For Immediate Release
Chicago, IL – November 21, 2018 – Zacks Equity Research highlights Berkshire Hathaway BRK.B as the Bull of the Day, Grubhub GRUB as the Bear of the Day. In addition, Zacks Equity Research provides analysis on SPDR S&P Homebuilders ETF XHB and Invesco Dynamic Building & Construction ETF PKB.
Here is a synopsis of two stocks and two ETFs:
Bull of the Day:
It’s no secret that the equity markets have been suffering lately. Investor sentiment has turned broadly negative and in many cases selling seems to beget selling, even when there’s no clear catalyst. We’ve seen downturns before that were the result of significant contagious events – the Asian Flu, the collapse of Long Term Capital Management, the Bursting of the Tech Bubble and the Financial Crisis of 2008.
We haven’t seen any compelling reason for the selling pressure of the past two months other than investor fear and the desire to protect the profits accumulated during the previous nine-year bull run. In many cases, investors seem to be dumping shares of even the healthiest companies as they race to the door.
One legendary investor has consistently recognized previous periods of turmoil as opportunities and used temporarily depressed share prices to bolster his portfolio at attractive prices.
The Oracle of Omaha has a famous bit of advice about investing – “Be fearful when others are greedy and greedy when others are fearful.” – and he has consistently put his money where his mouth is, making shrewd investments in the strongest companies when sentiment is at its worst.
Owning shares of Buffett’s holding company, Berkshire Hathaway is like getting a ride on the Oracle’s coattails as he and his top lieutenant Charlie Munger put their combined 100+ years of investing experience to work finding opportunity amid the chaos.
Berkshire is currently a Zacks Rank #1 (Strong Buy).
Munger coined the phrase “lollapalooza effect” to describe how a confluence of cognitive biases can result in situations in which groups of otherwise well-informed people can act irrationally.
Berkshire has capitalized on the irrational behavior of investors countless times, possibly none more notable than their tremendously successful investment in Goldman Sachsduring the financial crisis in 2008.
The contagious effects of falling share prices, loan defaults and huge losses in derivatives trades threatened to bring down the entire investment banking industry.
Shortly after the fall of Lehman Brothers, Buffett recognized that Goldman was a significantly stronger enterprise than other investment banks, all of whom had seen their share prices pummeled.
During the height of the panic, Buffett invested $5B in Goldman in a private deal that gave him a large ownership stake in preferred shares that paid a 10% annual dividend as well as warrants to buy an additional 43 million shares of common stock at $115/share. It was a win-win situation as Goldman then enjoyed the credibility conferred by Buffett’s investment and was able to raise additional capital in an equity offering and ultimately survived the crisis as strong as ever.
Buffett’s profit on the trade is estimated at $3.1B – a fairly tidy return that was made possible only because of his willingness to make a huge bet just as most others were at their most risk-averse.
In the event of any sort of crisis situation in the future, what investor wouldn’t want Warren Buffett at the helm, making the tough choices for them?
Berkshire tends to take large positions in high-quality, large-cap names and holds them for long periods of time, often adding to those positions during periods of opportunity.
Traders comb Berkshire’s quarterly SEC filings reporting their holdings and it’s not uncommon to see quick appreciation in any given name once the markets recognize that Buffet has spent the previous three months acquiring shares.
As of the end of the third quarter, Berkshire had approximately $86B – or 40% of its portfolio - in the shares of large banks, including $13B purchased during the quarter. Buffet loves banking and insurance businesses because of the natural spread between taking in deposits or premiums and investing/lending at significantly higher rates to make profits. He also favors what he calls “forever businesses” whose products and services are in demand in all economic environments.
Investment banks also tend to see improved financial results during tumultuous times because of both increased commissions and fees on a higher volume of customer business as well as increased margins on proprietary trading activity.
Bear of the Day:
Founded in 2004, Grubhub initially set out to use internet technology to eliminate outdated paper delivery menus for restaurants, allowing customers to quickly update menu choices and prices and reach a wider audience. Grubhub subsequently moved into providing delivery services as well, giving access to a wide range of restaurant choices to consumers who never have to leave home to enjoy their favorite menu items.
Grubhub now provides delivery services for over 80,000 restaurants in more than 1,600 cities in the US and the UK.
The company went public in 2014 and had seen shares appreciate as much as 475% from the offering price of $26/share, hitting a high of $149/share in September of 2018. A steep drop since then has Grubhub currently trading around $80/share and there are some dark clouds on the horizon.
The problem is increased competition in the food delivery space. Though its services have undeniable appeal to consumers and restaurants alike, there are no serious barriers to entry in the industry. Acquiring early brand recognition and a dedicated customer base provided a first-mover advantage for Grubhub, but several deep-pocketed competitors with experience in transportation now threaten to capture a significant share of the market.
Ride-sharing behemoth Uber built its business on the concept of utilizing idle assets. Realizing that many automobiles aren’t being used at any given time, Uber applied cell phone location and mapping technology to the problem, allowing independent drivers to use their own vehicles to provide rides to strangers for a fee.
After dominating the market for human passengers, Uber realized that cars on the road without a passenger could also be used to deliver mail-order packages and restaurant to-go orders. UberEats now delivers restaurant food in much the same way as Grubhub and has become enormously popular, especially with millennials who are already accustomed to using the company’s transportation services.
The website ridesharingforum.com recently conducted an experiment in which they ordered identical items using Grubhub, UberEats and a third competitor, DoorDash. They found that the total prices paid and the amount of time it took for the food to be delivered were essentially identical. The only minor differences were in the way the restaurants were compensated for the orders (invisible to the customers) and the method for tipping the drivers. In other words, from a customer perspective, the services are totally fungible. There’s no compelling reason to prefer one over the other.
