Trading Success
In this edition of the Smart Investor newsletter, we examine one of the leading operators of financial asset exchanges globally. But first, let us delve into the latest Portfolio news and updates.
State of the Market Update
Last week was ugly in the markets, with the technology stocks – and specifically the chip-related ones – tumbling across the board. The past six months’ scorching rally took valuations to extreme levels, and it was obvious that a significant correction was long overdue. Investor anxiety over the sustainability of further gains led to a renewed sensitivity to macro developments, which were previously brushed off amid investor optimism. Meanwhile, Fedspeak has turned hawkish—putting a question mark over the possibility of a rate cut this year—while tensions in the Middle East threatened to further push up oil prices. Therefore, it is no wonder that investor sentiment has started to crumble.
This week began on a positive note as geopolitical tensions subsided, freeing up investor attention to focus on the busiest week of this earnings season. Companies representing over 40% of the S&P 500’s market value release their results this week, including four of the Magnificent Seven squad, and hopes are running high that positive earnings surprises will breathe some air into the stumbling rally. However, we believe that JP Morgan’s strategists may be correct in their assessment that the past three weeks are just the beginning of a deeper correction in the markets.
Market corrections, however painful, are a normal and welcome part of a healthy market cycle. They are beneficial for long-term investors, allowing for much more attractive entry points, as well as providing opportunities to stake out greater positions in high-conviction bets. Of course, caution is warranted, as always, and we continue to closely follow macroeconomic developments, as well as earnings reports, watching out for any sign of trouble. However, we remain calm about any short-term declines driven by non-company-specific or industry-specific factors.
Portfolio Stock Updates
❖ Super Micro Computer (SMCI) tumbled by over 20% in the past week, as skittish investors were alarmed after the company confirmed an earnings release date without publishing preliminary results, contrary to its actions in the previous quarter. After a surge of more than 1,000% over the course of 12 months led to a peak in March, a significant correction was due. However, SMCI’s long-term prospects are intact, as is our investment case for the stock. SMCI is a high-beta stock, so its elevated volatility is to be expected.
❖ Arista Networks (ANET) was also hit hard last week after Rosenblatt Securities analysts issued a “Sell” rating as they think the company may have to stand up to stiff competition from Nvidia in the area of AI network switches. Meanwhile, other Wall Street analysts haven’t followed suit, with Evercore ISI reiterating their “Buy” rating on the same day. The firm’s analysts said that Arista’s leading market position and strong relationships with Microsoft, Meta, Broadcom, and other tech leaders support their assessment for the company capturing most of the Ethernet switch market. However, anxious markets were more attentive to negative news, especially after ANET’s valuation reached overstretched levels. We are closely watching the developments around Ethernet switch markets, but for now remain convinced regarding our robust outlook for the stock over the long term.
❖ Taiwan Semiconductor (TSM) was partly to blame for investor nervousness about semiconductor-related stocks in the past week. The world’s largest chip foundry surpassed analysts’ revenue and earnings estimates and maintained its Capex plans. TSM also said that it sees an accelerating demand for AI chips and expects revenue from this business line to more than double in 2024. However, the company’s assessment of the overall chip market—excluding cutting-edge technology—dampened investor sentiment. TSM cautioned that the smartphone and PC markets remain weak and reduced its outlook for the 2024 semiconductor market growth (excluding memory chips). The foundry leader still expects its revenue to grow by at least 20% this year, as AI-related chip demand continues to surge. In January, TSM said that revenue from AI semis is growing at a 50% annual rate.
❖ Elevance Health (ELV): The stock rose after the healthcare giant reported revenues and earnings that surpassed analysts’ expectations, while raising its full-year EPS outlook.
❖ GE Aerospace (GE): The company reported better-than-forecast revenues and earnings for Q1 2024. This was the last period for which GE reported the combined results that included GE Vernova, as the split-up between the two was completed on April 2nd. Following strong first-quarter results, GE Aerospace raised its full-year 2024 profit and free cash flow guidance.
