meritage Homes (NYSE: MTH), Intercept Pharmaceuticals (NASDAQ: ICPT), Apple (NASDAQ: AAPL), and FS Investment (NYSE: FSIC).
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Under Armour's turnaround is just getting started
Steve Symington (Under Armour C Shares): There's no denying that Under Armour investors just suffered through a terrible year. Shares plunged nearly 50% in 2017, most recently including a more than 20% single-day drop in early November after Under Armour announced its first year-over-year decline in quarterly sales as a publicly traded company. For that, we can thank a slowdown in Under Armour's large North American wholesale business driven by intense competition and multiple bankruptcies in the sporting-goods space.
I went out on a limb last month, however, to suggest that investors bet on the longer-term success of Under Armour's swift response -- that is, to restructure and put more emphasis on returns on investment, while fostering its high-growth international and direct-to-consumer businesses. Sure enough, shares surged later in the month, when at least one Wall Street analyst echoed my sentiment, citing early signs of improving demand, waning price competition, and his anticipation of the restructuring effort reducing expenses and improving operations in the coming quarters.
With that in mind, I think Under Armour stock has only just begun to rebound. And it's still a compelling buy for investors willing to pick up shares before the fruits of its turnaround become more evident.
Building on the biggest trend in housing
Jason Hall (Meritage Homes Corp.): According to the National Association of Realtors, existing home sales recently surged to their highest levels in over a decade. At the same time, the U.S. Census Bureau continues to report strong residential construction data, with building permits and housing starts consistently above the 1 million unit mark for more than two years now.
Yet as healthy as the housing market has become in recent years, lost-cost housing has remained a challenge. After more than a decade of struggles resulting from coming of age during the worst financial crisis in nearly a century, millennials are making money, starting families, and ready to buy homes, but there just isn't enough inventory to meet the demand.
Meritage Homes is taking advantage of this situation, dedicating 75% of its most recent land purchases to entry-level houses. It's paying off, driving profit up 15% last quarter. This strategy is set to pay off with even bigger profit growth, since low-cost new houses often generate higher margins than bigger, more custom homes. Since this is the least-served part of the market at present, and also the one with the most potential for demand growth over the next decade, it's a great time to be building entry-level houses. That makes Meritage worth a close look.
Even with its stock price near all-time highs, now's a great time to buy Meritage Homes. Trading for 14.3 times earnings, it's cheaper than most of its peers, and its low-cost strategy should pay off with years of solid earnings growth.
An incredible deal in the biotech industry
Sean Williams (Intercept Pharmaceuticals): A few years ago, Intercept Pharmaceuticals was considered the home run of the year among biotech stocks. Lately, it's been the goat.
It all began in September, when the Food and Drug Administration announced that 19 people with primary biliary cholangitis (PBC) who'd been taking Ocaliva, the company's only approved drug, had died. This immediately raised concerns about the safety of the drug, which is being tested in a handful of additional studies. But the issues raised have some fatal flaws of their own.
To begin with, PBC is a deadly disease if left untreated, and many of the patients who died were already extremely sick, or were being incorrectly dosed, in many cases by their doctor. The latter issue can be corrected with improved education of physicians, suggesting that Ocaliva wasn't truly at fault for a majority of these deaths.
Second, it's worth noting that the safety issues raised in PBC haven't been observed in other clinical studies. We have to remember that medicines can behave very differently depending on the disease. In the case of Intercept, all eyes are on the upcoming phase 3 Regenerate study in nonalcoholic steatohepatitis (NASH). NASH affects between 2% and 5% of adults in the U.S., and there are no approved treatments at the moment. A successful therapy that leads to NASH resolution or halts/reverses liver fibrosis could be a game-changer. In previous NASH studies, Ocaliva demonstrated no major differences from the placebo in terms of safety, other than a higher propensity for pruritus (itching), which is far from a severe adverse event.
