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Just over a month ago, we released our top 5 investments for 2022. As the year moves forward, with an exciting January on the books, we’re starting with our first update of our top 5 investments. These five investments, Energy Transfer (ET), Exxon Mobil (XOM), Palantir (PLTR), Facebook (FB), and AT&T (T), are expected to outperform the S&P 500 (SPY) through 2022.
The performance of our recommendations versus the S&P 500 is tracked below.
For each month, the tracking is based on the YTD performance (i.e., February will be from Jan. 1 to the end of February). The aggregate performance of the 5 investments (equally weighted basket) was -3.12% versus a 7.49% decline for the S&P 500 implying a one-month outperformance of 4.37% versus the S&P 500.
Obviously, one month is too short of a time to get a true metric of performance, but it’s a useful time to start.
The most significant concern in the markets currently is inflation, which has reached roughly 7%. One side argues that the issue is a temporary supply chain issue exasperated through issues such as a shipping container shortage, or ports around the country struggling to move goods into the country. As the supply chain adjusts to changing demand, it’ll need to adjust.
The second is that loose Federal monetary policy and rising wages will propel increased demand and spending which will cause permanent inflation that will last long after the various supply chain issues resolve themselves. Regardless of whichever camp you fall into, or whatever your opinion is, we expect 2022 to be the year of truth.
In our view, inflation is fairly transitory caused by three issues.
The majority of shipped goods come from China. China has instituted a Zero-Covid policy with frequent lockdowns, which expands the difficulty of moving goods. Combined with enormous demand and the price to ship a container of goods has become 10x versus the pandemic. That’s not based on economics or the government, it’s a short-term spike.
Similar to the shipping issues, consistent lockdowns are unpredictable, and unpredictability is horrible for the supply chain. Several countries in Europe have started to move towards a “no lockdown policy”, and over the next 1-2 years, we expect global countries to continue supporting vaccines but minimizing lockdowns.
Numerous industries with “just-in-time” manufacturing forecast very rigid demand schedules with a 1-2 year delay in changing that. As seen from the toilet paper and other shortages at the start of the pandemic, it doesn’t take a sizeable shift in demand to change things up. We expect demand to start getting more predictable.
In our view, these combined factors mean that inflation is more likely to be transitory. There are numerous studies that show a weak link between the wages earned by the poorest in society (minimum wage) and rising inflation, given that the poorest make up such a small % of income and spending. Even anecdotal evidence supports this (i.e., Denmark employees at McDonald’s earn 2-3x what they earn in the U.S. but a Big Mac is cheaper in Denmark).
Of course what happens in 2022 remains to be seen, but especially on the back of 1% in predicted interest rate raises for the year, we expect inflation to slow dramatically through the year rather than being the “economy ruiner” everyone is afraid of. With that said, it’s also worth noting our picks are balanced to perform in an inflationary environment.
Specifically, growth stocks underperform in an inflationary environment with potential interest rates, however, commodity stocks tend to outperform.
AT&T had a strong start to the year, which was slowed down by investor concern over the company’s earnings, which we discuss in more detail here. The biggest catalyst for the company this year is the spin-off of Time Warner + Discovery and the valuation the market assigns to that. Part of the punishment the company saw was structuring this as a spin-off instead of a split-off.
However, post spin-off, the company will still have $20+ in annual FCF with continued capital investments. The company will have an almost 20% FCF yield based on its market capitalization, with a manageable debt load. We expect the company, as it focuses on Fiber and its core businesses, will have significant shareholder return potential.
For catalysts, in 2022, investors should pay close attention to the spin-off in the next 6 months, and the company’s ability to drive its guidance for $23 billion in FCF in 2022. Risk wise, the largest company-specific risk in our view is increased competition from T-Mobile (TMUS) being a full-strength third competitor.
Energy Transfer remains one of our favorite midstream picks. The company recently announced a 15% dividend cut pushing its yield towards 7.5%. The company has a substantial debt load, but it’s already announced that it’s hit its target debt levels. That means the company could potentially provide shareholders with additional rewards in the upcoming months.
The biggest catalyst for the company, in our view, is its upcoming quarterly earnings along with its guidance for how it plans to spend its additional FCF for the year. Risk wise, investors should pay close attention to crude oil volumes to see if they begin to recover without too much volatility in oil prices.
Exxon Mobil has had a strong year so far, generating almost 20% market cap returns. The Brent crude prices have gone above $90/barrel, and Exxon Mobil has an incredibly strong portfolio of assets generating millions of barrels/day in production to take advantage of it. The company’s Guyana assets have a <$35/barrel breakeven and the Permian Basin has a lower breakeven.
The company is generating $10s of billions of profits annually at current prices, and we expect the company to utilize that for a variety of shareholder rewards. The company has no major specific catalysts in 2022, however, we recommend investors pay attention to Brent crude prices to see if strength remains throughout 2022.
Palantir is an interesting investment that has performed the worst in our portfolio. In our view, that’s because the market has re-evaluated the company’s growth potential. However, despite that, the company is strongly FCF positive with a 30% FCF conversion rate out of its most recent revenue, and strong margins.
We expect the company to continue those margins. The company has guided for 30+% revenue growth annually for the next 4 years, which indicates the potential for a comfortable double-digit FCF yield by the late-2020s. The company has some of the strongest risk-adjusted return potential out of growing tech companies, and we expect that to pan out.
Given Palantir’s underperformance YTD, the performance for our basket of stocks depends heavily on Palantir. For the year, we recommend investors pay attention to the company to see if it can continue finding new deals. Risk wise, the only specific risk is the company not meeting its guidance or increased competition from other large tech companies.
Facebook is another company we’ve discussed in more depth recently. The company saw the size of Instagram, in terms of active users double from mid-2018 to YE 2021. The company is focused on growing both its ARPU and growing its overall user base, which will support rapid growth in the company’s overall revenue.
Facebook has recently announced a $50 billion share buyback, enough to repurchase almost 6% of its market cap. This is something the company can comfortably afford along with the company’s continued investments in growth. In our view, Facebook is where Apple was in 2012. Investors believe it’s peaked, but the company is still growing and buying back shares for growth.
For 2022, we recommend investors pay attention to the company’s FCF and look for continued steady growth along with the execution of buybacks. The largest company-specific risk we see is increased competition from upstart social networks (such as TikTok) along with the potential for increased anti-trust pressure.
The largest risk to our thesis is something that targeted the specific sectors of our portfolio. For example, a massive lockdown that caused oil prices to collapse, combined with an economic downturn and high inflation, could target our recommended companies much more than the broader market. That could lead to the investments underperforming.
At this time, we stick by all 5 of our recommendations. While Palantir and Facebook especially have had a difficult month, underperforming the S&P 500, we stick by our thesis for the companies. Palantir has been impacted by a shift away from growth stocks, but we continue to expect the company to hit a double-digit FCF yield in the upcoming years.
Additionally, oil prices have remained strong supporting Energy Transfer and Exxon Mobil. AT&T is progressing well on the spin-off of Time Warner and merging it with Discovery. The short-term impact of a spin-off rather than a split-off won’t come up repeatedly through the year. This continued strength means strong return potential for the portfolio’s investments.
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The Value Portfolio focuses on deep analysis of a variety of companies with a primary focus on the energy sector. Occasional articles also focus on building a retirement portfolio or on other sectors (such as healthcare or technology).
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