Private equity has to make returns the hard way, says Goldman Sachs executive
Asset management chief Marc Nachmann warns firms can no longer rely on leverage and cheap money to fuel returns
Private equity can no longer rely on borrowing cheap money to fuel returns, and will have to go back to its roots of sourcing good deals and making operational improvements, according to the head of Goldman Sachs’s investment business.
“Private equity will look different over the next 10 years than it looked over the past 10 years,” said Marc Nachmann, global head of asset and wealth management at the US bank, in an interview. “It will be a little bit back to the future in a sense.”
The decade and a half of low interest rates that followed the 2008-2009 financial crisis heralded a boom in private equity, as managers made use of cheap and plentiful debt to embark on acquisition sprees. Falling interest rates raised asset values and cut the cost of capital.
“Over the past 10 years you could rely on lots of leverage, cheap cost of capital and multiple expansion, and you made your returns that way,” said Nachmann. “That will be harder to do going forward.”
While there is growing optimism that US interest rates have peaked after the biggest rise in decades, they are likely to remain high for some time. Nachmann was among those warning that private equity would need a different modus operandi from the one it had thrived on in the past decade.
“When private equity started out, it was about really good deal sourcing and then doing a lot of operational things to improve companies,” he said. “This goes back to the old days when people targeted undermanaged divisions of large companies or private companies that could be improved. A lot of the returns will come from sourcing really good opportunities and then the operational improvements.”
Bankers and industry executives are expecting more corporate carve-outs, when a private equity firm buys a business unit from a large corporation, such as GTCR’s $18bn carve-out of payments company Worldpay from FIS this year.
Goldman runs an internal “value accelerator” platform that works with its more than 300 portfolio companies to build the businesses.
Nachmann said he expected more “performance dispersion [between firms] than we’ve seen in the past few years”. Investors in private equity were “really digging in to see how people have made their returns”, he added, trying to understand how much came from leverage and multiple expansion — selling a business at a higher value than the purchase price — rather than operational improvements at portfolio companies.
Just over a year ago, Nachmann, a trusted lieutenant of Goldman Sachs chief executive David Solomon, was promoted to oversee Goldman’s newly merged asset and wealth management division, which had $2.7tn in assets under supervision at the end of the third quarter.
Expanding this business is crucial to Solomon’s push to revive the Wall Street bank’s stock market valuation and reduce its dependence on the more volatile earnings streams from its investment banking and trading businesses. But the division has been hit by some senior departures, including its chief investment officer Julian Salisbury.
Goldman has earmarked its alternative assets business, which includes areas like private equity, private credit and infrastructure, as a priority for growth. The bank is trying to focus more on investing money from outside clients rather than from its own balance sheet. As a result, its third-party capital in alternatives had grown from $40bn in 2020 to $219bn at the end of the third quarter. Goldman’s alternative funds are on track to raise $225bn from outside investors by the end of 2023, a year earlier than planned.
Nachmann said that the “disadvantage” of its investment bank’s strong position, it ranks top in M&A advisory, was that it runs more sales processes than its rivals, in which its private equity team cannot participate.
“The benefit of our strong investment banking franchise is that we know more companies than anybody else and we have really tight relationships,” he added. “We may see things way before anybody else sees them and you can work through unique situations that don’t end up in auction processes.”
Commenting on the general economic outlook, Nachmann said: “There are still plenty of risks around, but markets feel good barring exogenous issues that are not yet priced. Over the next few years, we expect US stocks to deliver marginally higher returns than bonds or cash.”
Turkey tightens internet censorship ahead of elections
New controls on VPNs underline Erdoğan’s moves to curb freedom of information
Turkey is tightening its censorship of the internet months before an important election, highlighting concerns that President Recep Tayyip Erdoğan’s government is further restricting civil liberties.
Documents seen by the Financial Times show that Turkey’s Information Technologies and Communications Authority (BTK) told internet service providers a month ago to curtail access to more than a dozen popular virtual private network services.
At the same time, social media site X said this week it had “taken action” against 15 posts as a result of a court order that also targeted several of the group’s rivals. X said it would have faced a ban in Turkey had it not complied with the order.
The latest interventions against online content, which come ahead of local elections in March, have fuelled concern that the government is further stifling independent sources of news and information in the country of 85mn people. Human rights groups and Turkey’s western allies say they fear that Erdoğan, Turkey’s leader for the past two decades, is backsliding on democratic norms.
“Widespread VPN blocks only take place in the most authoritarian of regimes,” said Andy Yen, chief executive of Proton VPN, one of the services that was targeted by Turkey’s internet regulator. “Blocking . . . the use of VPNs in Turkey is a very concerning move for internet freedom and privacy and is a breach of people’s fundamental human rights.”
Yen said that Turkey’s new attempt at restricting access to popular VPNs placed the country on a par with Iran and Russia. He added that sign-ups for Proton VPN had soared around the May 2023 presidential election and following the February earthquake when government censors briefly interfered with access to X.
The BTK told internet providers to block access to 16 VPN services, including TunnelBear, Surfshark and CyberGhost, and report back regularly to the regulator on their progress, according to the documents. The BTK did not respond to a request for comment.
VPNs — which allow users to route online traffic through an encrypted virtual tunnel — are widely used in Turkey and many other countries to circumvent censorship and make it more difficult for governments, companies and individuals to track browsing activity. Among the countries with the tightest controls on VPNs is China, where internet users try to bypass the “Great Firewall” that separates the highly censored domestic internet from the rest of the world.
While VPNs are used in more technologically literate parts of Turkish society, many Turks will never use such services and rely on online news media and television that is largely state-controlled or aligned with the government.
“VPN usage is not a criminal activity — people rely on it to secure their communications,” said Yaman Akdeniz, co-founder of the Turkish Freedom of Expression Association (İFÖD), a rights group.
Tests by the FT showed the VPN restrictions were at least partially effective, with service on one targeted provider seriously degraded while another service still appeared to function. The websites of targeted VPN providers were also blocked, making it significantly harder for new users without technical expertise to sign up.
Turkey has previously moved to curb certain VPNs, including after the 2016 coup attempt against Erdoğan. However, Akdeniz said that the latest measures were both more widespread and more effective than in the past, since service providers were required to report back on their progress in blocking services.
The BTK’s measures, which were first reported by Deutsche Welle, come after a sharp rise in the number of foreign and domestic websites censored or shut by Turkish authorities in recent years. The number of domain names that are completely blocked has reached an estimated 900,000 from about 350,000 at the end of 2018, according to İFÖD.
Turkey’s censors try to block a broad range of content including entire websites of some news providers such as Voice of America and Deutsche Welle, as well as social media posts and YouTube videos.
Censored topics vary widely but include articles critical of Erdoğan and his family, pro-Kurdish and opposition websites and material viewed as obscene or criminal, according to İFÖD.
In addition to blocking users’ access to individual web addresses and domain names, regulators and courts are increasingly ordering domestic news organisations to remove content from their archives.
However, Turkey’s Constitutional Court, the country’s top judicial body responsible for safeguarding citizens’ rights, on Wednesday annulled one of the rules that senior politicians, including Erdoğan, have used to block content they claim is infringing on their personal rights.
“The rules constitute a severe interference with the freedoms of expression and the press,” the court said, although the annulment will not come into effect until October, months after the local elections.
The internet censorship comes amid a darkening backdrop for broader freedom of expression in Turkey. Ekşi Sözlük, a popular discussion platform, was for example blocked following the February earthquake because it had coverage critical of the government.
Legal action was taken against more than 600 people, including over two dozen arrests, for “provoking the public into hatred and hostility” on social media in posts related to the quakes, according to an EU report from November, which warned of “serious backsliding” in freedom of expression in Turkey.
SoftBank’s Masayoshi Son piles debt on to Silicon Valley mansion
Japanese billionaire secured $92mn loan on California estate at centre of local planning controversy
SoftBank founder Masayoshi Son has piled debt on the Silicon Valley mansion he acquired for a record sum, using the showpiece house as security for a multimillion-dollar loan.
The technology investor tapped his sprawling nine-acre estate in Woodside, California, for cash in December 2019, at a time when his company’s fortunes were cracking under the weight of a failed WeWork IPO and Son was struggling to raise billions for a second Vision Fund.
Public records show that the Delaware-registered entity Son used to buy the property, SV Projects LLC, mortgaged the house to secure a ¥10bn loan — worth $92mn at the time — from Japanese bank Mizuho to another Delaware entity called SV America Inc. Details of the loan have not previously been reported.
Son bought the Woodside estate 11 years ago, paying $117.5mn — then the most for a US residential property — to acquire the property from Tully Friedman, co-founder of private equity giant Hellman & Friedman.
The new owner was originally cloaked by his limited liability company, but Son was revealed to be the buyer a few months after the purchase by the Los Angeles Times.
While not necessarily indicative of the market value, the price Son paid was nearly six times the home’s assessed value for property taxes at the time, according to public records. Even today, after a real estate boom in the area and a remade mansion, it is perhaps worth even less than the debt on the property.
Property site Redfin estimates the home is worth $23mn, though top real estate agents in the area said recent comparable sales would probably put its value in the range of $75mn to $90mn.
In recent years, the SoftBank chief has prodigiously tapped the Japanese group’s assets for cash, at one time or another encumbering everything from its shares in UK chip designer Arm to a chunk of its Alibaba stake.
Son also began to borrow personally from SoftBank to foot the bill for his investments in the group’s second Vision Fund, Latin America fund and shortlived hedge fund unit, SB Northstar. By the end of September, his personal debt to the tech group topped $5bn.
Nestled at the top of a hill and shrouded behind trees and fences, Son’s European-style villa is now mostly hidden from passers-by. Planning records show it has an elevator, bowling alley, four storeys and at least as many urinals.
