Many great stocks that used to be overvalued are now reasonably priced at the start of 2019.
This is largely due to the brutal stock market correction in the fourth quarter of 2018. Stocks have now recovered about half of their losses, but are still about 10% away from the all-time highs set in September.
I have been building fairly large positions in 5 different names in the past couple of months. These were added to my buy & hold portfolio and I don’t plan to sell them for a very long time.
These stocks may go up, down or sideways in the near future, but I am confident in the underlying companies and their ability to grow over the long-term.
Here are my top 5 stock picks for 2019.
1. Apple (AAPL): Strong cash flows with impressive shareholder returns
Apple has gotten in a bit of trouble in the past few months due to problems with their iPhone business. Their phones weren’t selling well in Q4, which was largely due to a sharp reduction in sales in China.
In addition, Apple decided late last year to stop reporting iPhone sales in their quarterly and annual earnings releases.
Given that the iPhone still amounts to about two-thirds of Apple’s sales, this caused many investors and analysts to panic, thinking that sales were about to drop off a cliff. This led to Apple stock dropping almost 40% from its recent all-time high.
This is currently the main risk of investing in Apple. If people stop upgrading their iPhones as much as before, then revenues will go down and could take a long time to recover. That is simply a fact.
However, Apple has several other business lines that are not only surviving, but thriving. Their services revenue is now over $10 billion per quarter. The sales of wearable devices are also growing fast year-over-year due to success of the Apple Watch and Air Pods.
Plus there wasn’t really too much to be excited about with the XS line of iPhones. As a previous iPhone X owner and current iPhone XS Max owner, I definitely think that the two types are very similar.
I believe that the iPhone will make a huge comeback in 2020 when Apple starts supporting 5G networking. This could lead to a new “super cycle” of upgrades for consumers, due to the massive improvement in bandwidth and latency for 5G.
But the main reason I want to own Apple stock now is the incredible shareholder returns. They are buying back a massive amount of shares each quarter, which increases my total percentage ownership of the company. They also pay a 1.7% dividend, which is growing each year.
If you combine their buybacks and dividends in the past year, the total shareholder return is greater than 10%. They could easily sustain this at 7-8% with their current financial results and continue growing their business at the same time. Even without dipping into their massive cash reserves.
At a PE ratio of only 14 with the heavy buybacks and growing dividend, Apple stock is one of the greatest bargains on the market. Warren Buffett, the world’s greatest value investor, has even made Apple stock the biggest part of his stock portfolio.
2. Alphabet (GOOG, GOOGL): Growing ad business leading several future “mega-trends”
I think it’s worth investing in Alphabet/Google for its advertising business alone.
They are the clear market leader in online search and their competitive advantage is so strong that it’s hard to imagine anyone ever taking market share away from them.
In addition, Google’s ad business powers a lot of the revenue-generating machine of the web. Many of the ads you see on websites are served through Google, which acts as an intermediary between advertisers and webmasters and takes a big cut of the revenue.
But Google is also doing other things that are incredibly impressive. They own YouTube, the biggest video streaming website, as well as Android, the biggest mobile operating system.
In addition, they are major players in some of the biggest “mega-trends” of the near future:
- Artificial Intelligence: Google seems to be the current leader in developing artificial intelligence.
- Voice assistants: Google Assistant is clearly the best voice assistant available on phones and smart-home devices.
- Self-driving cars: Alphabet’s Waymo currently develops the best self-driving car system and they are starting a paid robo-taxi service in some US cities this year.
- Cloud computing: Google’s cloud platform is currently in the third spot of cloud providers after Amazon and Microsoft.
Google’s stock is definitely not cheap at a PE ratio of 25. But you should also consider that they have $100 billion in cash, with no debt, and are growing at over 20% per year.
I think it is worth investing in Alphabet for the advertising business alone. This should lead to very impressive long-term growth for the company. But if one of their “other bets” takes off then that could lead to major additional upside for shareholders.
The main risk with Alphabet stock right now is their high business costs. They have been spending increasingly more money on growth and research, which has led to reduced margins.
3. Facebook (FB): Massive and fast growing online advertising business
Facebook had a really tough year in 2018. They were plagued with negative news headlines due to privacy issues, election interfering and various abuses of their platform.
I personally followed these news stories very closely and found that most of them were highly sensationalized by the media and made to appear much worse than they really were.
When a great company is in crisis, it often provides a fantastic investment opportunity, and I believe this to be the case with Facebook stock.