❖ W. R. Berkley Corporation (WRB) reported lower-than-expected revenue in Q1 2024 while posting a 50% year-on-year surge in net income thanks to strong returns from its investments and a robust underwriting performance. The commercial property and casualty insurer said it remains optimistic about maintaining strong performance throughout 2024.
Portfolio Earnings and Dividend Calendar
❖ The Q1 2024 earnings season is in full swing, with multiple Smart Investor Portfolio companies scheduled to release their quarterly results in the coming week. The reporting firms are Check Point (CHKP), EMCOR Group (EME), Textron (TXT), Applied Industrial Technologies (AIT), Super Micro Computer (SMCI), PayPal Holdings (PYPL), CDW (CDW), Corpay Inc (CPAY), Flex (FLEX), and Cencora (COR).
❖ There are no ex-dividend dates in the Smart Portfolio calendar until mid-May.
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New Buy: Cboe Global Markets (CBOE)
Cboe Global Markets, Inc. provides investment and trading solutions and products in multiple asset classes, including equities, derivatives, foreign exchange, and digital assets, across North America, Europe, and Asia Pacific. It operates through six business segments: Options, North American Equities, Futures, Europe and Asia Pacific, Global FX, and Digital.
In the U.S., Cboe owns the Chicago Board Options Exchange (CBOE), the world’s largest options exchange and the third-largest stock exchange in the country. Cboe also owns the stock exchange operator BATS Global Markets and the CBOE Futures Exchange. In addition, the company owns Cboe Fixed Income Markets and Cboe FX Markets. It also provides investors with access to spot and derivative trading of cryptocurrencies through Cboe Digital.
Cboe Global Markets also provides information solutions products across multiple asset classes and geographic regions. These include market data and access services, risk and market analytics, and the Cboe family of indexes. The company has originated several important market indexes, with its partners S&P Dow Jones, MSCI, and FTSE Russell, as well as on its own. The list of indexes it runs includes the most used measure of U.S. stock market volatility, the VIX Index.
In addition, Cboe has several venues across the globe, such as Cboe Europe, a leading operator of pan-European equity and derivatives trading and clearing services, including the largest pan-European stock exchange by market share. Cboe also operates through Cboe Japan, Cboe Canada, and Cboe Australia. No other exchange operator has a global footprint that compares to Cboe’s.
The company, founded in 1973 and headquartered in Chicago, Illinois, is one of the leading global platforms for exchange-traded products (ETPs). In April, Cboe announced that it had reached a new milestone, surpassing more than 1,000 exchange-traded funds (ETFs) listed across its global network of exchanges.
Embracing Market Volatility
After a long period of a relative lull in the markets, we may now be entering times of higher volatility, which requires a far more cautious stance. In these circumstances, the obvious choice is the stocks featuring a low Beta (a measure of a stock’s volatility in relation to the overall market). Cboe ticks this box perfectly, as it features a Beta of around 0.5 – meaning that in a broad market decline, the stock would be expected to fall roughly half that of the S&P 500, helping to protect the portfolio. On the flip side, it would rise much less than the market in a rally – but the Smart Investor Portfolio has several high-beta technology stocks to cover for that.
At the same time, Cboe is not only a “portfolio stabilizer” at a time of high volatility, but it actually profits from wild market swings. Higher volatility, coupled with trader anxiety, leads to stronger overall trading volume growth. This, in turn, fuels increasing transaction and clearing fees, which are important revenue sources for exchange operators. In simple words, Cboe profits even during economic recessions and sharp market selloffs since volatility pushes up its revenues.
Risk as a Source of Income
Besides the short-term outlook for market volatility, Cboe capitalizes on long-term market trends, some of which it helped to create. Thus, the company derives 61% of total net revenue from services associated with options trading. Options in general, and short-term options in particular, are becoming increasingly popular with retail traders.
Cboe Global Markets has always been a major innovator in the sphere of trading instruments, playing a pivotal role in the evolution of derivatives. The company has been behind many changes that led to the democratization of these instruments, including lowering the costs of trading as well as their accessibility to retail market participants.
