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BEST U.S. SHARES TO BUY FOR 2022

10th January 2022

My review of the charts for the majority of the stocks in the S & P 100 index, being the largest US companies as ranked by stock market capitalisation, revealed that fifteen of these had a very bullish (i.e. positive) outlook.

The above review focused entirely on technical analysis, which is the study of share price charts in an effort to predict future share price movements. If you are in any way dubious about the merits of technical analysis, I suggest that you read the article that I posted on my FREE website at www.sextonreadsthecharts.com in the 'Technical Analysis' section Q & A page, the first question being; 'So how does all this technical analysis stuff actually work?'

In my twenty five year career as a stockbroker, I came to the conclusion that technical analysis provided the investor with very useful information, and in the above article I have explained why this is so.

However, instead of relying entirely on technical analysis, I have now concluded a fundamental analysis of each of the fifteen US stocks identified as having very bullish charts. As a result of that analysis, I have reduced that number down to the following seven stocks:-

1. Union Pacific (UNP) $250.28

2. Berkshire Hathaway B (BRK.B) $318.93

3. Procter & Gamble (PG) $160.52

4. Morgan Stanley (MS) $104.13

5. Accenture (ACN) $373.00

6. Amazon (AMZN) $3,229.72

7. Qualcomm (QCOM) $179.68

The first three stocks above are defensive stocks. That means that these companies supply essential services. Therefore their share prices should prove to be fairly resilient, in the event that there is a stock market crash in 2022 or shortly thereafter.

The fourth stock above, is a banking stock, and should benefit when interest rates rise from the current very low levels.

The final three stocks are growth stocks. These are companies that are experiencing rapid earnings growth because they are supplying new products or services, which are displacing the products of other companies, and in some cases rendering them obsolete. Such stocks normally command very high valuations, but my fundamental analysis concluded that the above three remain good value despite the enormous gains they have made in recent times.

First, to the three defensive stocks, Union Pacific and Berkshire Hathaway B own the two railroads that control most of the rail traffic in the western half of the USA. That is an astonishing outcome, in these days of competition and markets authorities, anti-trust legislation and politicians blabbing on about protecting the consumer. It seems that politicians on the left, in the USA, are spending so much time talking about gender identity, the black lives matter 'campaign', and climate change, they have totally missed this issue.

So let Bernie Sanders, Elizabeth Warren, Alexandria Ocasio-Cortez and the rest of that crowd warble on about their favourite topics, and pick up some of the above stock. Because both of these companies are strong adherents of the first rule of capitalism.

And what you might ask, is the first rule of capitalism?

Eliminate all competition!

A poorly run business that has little or no competition to contend with, will make far more money for its owners, than an excellently run business which is experiencing strong competition with many other operators in the same sector.

Union Pacific owns the Union Pacific Railroad. The stock currently trades on a P/E ratio of 26 and has a forecast dividend yield of 1.87%. Therefore, it has a payout ratio of almost 50% (a P/E of 26.5 equates to an earnings yield of 3.77%). Analysts are forecasting a 14% growth in earnings per share, from $9.75 in 2021 to $11.37 in 2022. The railroad is expected to continue enjoying earnings growth of around 16.5% per annum for the following five years. Therefore, the price to earnings ratio looks to be reasonable, in my opinion.

This railroad has a very high profit margin of 29%. Not surprising, as it is one part of a duopoly. Growth in the US economy will propel revenue growth, and a high percentage of this will impact the bottom line ie net profit, due to this high margin.

An interesting irony here, is that Union Pacific is currently transporting record levels of the most environmentally unfriendly fuel the world has ever seen - coal. That is because natural gas prices have hit record levels, and coal is being used as a cheaper substitute.

It remains to be seen whether politicians will be capable of crafting an appropriate response to combat climate change. That would appear to me to be way above their competency level, so better to start taking defensive measures now (such as building flood barriers) than continue with the folly of believing we can stop the climate from changing by taking preventative measures.

But I digress. Berkshire Hathaway B shares was a stock that I disregarded many times in the recent past, on the grounds that the driving force behind that investment company, Warren Buffett, is old (he is now 91) and will die soon. It is his investment analysis ability that made the company such a stunning success, and it would surely command a lower rating when old Warren finally departs this mortal coil.