The company itself is still growing rapidly, with 30% year-over-year revenue growth in Q4 2018. This is a slowdown from recent years and quarters, but it is still the fastest growing of all the FANG (Facebook, Amazon, Netflix, Google) stocks.
Even the core Facebook platform is growing. It has mostly plateaued in North America and Europe, but it is growing fast in the rest of the world.
In addition, Facebook owns Instagram and WhatsApp, two other massive platforms with over a billion users each.
Facebook’s family of services now reaches 2.7 billion people each month and 2 billion people each day.
Here are the main reasons I am bullish on Facebook:
- The stock is incredibly cheap relative to its growth rate. Its PEG ratio is only 0.55, with a PE ratio of 22.
- Facebook is insanely profitable with an operating margin of 45% and profit margin of 40% in 2018.
- Their platforms are very strong in emerging markets like India and Indonesia, which could provide a multi-decade runway of growth as these countries get wealthier.
- Facebook is actively diversifying its revenue sources, including with hardware (Oculus and Facebook portal), payments in WhatsApp and commerce in Instagram. These could cause major upside for the stock in the next few years if they end up becoming successful.
Of course, Facebook is a controversial company these days and the media loves to write negative articles about them. But I think the headline risk will be smaller in 2019 as the media runs out of bad things to dig up.
Eventually these issues will be forgotten and the stock price will start to reflect the fundamentals again.
There are a lot of concerns about coming regulations for Facebook, which is a cause for concern.
However, regulations should also apply to their competitors and may actually end up cementing Facebook’s position as the dominant platform. This is because smaller competitors may not be able to keep up with all the expensive bureaucracy.
In addition, Facebook’s costs have been increasing fast due to investments in safety and security. But management has stated that the expense growth will slow down after 2019 and become more in line with revenue growth.
4. Microsoft (MSFT): Growth with recurring revenue and high shareholder returns
Microsoft was stagnant for a long time, but has become a growth stock again in recent years under the leadership of their new CEO, Satya Nadella.
Instead of selling one-time licenses of their products, they have made a major transition to recurring subscription revenue.
In addition, they are going after the cloud computing market with strong momentum and Microsoft’s Azure is now the second biggest cloud platform after Amazon Web Services.
Last quarter, their Azure cloud computing platform grew by 76% year-over-year, compared to Amazon’s 45%. This indicates that Microsoft is gaining market share faster than Amazon, so it’s possible that they may become the market leader soon.
The cloud computing market is currently worth over $100 billion per year and is growing rapidly. It is also insanely profitable with high margins.
But Microsoft is also doing a lot of other things right. Their revenue is diversified, with tons of revenue from selling the Windows operating system, the Xbox gaming platform, their Office range of software, among others.
They have also made several major acquisitions in the past few years, including LinkedIn and GitHub. LinkedIn revenue grew at 29% year-over-year last quarter.
Microsoft is also a mature company that is delivering a ton of cash back to shareholders. Their dividend yield is currently 1.74% and they spent $10 billion on buybacks last year, making their total shareholder return about 4%.
Microsoft also has about $40 billion in net cash on their balance sheet, so they have plenty of firepower available to continue expanding their business while rewarding long-term shareholders.
5. Berkshire Hathaway (BRK.A, BRK.B): Growing conglomerate provides diversification
Berkshire Hathaway is Warren Buffett’s massive conglomerate, which has been growing by double digits for many decades.
What Berkshire does is to buy whole companies or individual stocks when they are incredibly cheap.
When valuations in the market are high, like they have been for several years now, Berkshire hoards cash and waits for opportunities to buy assets below their intrinsic value.
Berkshire is one of the biggest owners of insurance companies in the US, but they have a diversified portfolio of businesses that include energy companies, candy companies, railroads, industrials, luxury items and real estate services.
They also hold massive amounts of stock in companies like Apple (AAPL), Coca Cola (KO) and major US banks like Wells Fargo (WFC), Bank of America (BAC) and JP Morgan (JPM).
What I like about Berkshire is that it uses Warren Buffett’s legendary value investing methods to deploy capital.
Although it isn’t growing as fast as it did during its early days, I believe Berkshire stock will continue to outperform the market over the long-term because of their discipline in capital allocation.
Because my buy & hold portfolio is highly concentrated in tech and internet stocks, I feel that owning Berkshire stock also provides diversification, because very little of their portfolio is invested in these sectors.
Berkshire Hathaway’s is currently sitting on over $100 billion dollars in cash, just waiting for a drop in the market to put money to work buying great businesses at big discounts.