It introduced VIX futures in 2004 and VIX options in 2006, basically inventing market volatility as a tradeable asset class. At times of change, market participants bet on a fall or a rise in volatility, helping to increase trading volume on VIX futures. Cboe was also the first exchange to offer futures contracts on Bitcoin back in 2019, positioning itself as a market leader in crypto futures trading.
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Catering to Retail
Another one of Cboe’s major innovations has been the shortening of the option expiration times until eventually the company introduced 0DTE (zero days to expiry) options on major indexes in 2022. These options allow traders to ride the market’s short- and immediate-term trends, as well as hedge risks, at a very low cost, which quickly turned them into a market staple. This development helped Cboe cater to retail traders, who represent an increasingly important segment of the market.
The ”retailization” of derivatives also fuels a fast rise in the number of ETFs utilizing these instruments, with the surge in volumes adding to the exchange’s income. In general, the exchange-traded instruments, many of which trade on Cboe’s platforms, have seen an immense surge in popularity in recent years, as a part of the long-term process of the democratization of the capital markets.
Not content to rest on its laurels, Cboe continues to innovate. Thus, a month ago it applied to the SEC to become the first exchange to enable issuers to offer ETF share classes of their existing mutual funds. If accepted, the change would further broaden retail access to various market instruments, while also helping mutual funds in their struggle against the acceleratingly high popularity of ETFs. Of course, larger trading volumes would also benefit Cboe’s revenues.
Track Record of Beating Estimates
Cboe has a very low debt despite its extensive M&A activity and investments in business expansion, which speaks volumes about its financial stability. The company features industry-beating profitability metrics, such as return on assets, equity, and investment. In terms of margins, Cboe may look marginally weaker than other U.S. exchange operators, other than its best-in-class net profit margin.
The company’s ability to churn out high net earnings shines through its quarterly reports. Cboe constantly reports year-on-year adjusted EPS increases, with the latest two quarters featuring double-digit rises in earnings-per-share. The company exceeded analysts’ EPS estimates in 11 out of 12 recent quarters.
Cboe reported a record year in 2023, with a 10% increase in net revenue and a 13% in adjusted EPS; the growth was led by its Futures segment, fueled by accelerated trading volumes. Particularly, index options trading volume surged by 36% from 2022. Cboe ended the year with $543 billion in cash and cash equivalents and a free cash flow of roughly $1 billion.
The company will release its Q1 2024 results on May 3rd. Analysts expect it to post year-on-year EPS growth of 7.5%; however, given its track record of beating estimates, it may well surprise on the upside again. Even if it doesn’t play out as in the past quarters, the company’s medium- to long-term outlook is strongly supported by several factors. These include the above-mentioned derivative trade growth, a multiyear stable increase in income from its Data and Access business, an exclusive contract with S&P Global to offer ETFs on its indexes, explosive growth in Cboe Japan, and more.
Total Return in Focus
Cboe’s stock has returned 30% over the past 12 months, outpacing the S&P 500, as well as the stocks of other U.S. exchange operators. This number includes the ~9% decline from an all-time high reached in February, which offers investors a more attractive entry point. Compared to its peers, CBOE trades below the valuations of Nasdaq and Intercontinental Exchange, and slightly above that of CME Group.
Cboe Global Markets rewards its shareholders through dividends and buybacks, further strengthening its investment case. It has been paying dividends for the past 13 years, increasing payouts annually at a CAGR of ~12%. While its current dividend yield of 1.2% is lower than the Financial sector’s average, Cboe’s strong financials, coupled with its low payout ratio, support the outlook for significant dividend growth in the future.
In addition, Cboe performs buybacks on an opportunistic basis under its existing long-term repurchase authorization. Thus, in 2023, the company bought back its shares for $84 million. As of December 31, 2023, the Company had $384 million of availability remaining under its existing share repurchase program.
Conclusion
Cboe Global Markets has a vast global footprint and a wide economic moat. The nature of its business makes it a perfect countercyclical stock, although it has merit in the market upcycle as well. The company’s focus on innovation allows it both to capitalize on emerging trends as well as to create them, supporting diverse revenue streams and strong growth potential. These factors, coupled with Cboe’s strong fundamentals, robust delivery, and alignment with its shareholders, support our belief that it can be a valuable addition to the Smart Investor portfolio.