Two people familiar with the purchase said Friedman was not looking to sell when Son approached him. Town records show he had just spent nearly a decade crafting a Georgian-style mansion on the land, but ultimately Son’s cheque book won the day.
“Tully said make me an offer and that’s what it took,” said one of the people.
Son soon decided to rebuild Friedman’s mansion, landing his SV Projects LLC at the centre of controversy in the little town of Woodside.
While his team handling the project won approval for a remodel, town staff visited the site in 2014 and discovered the “entire first floor was demolished . . . [and] the second and third floors were shored up above the basement”, according to a town report. Work was ordered to a halt.
Residents complained that they felt misled by the expanding project. “We’re struggling with the damage that has been done, and the waste of an eight-year-old house that has essentially been thrown away,” commented a planning commissioner at a July 2014 town meeting.
Neighbour Larry Sonsini, name partner of international law firm Wilson Sonsini, said at the meeting that he knew the owner, “who is a reputable businessman”, and urged the town to let the construction finish as fast as possible.
Eventually lawyers for SV Projects LLC prevailed. Work continued with an added $106-an-hour “special inspector” on site to monitor compliance.
Son’s new villa was completed just as SoftBank pulled in tens of billions of dollars from the Middle East to launch the $100bn Vision Fund. Soon a stream of Silicon Valley entrepreneurs were venturing up the home’s long gated driveway to pitch Son their biggest ideas.
SoftBank led a $250mn funding round for data security start-up Cohesity after the founder pitched Son there. Meanwhile, the founder of robot pizza maker Zume piloted one of its trucks up the hill to serve Son freshly heated pizzas, according to Bloomberg. SoftBank invested $375mn.
“It felt ostentatious,” recalled one tech founder who has met Son there. “Everything just looked expensive, from the sofa to the lighting fixtures.”
Son, SoftBank and Mizuho declined to comment. Friedman did not respond to a request for comment.
German insolvencies set to rise as Covid aid ends and economy stagnates
Well-known companies including Galeria Karstadt Kaufhof and Bree have filed for insolvency this year
German companies are expected to go bust at a higher rate this year following a sharp increase in insolvencies in 2023, as businesses hit by high energy costs and the end of pandemic aid throw in the towel.
Restructuring experts warn that many “zombie” companies kept afloat after the coronavirus pandemic by generous government aid and a suspension of the obligation to file for bankruptcy — which caused insolvencies to drop to unusually low levels — are now collapsing.
Since the start of this year, several well-known German companies — including the department store chain Galeria Karstadt Kaufhof and Hamburg-based bag maker Bree, whose customers include Chancellor Olaf Scholz — have filed for insolvency.
The ranks of struggling companies have been swelling because of Germany’s economic stagnation, combined with high interest rates, rising wages, elevated energy prices and a government budget squeeze. This is expected to push insolvencies up by between 10 per cent and 30 per cent this year, experts warn, taking them above pre-pandemic levels.
One such company is 85-year-old wooden toymaker Haba. Delivery failures caused by “wrong decisions” on IT systems at Haba’s online children’s clothing operation compounded the “heavy burden” the company was already enduring from the soaring cost of energy and wood, according to spokesperson Ilka Kunzelmann.
Ultimately, it was too much for the family-owned business based in Bad Rodach, a spa town in central Germany. Haba was granted insolvency by a court in December and expects to emerge in March after it has shed about a third of its 1,500 employees, shut its online clothing arm and sold a school furniture factory.
Steffen Müller, head of bankruptcy research at the Halle Institute for Economic Research, said the monthly rate of German insolvencies it tracks, which excludes unregistered companies that have few employees, has risen since last summer above the pre-pandemic average for the first time. In December, it hit its highest level for at least seven years.
“For the next two to three months we will definitely see higher insolvency numbers, you can see that from the early filing numbers,” said Müller. “The government gave a lot of aid to firms that had low productivity before the pandemic. That prolonged their lives. But now they have to repay the aid and many are struggling to do so.”
Figures released last week by the federal statistics agency showed the number of companies filing for bankruptcy in district courts had increased more than 24 per cent in the 10 months to October, compared with the same period of 2022.
Germany’s economics ministry said the business environment was “challenging” but played down the scale of the problem, saying: “In the longer-term perspective, and in comparison to the period before the pandemic, corporate insolvencies are currently not at a noticeably high level.”
Wolfgang Steiger, head of the opposition CDU party’s economic council, blamed the government’s “disastrous economic policy” for causing Germany’s insolvency rate to rise faster than many other countries. “High costs for energy and labour, which are a home-made problem, combined with the skills shortage, are causing financial distress for an increasing number of companies in Germany.”
The German economy contracted 0.4 per cent in the third quarter compared with the same period a year earlier after sharp falls in retail sales, exports and industrial production.
Growth in the country is expected to pick up to 0.6 per cent this year, according to the OECD. But it would still be one of the world’s weakest large economies and several analysts have cut their forecasts since the government slashed spending plans to fill a €60bn hole in its budget left by a constitutional court ruling against off-balance sheet funds.
As part of the budget cuts, Berlin this month ended the temporary low rate of VAT on restaurant meals it introduced during the pandemic, prompting warnings that thousands of eateries would go out of business. More than 15,000 restaurants, snack bars and cafés in Germany are at risk, according to data provider Crif, which estimated that insolvencies in the sector would rise again this year after jumping 36.5 per cent to 1,600 last year.
The German insurance association recently warned of a “massive increase in payment defaults” after credit insurers paid out more than €1.2bn in 2023, up 44 per cent on 2022. “We see significantly more and greater damage from insolvencies and delayed payments than in the previous year,” said the GDV’s Thomas Langen, who predicted German insolvencies would rise 10 per cent this year.
Jonas Eckhardt, specialist at restructuring advisers Falkensteg, said the weak economy was making it harder for companies to pass on higher energy, labour and raw material costs via higher prices. “The big question is — how much of this can I offload on my customers?”
He is predicting that insolvencies will rise more than 30 per cent in 2024 among companies with annual revenues in excess of €10mn.
The sharp rise in interest rates by the European Central Bank to tackle inflation has also made it harder for companies to emerge from insolvency by finding new investors, Eckhardt added. Only 52 per cent of companies could be saved through insolvency at the end of last year, down from 62 per cent two years ago, according to data from Falkensteg.
“Investors have become more risk-averse, and are holding back,” he said. “Those that still want to [take over an insolvent company] face higher financing costs. So it’s a high-risk transaction.”
This drying-up of investment and financing has hit younger, more vulnerable companies. Almost 300 German start-ups filed for insolvency last year, a 65 per cent increase from 2022, according to data provider Startupdetector. Among them was solar-powered car company Sono Motors, online trader Social Chain and anti-fraud software maker Fraugster.
Many of the bigger companies going bust last year were fashion retailers, transport providers, real estate companies and auto suppliers. There were also high numbers of collapses among German care homes and clinics as they struggled to pass on higher wage and energy costs to the health insurance system.
Bankruptcies have been rising across much of the world, according to German insurer Allianz, which forecast a 6 per cent increase in global insolvency numbers last year and a 10 per cent rise this year.
“Germany was lagging behind other countries, such as France, the Nordic countries and the Netherlands,” said Maxime Lemerle, lead adviser on insolvency research at Allianz. “But it is catching up with the trend definitely to the upside.”
While it is yet to match the high levels of corporate distress after the 2008 financial crisis, Lemerle said the recent rise of bankruptcies in Germany and elsewhere was now “more than a normalisation, but not yet a tsunami”.
Barron’s Weekend Summary: The 2024 Barron's Roundtable predicts a disappointing stock market
Cover:
-The 2024 Barron's Roundtable predicts a disappointing stock market with returns of minus-5% to plus-5% for the year. They don't anticipate a recession and expect the Federal Reserve to lower interest rates. However, they worry about stocks being too richly valued, leaving little margin for error. Some investors see massive capital investment, new technologies, and investor interest in the 493. The roundtable featured newcomers Rajiv Jain from GQG Partners and John W. Rogers Jr. from Ariel Investments. The group also discussed politics and investment picks.
Interview:
-No interview this week
Tech Trader:
-At CES 2024, PC makers are preparing to ship laptops powered by new processors from Intel, Advanced Micro Devices, and Qualcomm, including "neural engines" capable of running large language models and AI software. Intel's general manager, Michelle Johnston Holthaus, declared that AI is everywhere, transforming, reshaping, and reimagining the PC experience. Lenovo's president of international markets, Matthew Zielinski, believes that PC units should show low-single-digit percentage growth this year, potentially reaching double-digit growth in 2025. Microsoft is excited about the potential of its AI-powered Copilot software, which will launch keyboards for Windows-based PCs with a dedicated button. However, there is no real clarity on what AI PCs will offer, and retailers must train them to teach consumers about the benefits of AI.
The Trader:
-Tesla's stock fell by 3.67% after electric vehicle companies cut prices in China. The Model Y and Model 3 prices fell between 3% and 6%, with the base version starting at $36,000 and the Model 3 at $34,500. Tesla shares finished down 3.7% at $218.89, while the S&P 500 rose 0.1% and the Nasdaq Composite ended flat. Tesla aggressively cut prices globally in 2023 due to higher interest rates and EV competition. The pace of price cuts had slowed later in the year, with a US Model 3 starting at $47,000 in 2022 and ending at $39,000.
-FedEx's stock has dropped 11% since December 19, with the company predicting a low single-digit sales rate for fiscal 2024. The decline was attributed to a decline in shipments and rising prices. However, management maintained its profit outlook, calling for per share earnings at $17.75. FedEx is overhauling its cost structure for 2024, with analysts expecting an operating margin of 7.5%, up from 6.5% this year. Greg Branch, founder and managing partner at Veritas Financial, believes FedEx deserves the benefit of doubt as they have a cost plan in place.