It could also be argued that Wall Street is completely discounting the company's NASH program after safety concerns in PBC, and analyst commentary in late December that the start of the Reverse trial would be pushed back into early 2018 (it had been slated to begin enrollment in Q4 2017). Sales in PBC, along with strong clinical results in primary sclerosing cholangitis via the Aesop trial that should, in my view, lead to a label expansion for Ocaliva, could probably buoy Intercept near its current valuation. In other words, I believe you're getting a dart throw at the NASH indication for almost free, despite the fact that Ocaliva dazzled in the phase 2b Flint study by demonstrating statistically significant improvements in NAFLD Activity Score and fibrosis, relative to the placebo.
Everything is dependent on Regenerate at this point, which is expected to produce top-line data in 2019, but as a current shareholder, I see plenty of reward with minimal risk at this point.
An Apple a day
Danny Vena (Apple): It might be easy to dismiss Apple on fears that growth in its iconic iPhone may soon plateau. However, there are numerous reasons to think that Apple is still a buy.
The recently passed tax legislation will be a boon to Apple. The company currently has an estimated $252 billion in its overseas coffers that it can now repatriate. If the Cupertino company decides to bring it all back, Apple can take advantage of the one-time tax break and pay a tax rate of just 15.5%, resulting in a $49 billion decrease in potential tax liability. This would leave a tax bill of just over $39 billion due to Uncle Sam. Apple has already set aside $36.3 billion, nearly the entire amount due.
With this money, Apple can grow its dividend, increase its share buybacks, or tackle the growing debt resulting from its aggressive capital return policy.
There are other reasons to like Apple right now. Reports of slow iPhone 8 sales point to greater adoption for the flagship iPhone X. We haven't seen a full quarter of sales for the device, but soon after it was available for pre-order, the iPhone X hit a six-week wait time for orders. Rumors of supply chain issues were rampant and pent up demand could drive significant sales of these higher-priced devices, increasing margins.
Apple's dividend currently yields 1.45%, and its payout ratio of 26% leaves plenty of room to continue its bountiful returns to shareholders.
How do you like them Apples?
A double-digit dividend yield with capital gains potential
Jordan Wathen (FS Investment): Business development companies (BDCs) make their money lending to, and investing in, private companies around the United States. Like REITs, they pay out 90% of their income to avoid corporate-level taxation, thus resulting in annual dividend yields that can top 10%. I think FS Investment, which trades at a 20% discount to book value, and yields 10% per year, is a good relative value in the industry.
Recently, FS announced that a unit of Blackstone is stepping out as its manager, and KKR is stepping in. Along with a changing of the guard, the company will benefit from a reduction in operating expenses. When KKR steps in, the company's management fee will be reduced to 1.5% of assets, and management will have to earn a 7% return on equity before collecting any incentive compensation. The new structure better aligns management incentives with shareholders.
To be sure, the new fee structure isn't necessarily industry-leading, but it's far better than its current valuation would suggest. Shares trade at about 80% of book value, likely because some year-end tax loss harvesting, but management has every incentive to get the share price back over book. It's my view that an investor who buys at a discount of 20% or more to its last-reported book value of $9.43 per share can realize a market-beating return from dividends and capital appreciation. Should shares rally, look to cash in near book value -- closed-end funds and BDCs are best bought at a discount to book, and this is no exception.
The bottom line
Of course, there's no way to absolutely guarantee that these five stocks will deliver market-beating gains from here. But whether we're talking about Under Armour's budding turnaround, Meritage's bets on entry-level homes, FS Investment's attractive valuation, Intercepts favorable risk-reward ratio, or Apple's enviable financial position, they each offer investors an intriguing way to put their money to work as we kick off the new year.
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Danny Vena owns shares of Apple. Jason Hall owns shares of Apple, Meritage Homes, and Under Armour (C Shares). Jordan Wathen has no position in any of the stocks mentioned. Sean Williams owns shares of Intercept Pharmaceuticals. Steve Symington owns shares of Under Armour (C Shares). The Motley Fool owns shares of and recommends Apple and Under Armour (C Shares). The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends KKR and Meritage Homes. The Motley Fool has a disclosure policy.