New Sell: Jabil, Inc. (JBL)
Jabil, Inc. is one of the largest global suppliers of electronic manufacturing services and solutions. It provides electronic components to companies in various industries, from home appliances to smartphones and EVs. It is a financially stable company with low debt and industry-beating profitability metrics.
The company’s revenue streams are highly diversified by end-market, but not as much in terms of customer proceeds. Although it supplies over 300 of the biggest brands in the world operating in every end market, its top five customers were responsible for 42% of its net revenue in 2023, including 17% arriving from Apple alone. These numbers represent an improvement, as over the past years JBL has been acting to increase its customer diversification.
In addition, Jabil divested its Chinese mobility business, selling the unit to China’s BYD Electronic at the end of 2023. The division carried the lowest profit margins in the company’s portfolio while being the most capital-intensive. Thus, the divesture was seen as a highly positive development, which also helped the company to reduce its exposure to China, which up to the sale represented ~15% of Jabil’s revenues.
Besides, the receipt of $2.2 billion allowed the company to repurchase a large amount of its shares, helping the stock surge by over 80% up to its all-time high in March 2024. However, the stock has tanked by more than 20% since then, after the company posted FQ2 2024 revenues that missed forecasts. Moreover, Jabil issued weak guidance for fiscal H2 2024, saying it faced revenue headwinds. According to analysts, these headwinds arrive from weakness in Apple’s smartphone sales, as well as softening 5G, renewable energy, and EV segments. The EV market as a whole is weakening, dampening the near-term outlook for JBL, which counts most of the largest producers (including Tesla) among its customers. The growth in demand arriving from Jabil’s second-largest customer, Amazon, is not enough to substitute for these weaknesses. However, JBL’s continued expansion into the lucrative networking and data center space is expected to help it expand revenue and margins in the medium term.
After the initial disappointment, most Wall Street analysts were calm regarding the company’s longer-term outlook, as it is widely believed to be extremely well-managed. That is why last week’s announcement that Jabil’s CEO, Kenneth S. Wilson, is placed on paid leave due to a probe into a breach of company policies, came as a shock. Although Jabil said the issue doesn’t relate to or affect the company’s financial statements, there are still not enough details available to form an opinion about JBL’s further direction.
We remain positive in our outlook for electronic manufacturers and continue to hold Jabil’s closest competitor, Flex Ltd., in our portfolio. As for Jabil, we may revisit it in the future, after the current uncertainty is sorted out. For now, we believe it is prudent to lock in the gains and sell the stock.
Portfolio Stocks Under Review
❖ Molina Healthcare (MOH): The stock remains under review with medium urgency. Molina has been downgraded to “Sell” by BofA Securities analysts, who stated that Medicaid insurers are likely to witness margin pressures on “large portions of their membership,” impacting 2025 margins. In addition, the healthcare provider was excluded from Florida’s statewide Medicaid contract program, which dealt a blow to the stock. On the other hand, in positive news, MOH won a five-year deal to serve Michigan’s Medicaid members, which will strengthen the company’s presence in the state. We will read into the company’s earnings report, scheduled to be released later today, and decide on action vis-à-vis the stock.
Smart Investor’s Winners Club
*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite this week’s rebound, the brutal three-week selloff has taken its toll, harming some of the Portfolio companies’ performance. Still, our exclusive club’s ranks have expanded this week from 12 to 13, as ITT returned to the Club.
The Winners Club now includes SMCI, GE, AVGO, ANET, EME, CDW, GD, TSM, AMAT, ORCL, PH, STLA, and ITT.
The next in line to enter the Winners’ ranks is now the “fallen angel” APH with a 29.2% gain since purchase. Will it close the gap, or will someone else outrun it to the finish line?
Smart Investor Portfolio
| Portfolio Return YTD |
Portfolio Volatility (Beta) | Portfolio Dividend Yield |
| 10.57% | 1.00 | 0.77% |
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What’s Next?
Our next commentary will come out on Wednesday, May 1st. Until then – we wish you a world of investment success!
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Disclaimer
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