Features:
-The United Auto Workers Union's record wage increases from Detroit-Three auto makers have not significantly impacted new car prices, according to Kelly Blue Book. The average transaction price for December 2023 was $48,759, up from $48,247 in November but down 2.4% year over year. This rise in prices is attributed to seasonal factors and the fourth consecutive month of year-over-year declines, which is "unique."
-Oil investors have remained relatively calm amid rising Middle East tensions, with the risk of a price shock rising. The US and Great Britain attacked areas controlled by Houthi militants in Yemen, signaling a new level of violence in a fight that has been brewing for weeks and has serious consequences for the global economy. The Houthis have almost completely shut down the Red Sea, impacting 15% of global shipping, including oil and liquefied natural gas. Despite this, oil prices have barely budged as the conflict worsens. Analyst Helima Croft suggests that oil investors may be complacent about the steepening risks related to Middle East violence, as traders are hesitant to bet on oil rising due to a fear of overreacting.
Europe:
-Tesla is set to halt production at its German factory for two weeks due to Red Sea shipping attacks extending transport times from Asia to Europe. The disruption is affecting global supply chains and threatening to derail the fight against inflation. Tesla will stop nearly all production at its factory near Berlin from January 29 and resume production on February 12. Tesla shares were down 1.6% in early trading, while the S&P 500 and Nasdaq Composite were both up about 0.5%. The delay is not the most likely reason for the drop, as Tesla cut prices on its electric vehicles in China by 3% to 6%. The company reported operating profit margins of almost 17% in 2022 and is expected to improve in 2024.
Emerging Markets:
-Javier Milei, the new president of Argentina, has been praised for his swift and decisive government, which has seen Argentina's hard-currency bonds rise to the mid-30s. He has promised root-and-branch reform, addressing the state's deficits and overregulation, which are pushing inflation past 100% annually. Milei has cut the official exchange rate of the peso, abolished controls on food prices and rents, loosened labor restrictions, and prepared state companies for future privatization. Additionally, Economy Minister Luis Caputo has unveiled a package of tax increases and spending cuts to shrink Argentina's budget deficit by 5% of GDP.
Commodities:
-US natural gas prices have surged due to cold weather and new attacks on Red Sea shipping routes. Futures for US natural gas jumped 7%, reaching their highest since November, and have risen over 13% this year. Cold blasts could increase demand and lock in production, while continued tumult in the Red Sea has added to global supply concerns. The US produces more natural gas than it consumes, selling the surplus into global markets. The Red Sea attacks could drive energy prices higher by making it more expensive to ship liquefied natural gas to Europe and Asia.
Streetwise:
-Flight demand in the US is increasing, with legacy airlines expecting strong first-quarter results. Despite the temporary grounding of Boeing's 737 Max 9 fleet, the companies appear poised for profitability in both up and down cycles. However, shares in airlines like United Airlines Holdings and American Airlines Group have been lagging behind the market. Analyst Helane Becker, who covers airline shares for TD Cowen, believes that the industry is better for trading than long-term investment due to short-lived positive investor sentiment. Other analysts are more open to the possibility of airlines outperforming for longer, with industry profits for the largest airlines down only 19% from pre-pandemic 2019, but market values down 61%.
Nike races to keep from losing ground to more nimble rivals
CEO John Donahoe is trying to reposition sportswear giant as the market for running shoes undergoes big shifts
When John Donahoe took over as chief executive of Nike four years ago, the company had a stranglehold on the sport of running, its largest category. Now, it is at risk of falling behind.
Seventeen Nike athletes won individual gold medals in running events at the World Athletics Championships in 2019, compared with just five representing all other brands combined. Its Vaporfly 4% running trainers were such a technological breakthrough that competing brands were giving their elite athletes permission to wear Nike shoes in races with the logo covered up.
Four years later, the rest of the running world has caught up. The breakthrough of the Vaporflys — a carbon-fibre plate inserted into the midsole — has since been adopted by the rest of the market. At the 2023 World Athletics Championships, athletes representing brands other than Nike won more individual running gold medals, 12, versus Nike’s 10.
The changes in the running footwear market are the starkest examples of how much the sportswear industry has shifted during Donahoe’s tenure. Today, Nike’s competition goes beyond traditional rivals like Adidas as newer, more nimble shoe companies take market share.
Athletes who drove sales at the beginning of the century, such as US golfer Tiger Woods, are now in the twilight of their careers. And macroeconomic effects, from the pandemic to inflation and supply chain disruptions, have not favoured a global behemoth like Nike.
“We know we must be faster, increasing the pace of innovation, increasing the pace of market to consumer and increasing our agility and responsiveness,” Donahoe told analysts on an earnings call last month, as he announced the second big restructuring of the company during his term in response to slowing demand for its products worldwide.
The “everyday running category”, he added, “is the area where we have the most work.”
Wall Street analysts are concerned about Nike’s performance as its margins tighten and sales growth slows. Revenues for the most recent fiscal year, which ended in May 2023, rose 10 per cent year over year, but profits shrank 16 per cent. Excluding the nadir of the pandemic, Nike’s margins on earnings before interest and taxes are at 10-year lows. In December, it lowered its outlook for 2024, projecting sales growth of just 1 per cent, down from expected mid-single-digit growth.
The shortfall between the latest forecasts and earlier revenue projections, “is challenging CEO John Donahoe’s credibility”, wrote Jim Duffy, managing director of consumer and retail at Stifel.
To be sure, Donahoe has moved quickly to make changes. A former chief executive of ServiceNow, eBay, and Bain & Co, he hit the ground running after taking the helm. In the early months of the pandemic, he implemented one of the largest overhauls in the company’s history, eschewing Nike’s internal organisation by sport categories — such as running, basketball and football — in favour of silos for men, women and kids.
The changes were made in part to accelerate Nike’s transition away from relying primarily on selling its products through retail stores towards selling more directly to consumers, especially online. The latest restructuring, announced in December, is aimed at cutting $2bn in costs over the next three years.
In a statement to the Financial Times, Nike said the savings from this round of cuts would be reinvested into its running, women and Jordan brand divisions. Its newest running shoes, the Alphafly3, were worn by Kelvin Kiptum when he set a world record at the 2023 Chicago Marathon.
“We’ve proven in our labs that Nike racing shoes provide measurable benefits and we will continue to deliver breakthrough innovations for elite athletes and everyday runners alike,” the company said, adding that it would roll out newer models in the lead-up to the Paris Olympics.
When Donahoe first came to Nike it was “a period of a lot of disruption in the industry and globally”, said John Kernan, managing director at TD Cowen — even for big players with global name recognition. Nike’s primary rival, Adidas, has recently warned investors it could post its first annual loss in three decades, after cutting ties with Kanye West, the US rapper and designer of their Yeezy brand.
The age of social media has also allowed upstart brands to scale more effectively. Two newcomers in particular — Hoka and On Running — have benefited from stronger direct sales and strategic endorsements. They have also capitalised on the appetite from big retailers to reduce their reliance on Nike amid Donahoe’s emphasis on direct sales.
Mary Dillon, chief executive of shoe retailer Foot Locker, said Hoka and On Running were two of its fastest-growing brands. The retailer said 36 per cent of sales in the most recent quarter came from brands other than Nike, up from 32 per cent the year before, and on track to reach Foot Locker’s goal of 40 per cent by 2026.
Hoka, originally a niche brand known for “maximalist” shoes with thick soles, is the fastest-growing brand in the Deckers Outdoor Corporation portfolio, outpacing sibling brands Ugg boots and Teva sandals. In December, Hoka took over the sponsorship of a top US competition for high school cross-country running, improving its visibility with the target youth demographic.
On Running, a Swiss brand founded in 2010, received a global profile boost in 2019 when tennis champion Roger Federer invested in the company. Since then, the company has gone public, signing top-ranked tennis player Iga Świątek as well as Hellen Obiri, the 2023 winner of the New York City and Boston Marathons. Both athletes had previously been outfitted by Nike.
Federer’s effect on On Running could be a template for Woods, who left Nike this week after 27 years. Both men spent decades of their pro careers in the swoosh while breaking records in their respective sports.
In the meantime, analysts think Nike should focus on its strengths. “It is still a great company, but the industry is much more challenging and there is only so much management can do,” said Kernan. “Brands cannot be all things to all people anymore.”
U.S.’s Biggest Renewable Project Is Under Way, Finally
Sluggish timeline is problem for Biden administration as its seeks 100% clean electricity by 2035
A wind and power transmission project, called the largest of its kind in the country, has raised $11 billion in financing, kicking off a year when many utilities are expected to step up much-needed spending on the power grid.
Pattern Energy Group has started construction on its SunZia project, a wind farm in central New Mexico, where more than 900 wind turbines will generate over 3,000 megawatts of clean energy. A 550-mile transmission line will bring the power to some three million people in Arizona and California.
The problem: The project has been in the works since 2006, when Taylor Swift released her debut album. It was “fast-tracked” in 2011 by the Obama administration.
Such a sluggish timeline could threaten President Biden’s ambition to reach 100% clean electricity by 2035. A Princeton University study found that if the U.S. continues to expand transmission at the 1% pace of the previous 10 years, that would result in more coal and natural-gas consumption than if Biden’s Inflation Reduction Act hadn’t passed. That is because the law creates incentives for more power consumption by electric vehicles and other clean-energy devices.
John Podesta, White House clean-energy adviser, said at an Energy Department conference last year that the country needed to dramatically accelerate work on transmission to reach the administration’s clean-energy goals. “We need to deploy transmission lines at twice the current pace than we’ve experienced in the last couple years,” he said.
Spurred in part by federal clean-energy incentives, a manufacturing renaissance and growth in data centers, electricity demand is surging. Electricity demand is expected to grow a cumulative 4.7% over the next five years, an increase from forecasts of 2.6% growth over that period made the previous year, according to Grid Strategies, a power-sector consulting firm.