Uber is not standing still either. Continuing with the theme of using idle capacity, Uber is now a partner in over 1,600 “virtual” restaurants in which underutilized kitchen space in existing restaurants is used to produce menu items for restaurants that don’t actually exist as physical spaces where customers could go. The restaurant partners get to share some of the cost of rent and labor that would otherwise be wasted and Uber gets to keep part of the menu prices – around 30% - as well as the delivery fees.
Can Builder Confidence Recover from November’s Sharp Plunge?
The confidence level among the nation's homebuilders plunged eight points in November, the sharpest one-month drop since 2014. The November reading is also the lowest since mid-2016 as rising prices and borrowing costs are coming in the way of buyers’ affordability, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index.
Following the latest reading, the SPDR S&P Homebuilders ETF dropped 0.4%, while Invesco Dynamic Building & Construction ETF fell 0.9%. Meanwhile, homebuilding stocks have already been thrashed this year in anticipation of slower growth in housing and higher costs for construction companies. The Zacks Homebuilding industry has lost 34.7% this year, whereas the broader S&P 500 Composite market has gained 2.2%.
Homebuilder sentiment fell eight points in November to 60 from October and all three indices — present sales, future sales and buyer traffic — registered a fall. In the words of NAHB Chief Economist Robert Dietz, “While home price growth accommodated increasing construction costs during this period, rising mortgage interest rates in recent months coupled with the cumulative run-up in pricing has caused housing demand to stall.”
Current sales conditions fell seven points to 67. Buyer traffic plunged eight points to 45 (the lowest since August 2016) and sales prediction over the next six months dropped 10 points to 65. Regionally, the HMI reading was dismal for South and West, declining 2 points and 3 points to 68 and 71, respectively. However, Northeast and Midwest ended on a positive note, increasing two points and one point, respectively.
Affordability Taking a Toll on Housing
Challenges like inventory shortage are prevailing in the U.S. real estate market and creating upward pressure on prices in several parts of the country, thereby affecting affordability. In addition to this, rising mortgage rates in recent months has been making the operating backdrop tough for homebuilders.
According to Freddie Mac’s latest Primary Mortgage Market Survey, the 30-year rate remained unchanged from last week, averaging 4.94% for the week ending Nov 15, 2018. Notably, this is still an increase from last year’s rate of 3.95% and the highest since February 2011.
Meanwhile, higher home borrowing rates have kept many potential buyers on the sidelines. Mortgage applications in the United States dropped 3.2% in the week ended Nov 9, after a 4% drop in the previous week, per the report from the Mortgage Bankers Association. Moreover, refinance applications decreased 4.3% and applications to purchase a home fell 2.3%.
Apart from rising mortgage rates that are expected to pose serious threats to the construction market, higher input costs are also compressing homebuilders’ margins at a time when political pundits are seriously considering a national infrastructure revamp.
Construction material prices increased 7.9% year over year and 0.5% month over month in October, according to an Associated Builders and Contractors (“ABC”) analysis of information provided by the U.S. Bureau of Labor Statistics. Prices for nonresidential construction inputs also increased 0.5% month over month and more than 8% year over year.
Is Recovery Due in the Near Term?
Despite the sharp fall in builders’ sentiment, an important economic indicator, the reading remains in the positive territory as any reading above 50 signals improving conditions. Homebuilders indicated continued consumer demand for new homes. That said, the recent market data related to sales, permits, starts and existing home sales revealed a decelerating growth rate, which raised apprehensions about housing recovery. Moreover, labor shortage, trade-driven material price increases, limited land availability along with increases in new and existing home sale prices have been making things worse.
Notably, the Federal Reserve hiked the funds rate for the third time this year in September to 2-2.25% in response to a strong U.S. economy and signaled a gradual pace of rate hikes, going forward. It was the eighth hike since late 2015. The central bank maintained its forecast of the fourth rate increase before the year end and three more in 2019.
The Fed is expected to raise interest rates in December. However, the recent housing slowdown may influence the extent to which the central bank will actually extend its interest rate hikes since late 2015.
Economist Dietz also stated, “Recent policy statements on economic conditions have lacked commentary on housing, even as housing affordability has hit a 10-year low,” said Dietz.
Homebuilding biggies, like Lennar and KB Home, have also trimmed their expectations recently. KB Home slashed its guidance for fourth-quarter fiscal 2018 revenues and average selling prices. Lennar has also adjusted both deliveries and new order guidance for the fourth quarter of fiscal 2018, to reflect the impact of Hurricane Florence and the sluggishness that it has been currently experiencing.
The only thing that is positive for the homebuilding industry is robust economic growth and a solid job market that provide the basis for demand.
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About the Bull and Bear of the Day
Every day, the analysts at Zacks Equity Research select two stocks that are likely to outperform (Bull) or underperform (Bear) the markets over the next 3-6 months.
About Zacks Equity Research
Zacks Equity Research provides the best of quantitative and qualitative analysis to help investors know what stocks to buy and which to sell for the long-term.
Continuous analyst coverage is provided for a universe of 1,150 publicly traded stocks. Our analysts are organized by industry which gives them keen insights to developments that affect company profits and stock performance. Recommendations and target prices are six-month time horizons.
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Grubhub Inc. (GRUB) : Free Stock Analysis Report
SPDR-SP HOMEBLD (XHB): ETF Research Reports
PWRSH-DYN BLDG (PKB): ETF Research Reports
Berkshire Hathaway Inc. (BRK.B) : Free Stock Analysis Report
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