The grid isn’t ready for that surge in demand, and current processes for expanding the grid aren’t either, experts said. State and federal red tape often delay large-scale infrastructure projects for years. The average federal environmental review takes 4½ years, according to a 2020 White House report.
Despite widespread agreement in Washington that the permitting system for infrastructure projects is flawed, lawmakers have repeatedly failed to reach an agreement to streamline it. Sen. Joe Manchin (D., W.Va.) failed to secure support for a deal to include permitting reform as a companion to the Inflation Reduction Act. Biden and U.S. lawmakers last year made streamlining the federal permitting process a central topic in negotiations about raising the debt ceiling, but weren’t able to reach a deal with Republicans.
Some are hoping the tide will change in 2024. Sen. John Hickenlooper (D., Colo.) and Rep. Scott Peters (D., Calif.) last year introduced legislation that would require the nation’s three big power regions to be able to transfer 30% of their peak electrical loads to nearby regions, which supporters say would give them more flexibility to move renewable power to areas where it is needed.
Another bill introduced in December by Reps. Sean Casten (D., Ill.) and Mike Levin (D., Calif.) would help spur the expansion of power lines, in part by providing tax credits for transmission projects. Both efforts face an uphill battle among Republicans, who control the House, during a contentious election year.
The Energy Department is deploying billions of dollars to improve and expand transmission. In September it announced grants to tribes, territories and 11 states as part of a $2.3 billion program designed to strengthen the grid and make it more resilient to outages and extreme weather. The department’s Grid Deployment Office manages about $25 billion from the 2021 infrastructure legislation and the Inflation Reduction Act, according to department officials.
The DOE funds, while helpful, are a drop in the bucket when it comes to the trillions of dollars it will take to upgrade and expand the grid.
Some developers, such as Pattern Energy, have found success tapping public markets for funds. “We are optimistic that the government can help speed the permitting process, which will be critical to achieving the country’s decarbonization goals,” Pattern Chief Executive Hunter Armistead said. “If good projects can get through development, we believe that efficient capital will be available to bring them into construction.”
The best hope for large-scale transmission change in 2024 likely sits with the Federal Energy Regulatory Commission, which later this year could approve a rule that would change how utilities plan transmission projects. Under the rule, utilities would have to make long-term plans for power transmission based on federal requirements that they provide the best and most reasonable rates for consumers.
That is something few utilities do these days, said Rob Gramlich, president of Grid Strategies. The requirements would push utilities to build more transmission capacity because it would help provide the cheapest power to customers, he said. Critics of the rule, or at least parts of it, say it could clash with oversight of utilities by local regulators and potentially lead to increases in consumer bills.
The Market’s Gains Won’t Come Easy From Here, Barron’s Roundtable Pros Say. 8 Stocks for Now.
Interest rates will come down, but our panelists don’t see another magnificent year for stocks. Eight picks to beat the odds.
It is always a stockpicker’s market. You just have to pick the right stocks. If you picked the so-called Magnificent Seven last year—a group of highflying, mostly tech stocks that powered the S&P 500 to a 24% gain—you looked in the mirror and beheld a genius.
It is always a stockpicker’s market. You just have to pick the right stocks. If you picked the so-called Magnificent Seven last year—a group of highflying, mostly tech stocks that powered the S&P 500 to a 24% gain—you looked in the mirror and beheld a genius.
This year, it might be wise to avoid mirrors.
With a few exceptions, the members of the 2024 Barron’s Roundtable expect the stock market to disappoint, with the index delivering returns of minus-5% to plus-5% for the full year. No, they don’t see a ruinous recession, and yes, they expect the Federal Reserve to lower interest rates at some point during the year. Their main worry is that stocks are too richly valued, leaving little margin for error.
Those with a sunnier view cite massive capital investment across the economy, the promise of new technologies like artificial intelligence, and incipient investor affection for the less magnificent 493. Bullish or bearish, these 11 money managers and market mavens duked it out Jan. 8 in New York, at a daylong gabfest hosted by Barron’s. They also shared their best investment bets for the new year.
A few more notes: The 2024 Roundtable featured two newcomers—Rajiv Jain, chairman and chief investment officer of GQG Partners, a global asset manager with $120.6 billion in funds under management, and John W. Rogers Jr., founder, chairman, co-CEO, and chief investment officer of Ariel Investments, a global value-oriented asset management firm that oversees about $15 billion. Also, the group delved into politics a bit more than usual this year, propelled by the potential investment implications of the coming election and their growing concern about America’s fiscal burden.
In addition to big-picture prognostications, Week One of our three-part Roundtable series includes the investment picks of Meryl Witmer and Todd Ahlsten. Meryl, a general partner at Eagle Capital Partners, shops among the unnoticed and underpriced, while Todd, chief investment officer of Parnassus Investments, pounds the table for “great American companies,” also underpriced. Read on for an edited version of this year’s lively proceedings.
Barron’s: Todd, you were the most bullish of our bunch last year, so let’s kick things off with your predictions for 2024.
Todd Ahlsten: I remain relatively positive on the markets. I have a year-end price target for the S&P 500 of 5225. That implies a roughly 12% return, based on my expectation that the index will trade for just over 19 times 2025 estimated earnings of $270.
I am focused on three things: How does the S&P 500 look as an asset class? How does the economy look? And, how do monetary policy and liquidity shape up?
The S&P 500 is an awesome asset class. Think about the innovation in cloud computing, semiconductors, life sciences, industrial automation, transportation, electrification. This index is a collection of advantaged assets that continue to get more advantaged. TAMs [total addressable markets] are increasing, as are profit margins. Return on capital was more than 22% last year. We are looking for earnings to grow by at least 10% in 2024, and more than half that growth will probably come from the Magnificent Seven Alphabet, Amazon.com, Apple , Meta Platforms, Microsoft, NvidiaTesla. There are massive waves of capital investment going on in the economy, in AI, cloud computing, and elsewhere.
Doesn’t the market reflect a lot of good news?
Ahlsten: Stocks started last year at 17 times future earnings. The S&P’s price/earnings multiple now is roughly 20 times, which isn’t cheap, but reasonable. We expect to see broader participation in the market this year. Industries such as housing, transportation, and shipping have had rolling recessions. As they recover, the market’s breadth will improve.
The economy will be a bit of an adult swim this year, with significant crosscurrents. We are in a period of higher interest rates and lower liquidity, but entering a period of lower rates and more liquidity. The economy might exit the year in a stronger position in a more supportive environment.
Growth is decelerating, and we could have a soft recession in the second or third quarter, but the outlook isn’t grim. We have a 3% year-end target for the 10-year Treasury yield. Commodity prices are relatively low, and it is an election year, so we might see some fiscal stimulus, as well, toward the end of the year.
The politics of America are problematic, for sure, but too many people inflict their political views on their economic and investing outlook. We need to remember that we are investing in an awesome asset class with widening TAMs, increasing margins, and higher cash flows.
What do you worry about?
Ahlsten: Trade wars, China, politics, the possibility of a hard landing, the long and variable lags of monetary policy. Interest rates have gone up at the fastest rate in 40 years. On the other hand, the consumer is in relatively good shape, as are corporate balance sheets. A lot of companies extended duration on their debt.
Sonal Desai, CIO and portfolio manager, Franklin Templeton Fixed Income, San Mateo, Calif. PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Sonal, monetary policy will be center stage again this year. How do you expect things to unfold?
Sonal Desai: I’m out of agreement with the market much less than I had been.
I’ll make four points on the macro backdrop. At this time last year, the federal-funds rate was at 4.25%-4.50%. Now, it is at 5.25%-5.50%. The Federal Reserve has indicated it is likely to cut rates by 75 basis points this year, although as recently as a few weeks ago, the market was pricing in 150 basis points of rate cuts. [A basis point is a hundredth of a percentage point.]
We expect the Fed to lower rates by 75 basis points, but March is too soon for reductions to begin. The economy is robust. Inflation isn’t falling rapidly enough to justify a cut in March. Given the massive bond and equity market rallies at year end, financial conditions take us back to when the fed-funds rate was 1.75%. The market has eased for the Fed.
Second, I am struck by the Fed’s newfound lack of prudence. In December, the Fed took a well-deserved victory lap on inflation, which has declined substantially, without much damage to the economy. But I was surprised that the Fed softened its language to the degree it did, encouraging the markets to believe there will be a rapid return to abundant liquidity and an extremely low fed-funds rate.
Third, fiscal policy is enormously loose. The fiscal deficit needs to be financed. Given that it is an election year, I’m not surprised that we just got a top-line agreement on the federal budget. Neither the Republicans nor the Democrats are going to curtail the fiscal spend this year.
Finally, in the medium term, we are moving to normalize policy. I expect that will take us back to the old normal—the pre-global-financial-crisis normal. The markets and the Fed are looking at the wrong neutral rate of interest. They expect something like 2.25%-2.50%. I believe the long-term neutral rate is closer to 4%.
We expect more volatility in the coming quarters, with the 10-year yield possibly going back toward 4.50% and ending the year around current levels. Todd, what would your S&P 500 forecast be if the 10-year Treasury yield were 3.75% or 4%?
Ahlsten: It would depend on why yields were higher. The companies in the S&P 500 did a great job of managing inflation. Earnings could be higher because of higher nominal GDP [gross domestic product]. Also, what type of multiple would the market put on higher earnings? I would probably maintain my price target, depending on why rates go up.
Bill, what is in your crystal ball?
William Priest: I have a somewhat different take. I see a roller-coaster year. Globalization is over; the law of comparative advantage is running backward. We are unwinding the efficiency and security of supply chains, which means higher costs. Different trading blocs could develop as the year unfolds. Countries will want to trade with “friends.” We’ll wind up with a world of more tariffs. Nevertheless, the dollar will maintain its haven status. The deficit, and spending on Social Security and healthcare, military and education, and the interest on the debt are enormous.
All these trends create a modest negative backdrop for the stock market. They are also bad news for emerging markets, which benefited from low-cost labor. Now, AI and other technologies are supplanting labor. If you can substitute technology for labor costs and hold revenue constant, your margins go up. If you can substitute technology for physical assets, your asset returns go up. There isn’t a company in the world that isn’t focusing on these principles.
William Priest, chairman, co-CIO, and portfolio manager, TD Epoch, New York PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Also, the growth rate in China is likely to fall sharply. China will be lucky to see 3% GDP growth next year. It will never see the population it has today unless it gets birthrates up. The growth rate is a function of growth in the workforce and growth in productivity. It is hard to see growth in China that isn’t in the low-single digits.
Moving on, central banks will tolerate higher inflation because they have an excuse: It isn’t their fault! The problem is related more to supply than demand. Cash-flow growth of 12%, which seems the standard expectation for 2024, is too optimistic; 6% to 8% seems more reasonable.
My biggest worry is that democracy appears to be ebbing. I don’t know what that means for free markets and valuations. Harvard professors Steven Levitsky and Daniel Ziblatt wrote a good book on the subject published in 2018, How Democracies Die. Autocracy is on the rise.
In more mundane matters, what is your market forecast?
Priest: It is a plus-5%, minus-5% kind of market this year.
Abby, what is your view?
Abby Joseph Cohen: Todd and I had the same forecast for last year. We were more optimistic than everyone else in this room.
Apologies. We should have begun with a duet.
Cohen: I see some differences in our views this year. Last year saw a heavy concentration of performance in the S&P 500. The relative price/earnings multiple of the so-called Magnificent Seven was 1.7 times the S&P 500 multiple, while the rest of the index traded at 0.9 times the market’s P/E.
This will be a year of alpha—that is, stock selection—not beta, or just hugging the index. Last year, even S&P 500 companies were hurt by exposure to Europe and emerging markets. I don’t see that changing dramatically. I share people’s concerns about China.
Also, while U.S. consumers are in good shape, they aren’t in the same great shape as last year. Consumers entered 2023 with extreme levels of excess savings and demand. They wanted to spend not just on goods but also on experiences: Taylor Swift tickets, heavy-duty travel. Hotel stocks were among the market’s best performers. Some of that ammunition has been used up, and there is a little more friction in the labor market. The unemployment rate is low, but there aren’t as many open jobs available relative to people looking for work.
Many companies in the S&P 500 immunized themselves against rising interest rates by issuing long-term debt at low rates. I strongly agree with Bill, however, that we will see increased costs from onshoring. We’ll also see more corporate spending on technology, and duplicative spending on energy as we move toward green-sourcing.
There will be significant issues this year in the U.S. Congress. It is good to see a top-line budget agreement among congressional leaders and the White House, but we don’t know whether members of the House of Representatives will vote for it. There could be a government shutdown as soon as Jan. 19, or on Feb. 2. I am also concerned about the politicization of foreign policy, something relatively new for the U.S. I worry about funding for Ukraine being held back because of domestic political considerations. It is one thing to have an objection to such funding, but it is disturbing that it is tied up with election-year politics. It is highly disturbing that we haven’t yet provided funding to resupply our defense companies, or for Israel or Egypt.
Abby Joseph Cohen, professor of business, Graduate School of Business, Columbia University, New York PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Where does this leave the market?
Cohen: My valuation work leads me to an S&P 500 target on the order of 5000. I don’t anticipate earnings or cash-flow problems, but am concerned about price/earnings ratios and other valuation metrics. Also, the risk premium might rise in the U.S. A government shutdown could have a negative impact on the dollar, and on the credit rating of Treasury securities. I don’t expect a notable drop in interest rates.
Now for some book recommendations. In The Crisis of Democratic Capitalism, Martin Wolf discusses the balance between democracy and capitalism that allows economies to grow. I also have a fiction recommendation, because we’re all getting so serious here. James McBride’s The Heaven & Earth Grocery Store is a tale of people from different backgrounds coming together as a community.
Does anyone else have a recommendation for the Barron’s Book Roundtable?
Ahlsten: Breath, by James Nestor, looks at the science of breathing. Breathing through the nose reduces stress, anxiety, and fear.
Let’s all try it now.
Mario Gabelli: There are a lot of issues to consider. The U.S. and China represent over 40% of the world’s $110 trillion of gross domestic product. In the U.S., data on the consumer sector, 70% of the economy, remain positive, but we are mindful of the inflation impact on low-income households. The industrial sector will benefit from reshoring and fiscal stimulation, and there is pent-up demand for single-family homes.
Overall revenue for U.S.-based operations will remain solid, with gross margins improving. Selling, general, and administrative costs are under control, but interest expense and rising corporate taxes, along with selected currency concerns, are trimming some of the profit improvement.
My bigger concern deals with the $34 trillion of U.S. debt. The U.S. needs to grow revenue and hold costs. The Federal Reserve continues to try to contain inflation and reduce aggregate demand while fiscal policy is increasing demand. This results in higher-for-longer interest rates, a higher deficit, and a drag on the economy.
The market has discounted some of this, but the main concern I have is an “event.” Iran is trying to develop a nuclear bomb. North Korea and Russia have nuclear weapons. Four years ago, we didn’t think about Russia invading Ukraine. We didn’t think about a bank crisis last year, or the Mideast crisis. Is the market prepared for an event such as the use of a nuclear weapon, or the prevention of its use, that could cause a 20% to 30% selloff?
Mario Gabelli, chairman and CEO, Gabelli Funds, Greenwich, Conn. PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Is it ever prepared for such things?
Gabelli: With regard to interest rates, [Fed Chair Jerome] Powell can’t make another mistake. What will he do if oil prices, now around $72 a barrel, shoot up? The U.S. has taken the Strategic Petroleum Reserve down to 50% and has to rebuild. This reduces supply and increases demand and leaves you and me vulnerable to an energy shock, as in the 1970s.
But what does it matter? Short-termism is prevalent as algorithms, momentum investing, and exchange-traded funds influence trading. The Dow industrials will be the equivalent of 1,000,000 in 40 years and was under 1,000 about 40 years ago. So, invest long term.
I am in the plus-5%, minus-5% camp that Bill mentioned for the Dow and S&P 500. Keep your seat belt fastened. You want to own businesses that will flourish, bought at a fair price.
Rajiv, are you ready to dive in?
Rajiv Jain: I think so, because I disagree with at least half of what has been said. First of all, the survival of democracy has no correlation with stock market performance. South Korea didn’t have fair elections until 1993, but the stock market did well for 30-plus years before that. The same was true for Taiwan, Chile, and China. Things could go the other way, too, as happened in Russia two years ago.
The seminal event of the past few years was the Russia-Ukraine war. It divided the world into countries that have energy security, such as the U.S., Canada, and Brazil, or are willing to buy oil from Russia. Europe is a basket case. Liquefied natural gas went from $3 per million British thermal units to $13 per MMBtu—which no emerging market can afford in the long run without bad things happening. The Eurozone Manufacturing PMI [purchasing managers index] peaked in late 2021, and has tanked since the war. France and Germany PMIs are back at almost the lows of the 2008-09 financial crisis, and in some cases worse.
Power prices in Germany have gone up more than 50%. You can’t operate a chemical or almost any manufacturing plant with those kinds of prices, if sustained. Germany is reopening lignite coal mines because it shut down nuclear power plants and offshore wind isn’t dependable. The ESG [environmental, social, and governance] bubble is bursting in stock markets because reality is sinking in. You can’t say no to fossil fuels because half the world would starve without fossil. China is getting cheap Russian gas for $2.50-$3.50 per MMBtu. They’re doing fine from an energy perspective.
What were the best-performing currencies against the dollar in the past three years? Not the euro. The yen is a disaster. The winners are the Mexican peso and the Brazilian real. I disagree with Bill. Emerging markets are doing fine, with the exception of China.
The Chinese economy is kind of OK. The Chinese stock market isn’t. Chinese state-owned enterprises are doing much better than the private sector. That’s the negative part of heavy-handed intervention in the public sector.
Rajiv Jain, chairman and CIO, GQG Partners, Fort Lauderdale, Fla. PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
What do you see in the rest of Asia?
Jain: Countries like Indonesia, Malaysia, and India are in pretty good shape. In Latin America, we have never been more bullish on Brazil. GDP and equity markets are doing well despite little stimulus during Covid and high interest rates.
From a market perspective, there is a tale of two cities. Corporate earnings in the U.S. and Europe have been far stronger than anyone expected, which is why the markets have done well. But the corporate reforms in many countries have been quite significant, and that is a positive from a broad market perspective, minus Europe. We feel that until the energy sanctions against Russia are reduced or lifted, the European economy would have a tough time gaining traction.
Cohen: Fascinating comments. For the first time ever, we have seen that FDI [foreign direct investment] into China has stopped. Are you seeing the FDI redirected to some other emerging economies?
Jain: Yes and no. Mexico is a big beneficiary of nearshoring, or offshoring moving away from China. India and Indonesia have seen some foreign investment. We have seen a cycle play out over the long run: Good markets lead to bad policies, which lead to bad markets, and then to better policies, which lead to good markets. We are entering the good-markets phase after good policies over the past few years.
Brazil has privatized some of the most difficult companies to privatize, like its largest power company. Saudi Arabia has almost 60 companies lined up for privatization in the next couple of years. Government ministers say, “We want to make sure you guys make money.” From Europe, all we get are more penalties or regulations—nationalization of utilities, for example—while emerging markets are privatizing them. Other countries are privatizing them. My point is, policies are very different now in some of these emerging countries. That is bullish.
That said, multinationals aren’t doing as well as they used to in a lot of emerging countries because of the growth of domestic competition. Unilever is barely getting 2%-3% volume growth in some of its bigger emerging markets. The largest banks in these countries are far better than European banks. Several banks in Brazil have $30 billion or higher market capitalizations, comparable to Europe, but with much higher return on equity.
You haven’t said much about the U.S. Are you bullish or bearish?
Jain: I’m very bullish. I agree with Todd. I am not bullish on the economy, but the broad market is dominated by some of the highest-quality companies globally. They figured out ways to make money. Also, the U.S. still has $3 gas. If power prices go up 60%-70%, Europe’s industrial base will be hollowed out, but that isn’t the case in the U.S.
Henry, give us your two cents.
Henry Ellenbogen: I agree that the risk-free rate of interest will be higher. In the past few years, people tended to focus on the tensions in world affairs. But the big message for all asset owners is that capital isn’t going to be free any more. I remember Bill mocking modern monetary theory at this table a few years ago. I don’t hear anyone talking about MMT today because central banks, including our Fed, have been clear that it was a failed experiment.
If capital isn’t going to be free, we have transitioned from an era driven by speed and momentum investing to an era of skill and judgment. That means it is a stockpicker’s market. Transitions are bumpy, but companies no longer get a free pass to drive profits or growth. They now have to do both, which is healthy.
A lot of the excess was in smaller companies—SPACs [special purpose acquisition companies], more than 400 IPOs [initial public offerings]— and private markets, whether venture capital or private equity. Investors in private markets are just starting to take markdowns. Public-market investors took markdowns in 2022.
I agree with Mario: You have to take a long-term view and be positive on the prospects for the U.S. The agility and ability of the American business sector is like nothing else in the world.
Henry Ellenbogen, CIO and managing partner, Durable Capital Partners, Chevy Chase, Md. PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Last year, you were enthusiastic about AI. What lies ahead?
Ellenbogen: We are winning the next major cycle in technological innovation. AI drove most of the S&P’s gains. Duolingo, one of my 2023 picks, is a microcosm of what can be done with AI. The company is using AI to write curricula not only in language but also in math and music. It is using AI to personalize education.
GitHub from Microsoft Copilot is increasing the productivity of software engineers. We are so far ahead of China on this. Europe hasn’t even gotten to the starting line. So, yes, there are reasons to be concerned politically in the U.S., but when you think about our business culture and innovative capability, the story is positive.
Americans tend to get more pessimistic toward Election Day. That impacts consumer confidence. By the fourth quarter, however, people will see that earnings are accelerating, as the Fed has signaled it will be easing. I see a modestly up year, probably tilted toward post–Election Day.
Investing in AI will be expensive. How will companies manage the costs, and when will we see revenue from this technology?
Ellenbogen: AI is as big if not bigger than all the technology waves I have seen in my career: internet, mobile, cloud. Certain companies, like Uber Technologies, wouldn’t exist without mobile technology, but it also benefited traditional businesses like Domino’s Pizza. Cloud computing benefited the insurgents. With AI, incumbents can do well. Companies don’t need to retool their infrastructure, or change customer incentives. But they need to do the heavy lifting to have their data in a clean structure, or they need to have clean code. Companies with modern architectures and modern code bases are getting a lot of benefits. Yes, there will also be losers. Some S&P 500 companies will have to prune other things out of their cost structure to invest in AI.
Gabelli: The New York Times has sued Microsoft and OpenAI for copyright infringement. Is this the Achilles’ heel of AI? [Holds up newspaper.]
Ellenbogen: No, because licensing is something we have already dealt with. YouTube resolved copyright lawsuits. The rights holders got paid. The same will happen here.
Ahlsten: Lisa Su, the CEO of Advanced Micro Devices
-0.99%
, is talking about a $400 billion accelerator GPU [graphics processing unit] market by 2027. That is a massive ramp from about $45 billion today, where Nvidia’s data-center revenue sits. It implies more than $1 trillion of data-center and cloud AI spending by 2027. But to your point, Mario, we have a $650 billion digital ad market. That is going to monetize AI. Life-sciences companies and players like Intuit, Microsoft, Adobe, Amazon, and Google are all going to put capital behind AI.Desai: Expectations seem to have run ahead of what AI can deliver.
Ellenbogen: The leading tech companies are already getting substantial value from AI. Dispersion of the technology to traditional companies will take more time. Also, great consumer applications haven’t been written yet. Sure, there is hype in the stock market, but it will dissipate. Then, the companies that drive value will do well.
Scott, join the conversation.
Scott Black: I’ll start with the economy. I expect to see a deceleration in real GDP growth this year, but not a recession. Most forecasts put real GDP growth somewhere between 0.7% and 1.4%. The key for the stock market this year will be whether the Fed breaks the back of inflation like [Former Fed Chair Paul] Volcker did in the early 1980s.
The consumer price index, ex-food and energy, is now around 4%. Some forecasts put 2024 inflation at 2.4%. If inflation really gets down to that level, rates can come down, but I expect the Fed to stay the course for the next three to six months. I don’t look for any diminution in the fed-funds rate. The market will be choppy, and its performance will depend on whether we defeat inflation.
The other thing you should look at is M1 and M2 [money-supply measures]. They are contracting. M1 is down 9.6% year over year, and M2 is down 3%. The Fed’s balance sheet had $7.74 trillion of total assets as of Jan. 3. That’s down by $842 billion year over year, and down from $9 trillion at the high.
Monetary policy has been highly contractionary, but our chronic fiscal deficit is a disaster. It was $1.54 trillion last year, according to the Congressional Budget Office, but will rise to an estimated $1.57 trillion this year and to $1.76 trillion next year. The deficit is running at about 6% of GDP, which is unsustainable. The national debt is now $34 trillion, or about 1.23 times GDP. We are on a perilous course.
Scott Black, founder and president, Delphi Management, Boston PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Gabelli: The government put back $300 billion of theoretical student-loan forgiveness against the deficit, so the actual default for the fiscal year just ended was much higher than the reported number.
Black: The interest on the debt will be $745 billion this year, creating a crowding-out effect.
Gabelli: Scott, pay more taxes.
Meryl Witmer: Who should the U.S. government tax to raise more revenue?
Black: They need to increase taxes on corporations.
Witmer: The amount raised would be too small, and it is bad policy.
Black: They will also have to rein in spending. There isn’t a lot of discretionary spending in the budget. We were talking about these issues 15 years ago. At some point, we will have to face the music.
Now, let’s talk about valuation. Bottom-up estimates for the S&P 500 are $242.44 for 2024, implying a 13% gain year over year. That is unrealistic. My estimate, $230, represents a 7.6% increase. I assume a 1.4% gain in real GDP and 2.5% CPI. Then I add about 40 basis points of operating-margin improvement. My estimate implies that the market is trading for 20.4 times earnings. It is slightly expensive, given the level of interest rates.
The Nasdaq 100 and the Russell 2000 benefited tremendously when bond yields fell late last year. The Nasdaq 100 is trading for 27.9 times expected earnings, and the Russell is trading for 26.8 times. Others have said it will be a stockpicker’s market. I don’t see much direction to the market in the next six months, until we know that the Fed can cut rates.
Every year, it seems, we say it’s a stockpicker’s market. Meryl?
Witmer: I heard Steve Schwarzman [the CEO of Blackstone] speak recently. Although the numbers that Powell looks at are as Scott described, Schwarzman said that based on his adjustments, the inflation rate today is really about 2.5%. The Fed will likely be a couple of quarters behind, but rates will come down.
I’m a stockpicker, and I don’t see a lot of good values. The 401(k) [retirement plan] money will flow into the market, probably lifting stocks in January. But I wouldn’t be surprised to see a 5%-10% drop thereafter. We might see some opportunities then, and I see some positive things about the U.S.
John, what is your outlook for ’24?
John W. Rogers Jr.: Bill discussed possible challenges to our democracy. We are all on pins and needles about the 2024 election. Partisanship exists like never before. Yet, many of us go to the Berkshire Hathaway annual meeting every year, and Warren [Buffett, CEO of Berkshire] reminds us every year that our capitalist democracy is the best system ever invented. We always find a way to regain our winning edge. Mario talked about the importance of thinking long term. Our logo is a turtle. We believe in patience.
The market’s performance has been bifurcated. On one side are large-cap growth stocks, on the other small-cap value. According to JPMorgan Chase, the 20-year average P/E multiple of the large-cap growth index is 18.9. Recently, it was 26.5. The 20-year average P/E for small-cap value is 16.7. Today it is 16.3. We have seen the valuation gap between large growth and small value before. In 2000, the S&P 500 was flying. But when the dot-com bubble burst, small-caps outperformed large-caps by 42%.
John W. Rogers Jr., founder, chairman, co-CEO, and CIO, Ariel Investments, Chicago PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
I wouldn’t be surprised to see the S&P 500 down 10% to 15%. It is overvalued after posting a great return in 2023. We see opportunity in the small-cap value space. You might expect me to say that, given much of my life’s work, but there are a lot of neglected stocks. The research on small-cap value is the worst I have ever seen.
Witmer: There isn’t any.
What will spark a turnaround?
Rogers: We talk to the management teams of our holdings every quarter. During last year’s second and third quarters, there were a lot of earnings disappointments. Today, you can feel the optimism building. Company management teams are buying stock personally, at a higher level than I have seen in a long time, and corporations are buying back stock. Earnings growth will power the recovery.
Ellenbogen: To put that in context, the S&P 500 missed estimates by 2% to 3% last year. The Russell 2000 missed by more than 20%. The S&P 500 outperformed the Russell 2000 purely because of earnings growth.
Gabelli: Don’t forget that bank stocks make up about 20% of the Russell 2000. When we had a bank crisis in March, centered on the value of hold-to-maturity assets, those stocks fell, hurting the index.
Cohen: One of the catalysts for a small-cap turnaround will be mergers and acquisitions. The preconditions are valuations and earnings growth. Many larger companies are flush with cash and have low interest rates on their debt. They are looking to expand. Private-equity investors are also potential buyers. Money keeps flowing into private equity. Whether that is sensible or not is beside the point.
Ahlsten: Amazon.com, Alphabet, and Microsoft also could be buyers. They can’t just buy other large companies due to regulatory issues.
Gabelli: Today, three healthcare deals were announced. We have also seen a tsunami of deals in the oil patch. You are going to see a lot more corporate lovemaking.
Rogers: I agree with Abby that private-equity dollars are massive, and as rates go lower, people will be able to do more deals. Also, the Fed lowered interest rates in 2001. It didn’t help growth stocks outperform; the opposite happened.
Black: I invest in many mid- and small-caps. As a risk class, mid- and small-caps have systematically underperformed the S&P 500 since 2007. Interestingly, the Russell 2000, which had an upturn in November and December, outperformed the equal-weight S&P 500 last year by three percentage points.
Also, about 40% of small-cap companies have no earnings, so it isn’t fair to say the Russell 2000 is cheap. It is expensive. You can’t say it trades for 17 times earnings, ex-negative earnings. If you include everything in the index, the multiple is 26.8 times. Meryl is right: It comes down to individual stock selection. As a homogeneous risk class, I’m not convinced small-cap outperforms large-cap over time.
Rogers: There is so much pessimism because of what Scott said. The late John Templeton always said you want to buy when there is maximum pessimism. Most of us value managers are getting up in age. You don’t see a lot of young value managers. But once everyone gives up on a sector, that’s where the opportunity is.
Priest: Andrew McAfee and Erik Brynjolfsson published a great book in 2017, Machine, Platform, Crowd, about platform economics. Once you start to substitute technology for labor and physical assets, the scale effects are enormous. The endgame is winner take all. I think it’s game over for a lot of small-caps. They will find it difficult to compete other than through partnering or selling out to larger companies with scale.
We won’t resolve this debate but we can get David’s take on the world.
David Giroux: Over the past six years, the macroeconomic consensus has so often been wrong. At the beginning of 2018, the S&P 500 traded for 18-19 times forward earnings. The expectation was rates would go to 4%, and the economy would see rip-roaring growth. Earnings grew by 20%-plus that year, and yet the market was down. Investors worried late in the year about a recession, and rates fell.
In 2022, 100% of economists, when surveyed, said we would have a recession and high rates forever. Yet, today everyone is expecting lower rates, lower inflation, and a soft landing.
Bringing that back to markets, if I could choose between a rosy macroeconomic outlook and lower valuations, I would always choose lower valuations. We are probably not going to have a recession in 2024. Interest rates will likely come down. But stocks are expensive; there is no margin of safety. The macroeconomic consensus has to be right to support stocks here. I agree with Bill that it will be a minus-5%/plus-5% kind of year. On a five-year basis, we are looking for a 6.5% average annual return, below trend. Yet, there are still values.
Such as?
Giroux: We see good value in managed care, life-sciences tools, utility stocks, and waste. We still see good value in companies like Microsoft, Intuit, and Salesforce, which has a low valuation. I was underweight energy for a decade, but we are seeing good value in energy now as some supply-and-demand dynamics have changed.
AI is in its early days. Large companies are still doing beta testing and trying to figure out the scope of this technology. GitHub Copilot for engineers can increase productivity by 50%. Return on investment on this technology is off the charts, well north of 100%.
David Giroux, CIO, T. Rowe Price Investment Management, T. Rowe Price, Baltimore PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
The long-term beneficiaries are software companies. A lot of large-cap software companies are growing revenue at 10% or more. With AI, in the second half of the decade, they could increase that growth rate by one or three percentage points. AI will also deliver a big bottom-line benefit. If a programmer will be 50%-100% more productive in four years, you won’t need to hire as many programmers as in the past. Software companies will likely generate more margin expansion.
Microsoft is the premier way to play AI on a long-term basis. The stock is a little more expensive than it used to be, but not much more expensive. Three years prepandemic, it traded for 1.53 times the market multiple. Today, it trades for 1.59 times.
We should also consider the second-derivative effects of AI. Over time, it will lead to an imbalance in supply and demand for white-collar workers. It will push growth lower, and the unemployment rate will probably be structurally higher than in the past decade. It will also make 2% inflation more achievable long-term.
One more thing: As a balanced manager, we still see good value in high-quality leveraged loans and high-quality high-yield bonds.
What will we be talking about when we gather a year from now?
Ahlsten: An economic recovery, lower interest rates, lower inflation, a higher stock market, and a better outlook for 2025.
Priest: Continued deterioration in the geopolitical situation.
Rogers: An extraordinarily complicated election whose outcome could be thrown into the Supreme Court.
Rajiv: More of the same. Most trends are protracted. Geopolitics won’t shift dramatically, and the U.S. economy will be fine.
Cohen: We’ll be talking about the U.S. election and leadership in several other nations. Things look a little dicey for leaders in France, Germany, and the United Kingdom. We may be dealing with a different cast of characters next year. Also, I agree with John that our election consequences could be messy. And we’re all going to come with new book recommendations. Hopefully, some will offer comic relief.
Black: The outcome of the election could be an issue.
Giroux: We’ll be talking about AI, and the potential for $3 trillion of tax cuts to expire in 2025. We’ll be talking about the Magnificent Six instead of the Magnificent Seven, as Tesla will be out of that group. It could be a big underperformer this year. It is an auto company with a high valuation, and is losing market share.
Is there a logical replacement in the Mag Seven?
Giroux: There are probably other names you could put in that group today, whether an Adobe or a ServiceNow. Lastly, I expect the economic consensus to be very different a year from now.
Ellenbogen: From an investment perspective, we are firmly in the world of positive real rates. Companies will have to be agile, and you will want to invest in those that balance growth and profitability.
Despite the challenges, we will be aware that the U.S. is unique in the world. We have population growth above the replacement rate, and whether you call it luck or something else, our business climate is unique. We are the world leader in AI. We could also be talking about GLP-1s [diabetes and weight-loss drugs], which won’t be supply-constrained in the future, and could bring down healthcare costs. As the supply increases, you could see price cuts. We are the most obese country in the world. Shifting the curve on obesity could improve productivity and lower healthcare costs.
Desai: We will be talking about many of the same things we discussed today, because nothing will be solved. And we will definitely be talking about the U.S. fiscal position. Also, my macro forecast was pretty darned close last year. Just noting.
Gabelli: We will spend a lot more time trying to figure out how to solve our fiscal problems, which will become more visible after the election.
Witmer: The U.S. will be fine. We tend to muddle through. Taxes have to go up. Nonprofits should probably be taxed on incoming funds. The large estate-tax exemption is due to sunset at the end of 2025. That will raise some money.
Desai: As an economist, I have to tell you that the only solution on taxation is a VAT [value-added tax]. That is how the rest of the world finances progressive policies. Unfortunately, you can only finance a progressive wish list with a regressive tax, the VAT, and not with our complicated tax system.
Witmer: So, let’s get rid of some of the progressive wish list.
And let’s move on to your stock picks. Meryl, you have the floor.
Witmer: My first pick is Graham Holdings. The stock is trading for $680 a share. It has 3.6 million Class B shares, which trade, and 0.96 million Class A shares. The market cap is $3.1 billion. The A shares control the vote and are owned by the Graham family, which also owns a lot of B shares. I have zero concerns about unfair dealings, given their ownership of two share classes. Graham CEO Tim O’Shaughnessy, who is married to a Graham family member, is a rational businessman. His true north is to generate increasing amounts of free cash flow per share, which is music to my ears.
Meryl Witmer, general partner, Eagle Capital Partners, New York PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Graham owns a lot of businesses. What are they?
Witmer: We value Graham on a sum-of-the-parts basis. Kaplan International is the biggest of its education businesses. It partners with universities predominantly in English-speaking countries, and helps international students matriculate by helping them fulfill academic and English fluency requirements. It also owns housing, which it provides to the students. KI has long-term contracts with most of the schools with which it works.
With the school year that started in September 2023, the business is getting back to baseline post-Covid and should see continued improvement. At some point, it could see incremental growth from the U.K. government increasing its tuition cap, which has been flat since 2017. KI could also benefit as the U.S. student-visa administration clears an 18-month backlog. The education segment has higher-education and supplemental-education divisions, as well. Upside could come from the possibility that U.S. colleges will again require standardized testing for undergrad admission.
The education segment had adjusted operating cash flow of $169 million in the 12 months ended in September. We calculate free cash flow of $135 million and value the business at 8.5 to 11 times free cash. Using the midpoint, that’s $1.23 billion.
What else does Graham own?
Graham’s broadcasting segment owns TV stations in various U.S. cities. Operating cash flow has been steady when averaging election and nonelection years. We value this business on the average of the past two years’ operating cash flow, minus $13 million for capital-spending needs. At a multiple of 5.5 times free cash, the business is worth more than $1 billion.
Graham also has a manufacturing business that we estimate has been hurt by $20 million a year due to the slowdown in commercial office space. The other businesses are solid, with Hoover Treated Wood a gem. We put a 7.5 multiple on 12-month trailing free cash flow of $56 million, to value all the manufacturing businesses at $420 million.
Graham also has a fantastic healthcare segment. It offers in-home hospice care and infusions via wholly owned and joint ventures. Competitor Option Care Health trades at a rich multiple. We are conservative, however, and put an 8.5 multiple on free cash flow. Adding $100 million for joint-venture interests, we get a $450 million valuation.
The automotive business owns car dealerships. We value that at seven times pretax free cash, or about $260 million. Graham also has an “other” segment, including restaurants and Framebridge, a custom framing business. We value the segment at just over $200 million.
Graham has a pension fund that is overfunded by $1.6 billion, or almost $350 a share, pretax. It is finding innovative ways to use the earnings on the excess to retain nurses in the healthcare segment. Starting this year, it will offer a pension contribution in lieu of a 401(k)-account match, which should save about $10 million a year while sheltering earnings. We value this at $525 million, but it could be worth much more.
Other assets include loans to universities, cash of $160 million, and $575 million of equity holdings. There is also $762 million in debt, and we value unallocated corporate expense at about negative $400 million. Add it all up and we get $835 a share. With free cash flow of over $100 a share in the next two years and growth in the business, we expect Graham to trade above $1,000.
Ellenbogen: We have some overlapping healthcare investments. Graham’s healthcare division is probably worth twice your estimate, and the unallocated segment has a lot of profitability. As people realize the quality of the healthcare business and it approaches $100 million of operating earnings over the next couple of years, the stock will rerate. Conglomerates tend to trade at a discount to the value of their holdings until one division really excites people.
Witmer: My next and last pick is Wintrust Financial, trading around $91. It has 61.2 million shares outstanding and a market cap of about $5.5 billion. Wintrust is a financial holding company with 15 community-bank subsidiaries in Illinois and Wisconsin, and a leasing company and wealth management operation. It also lends to insurance agencies and finances life-insurance policies, a specialized and profitable business.
Wintrust has total loans of about $41 billion, including $10 billion to commercial real estate, but only about $3 billion of that is for office and mixed-use properties. Charge-offs are only about 0.1% a year, and nonperforming assets were 0.26% at the end of September. Deposits total $44 billion, with $10 billion at zero interest cost.
Wintrust has been earning at about a $10 a share annual run rate, up from $8 in 2022. Book value was $75.19 at the end of September. By the end of this year, with retained earnings, it should be about $86. A multiple of nine or 10 times earnings is too cheap for this kind of quality. The stock should compound nicely over time.
Thanks, Meryl. Todd, you’re up.
Ahlsten: I started covering semiconductor stocks soon after I joined Parnassus at age 22, but we didn’t own Intel then. It wasn’t a value stock. Today, it is more so. The market cap is $203 billion—more than 50% below the peak in 2000. There is a chance that in three to five years, Intel could be one of the Magnificent Seven. The CEO, Pat Gelsinger, has said this could be one of the great turnarounds in U.S. corporate history. I won’t go that far yet, but we bought the stock in May after not owning it for several years.
Intel lost market share to AMD in central processing units [CPUs] for PCs and servers. It fell behind Taiwan Semiconductor Manufacturing in process technology, and far behind Nvidia in GPUs, used for AI applications. Annual revenue has fallen from about $70 billion to the mid-$50 billion area since 2019. Gross margins have fallen by 17 percentage points while research-and-development expenses have spiked by 7.5 percentage points.
How will a turnaround happen?
Todd Ahlsten, CIO and lead portfolio manager, Parnassus Core Equity fund, Parnassus Investments, San Francisco PHOTOGRAPH BY MACKENZIE STROH; GROOMING BY STACY SKINNER
Ahlsten: Intel will reduce structural costs. More importantly, Gelsinger is doubling and tripling down on process technology. Intel is positioned to potentially reclaim the lead with gate-all-around technology, the next frontier in transistor architecture for the industry. This increases the power, efficiency, and productivity of Intel’s CPU and GPU chips. The company will be an early adopter of high numerical aperture EUV [extreme ultraviolet], a type of equipment used in photolithography. It is using new bonding and packaging, and packaging its chips with wires, logic, and memory. Intel can start to stabilize and regain market share in several areas. It is an American icon. I like to buy great American companies.
Intel will put $120 billion of capital to work over five years to become a foundry to the world. Pat is separating the company into a design business and a foundry. This is a difficult endeavor.
What makes you think it will work?
Ahlsten: In September 2022, former Cadence Design Systems CEO Lip-Bu Tan joined the Intel board. He is a specialist in electronic design automation. In three years, the GPU and foundry businesses could each have $2 billion to $3 billion of incremental sales, making them somewhat competitive with Nvidia and TSMC. In the long term, the foundry segment could do tens of billions in sales. There is a chance that Intel will be building parts for Nvidia, Apple, and Google by 2030. I emphasize “chance.”
Intel’s stock gained 90% last year, to a recent $47. In three years, Intel could have more than $4 a share of earnings power, and more than 25% operating margins. Apply a multiple of 18 times earnings and you get a stock price of $72. The company’s long-term target is to get to a 60% gross margin and 40% operating margin.
Will being a foundry and design firm create conflicts?
Ahlsten: Intel is building two companies in one. It is breaking out the financials, and there will be increased accountability in both businesses. We’ll know in 2025 whether the story works. The stock’s downside is in the mid-$30s.
Black: Nvidia and ARM aren’t going to stand still. How will Intel compete?
Ahlsten: The growth of accelerated computing will require a lot of CPUs. Plus, Intel is innovating elsewhere. People want an alternative to Nvidia, which we also own.
Oracle offers a rare chance to invest in AI, software, artificial intelligence, and cloud computing at a reasonable multiple. The market cap is $280 billion. The stock is trading for $104, or 18 times earnings. We see upside to $155 in 2½ years, based on a 4% yield on free cash flow. Unlevered free cash flow could total $20 billion in fiscal 2027.
There is a lot of durability in Oracle’s cloud-transition story. The company could sustain a 50% growth rate in infrastructure as a service for the next couple of years. Second, Oracle is transitioning from licensing-based software to a SaaS [software as a service] model. Meanwhile, the database business has stable cash flow.
Oracle’s transition isn’t cheap. In our view, capital sending for the cloud infrastructure segment will be $6 billion to $7 billion. Oracle is trading at a 10% discount to the market. Last fall, it traded at a 15% premium.
I’ll probably double down on my third stock, Deere, for the rest of my career. It is such a great company that you want to buy it, close your eyes, and go drink beers in Thailand for 10 years.
Speak for yourself, please.
Ahlsten: About 16% of global climate emissions come from agriculture. Deere’s precision ag technology can help reduce water, fertilizer, and pesticide use, and crop inputs. The company has a wide moat. We are in an ag downturn; corn prices fell 30% last year, putting pressure on farm income.
Gabelli: But farmers’ cash receipts will still be $520 billion to $525 billion this year, way above the average level of the past 10 years.
Ahlsten: The fleet age is still OK. Dealer inventories aren’t that elevated. Deere is getting better with each cycle; margins are peaking at higher levels. Deere could earn $24 a share in 2025 in our bear case. The stock is trading for $400, so you’re not paying a high multiple. It could trade up to $540 in two years, based on a multiple of 18 times midcycle earnings of $30 a share in 2026. By then, it could have 1.5 million connected machines and 500 million engaged acres, 250 million of them highly engaged.
Black: You left out Deere Financial, a substantial earner for Deere.
Ahlsten: It is a fantastic asset and has low loss rates, backed by strong farmer balance sheets and land.
Thermo Fisher Scientific is a fantastic company in life sciences. It is known for reagents and lab tools. The valuation has been suppressed for three reasons. Annual revenue for Covid testing peaked around $9 billion during the pandemic and could fall to $300 million next year. Also, we saw a great biotech funding environment in 2021, which has ended. And, China has reduced its purchase of life-sciences tools.
Thermo Fisher should return to revenue growth this year, and mid- to high-single digit growth in 2025. The company earned about $22 a share in 2023 and trades for 24 times earnings. You’re buying it at a cycle trough. The stock could trade at about $750 in three years, or for 25 times 2027 estimated earnings of approximately $30 a share.
What is the driver?
Ahlsten: Thermo has a trophy collection of assets and recurring revenue. It is building the backbone for all sorts of molecules used in drug research and development. It has a great record in M&A. The CEO, Marc Casper, puts capital in the business. We don’t know when business from China will return, but it was only 8% of revenue, and we have a biotech funding trough. But long term, research spending is up and to the right, and Thermo, along with Danaher, which I also own, should do well.
Last night I stayed at a Marriott hotel. Marriott International has 72% underlying Ebitda [earnings before interest, taxes, depreciation, and amortization] margins, and a 25% return on capital. The stock trades for $222, or 23 times earnings, and the market cap is $65 billion. Marriott is the largest premium hotel company, with 16% share, and has 31 brands. It has been a high-quality compounder for years.
There is a structural imbalance between supply and demand for hotels, especially in the premium market. Pre-Covid, there was 2%-3% annual supply growth. Now, with inflation and higher interest rates, growth is down to 0%-2%. Demand growth was 3%-4% in the decade through 2019. Now it is 4%-6%, given the travel rebound and other factors.
What does that mean for Marriott?
Ahlsten: RevPar, or revenue per available room, grew by 2%-3% in the past decade. Growth could be 3%-6% in the next decade. There are 192 million people in Marriott’s loyalty program, Marriott Bonvoy, which the company is leveraging to generate non-hotel revenue. Management expects 18%-19% of fee income to come from non-hotel sources through 2025.
Marriott has a good pipeline of new properties that could generate $500 million of Ebitda in three years. The stock has upside to $280 in two years, when it could trade at 22 times 2026 estimated earnings of $12.75 per share.
Ellenbogen: Do you like Marriott better than Hilton Worldwide?
Ahlsten: I like them both.
Intercontinental Exchange trades for $125, or 21.5 times earnings, and has a $72 billion market cap. The company owns financial exchanges; Black Knight, a provider of mortgage and real estate–related technology; the Ellie Mae mortgage-processing business; and a fixed-income information business. About half the business is exchanges, and roughly 35% of the exchanges serve the energy market. They are increasingly valuable, given the volatility in energy prices. Between Black Knight and Ellie Mae, ICE can now digitize and automate the whole mortgage process. ICE has had nice customer wins.
Even though 76% of ICE’s mortgage technology revenue is recurring, the company faced headwinds last year around the Black Knight acquisition and uncertainty in the housing market. Now, it is all systems go. ICE could realize $200 million of deal synergies in the next few years and then start buying back shares again. We see $8.60 a share in earnings power in 2027. Based on a P/E multiple of 25, we get a stock-price target of $215.
Thank you, Todd.