However, I have changed my mind about this stock, following my recent fundamental analysis of it. I think Buffett has made so many good investment decisions in the past twenty years, that new investors in this stock will continue to benefit from these for many years to come.

For example, it bought the Burlington Northern Santa Fe (BNSF) railroad in 2009, thereby investing in the duopoly with Union Pacific described above. It also owns a substantial energy business that produces electricity and natural gas - another defensive business supplying an essential service.

Very few analysts cover Berkshire Hathaway as it is such a difficult company to value, due to the large insurance underwriting business it owns. This underwriting business covers the risks that no other insurance company in the world will cover, as none of them are large enough to be able to pay out the claims that would result. These risks arise from large natural disasters leading to enormous losses for the insured, and this is called 'super cat' (super catastrophe) insurance. 'Super' in American English meaning 'very big', unlike in this part of the world where 'super' means 'very good'.

Perhaps there will be an enormous natural disaster at some time in the future, and the related claims will clean out Berkshire Hathaway. That is why so few analysts are prepared to value this stock. However, there are two very good reasons why this 'super cat' underwriting business is a very profitable one.

Firstly, Berkshire Hathaway has no competition here, as no other insurance underwriter is big enough to cover these risks. Remember what I said earlier about the first rule in capitalism is to eliminates all competition. Therefore there is no competitive pressure to contend with, when these premiums are being priced.

Secondly, there is no correlation between the performance of the economy, and the related performance of the stock market - with the occurrence of large natural disasters. Therefore this underwriting business provides the company with very significant diversification of risk.

In May 2020, a website called GuruFocus.com made a decent effort at valuing Berkshire Hathaway B shares. It valued the insurance underwriting business at two times 'float'. That is the most common measure used in that industry, and means two times the surplus of assets over the value of projected liabilities. On applying that, it found that the remaining businesses were valued at less than 10 times earnings.

However, Berkshire Hathaway B shares have since risen by 72% since that analysis was done. We do know that the earnings of the railroad it owns have risen by nearly 30% since then, and that of the electricity business by a similar amount. The S & P 500 index is up about 60% since then, and the huge stock portfolio held by the company is up by a similar amount. So we are now probably looking at a valuation of around 15 times the annual earnings of the non-insurance businesses - still a fairly modest valuation.

A further item that makes Berkshire Hathaway B a good defensive stock is the large amount of cash, and cash equivalents, it is holding, due to Buffett's concern that there are very few cheap stocks available in recent times. As at 30th September 2021, the total value of the equity portfolio was $311 billion, with a further $144 billion in cash or equivalents. That cash figure represents almost one third of the total funds available for investment.

Therefore, if there is a stock market crash in 2022, or shortly thereafter, Berkshire Hathaway B will be well positioned to pick up a lot of cheap stocks. Instead of trying to identify what and when to buy, you can leave Buffet and/or his lieutenants do this for you.

The B shares were created due to the A shares appreciating so much in the past 50 years or so. Each B share is worth 1,500-ant of an A share. The B shares were created by the company as the A shares (currently trading at $474,457) are out of reach of most private investors.

Berkshire Hathaway B does not pay a dividend, on the grounds that this is tax inefficient (as most shareholders will have to pay income tax on this) and also on the grounds that the company will probably do a better job in reinvesting your money than you will do yourself!

The third defensive stock selected is Procter & Gamble. This company provides a diverse range of branded consumer packaged goods, such as Head and Shoulders shampoo, Old Spice aftershave, Crest toothpaste, Gillette razor blades, Daz washing powder, to name but a few. These are everyday household items, the demand for which is unlikely to decline very much in the event of a significant downturn in the economy. Therefore it is a classic defensive stock.

The forecast dividend yield is 2.13%. At first glance, the P/E looks high at 29.6 but on careful examination, it is actually quite reasonable. The balance sheet is very under leveraged. The long term debt is only $20.5 billion, versus shareholders' funds of $46 billion. The normal ratio for an efficient balance sheet is considered to be 2 to 1, whereas

P & G's long term debt to equity ratio is less than 0.5 to 1. Therefore it could increase debt by $70 billion and do a massive share buyback, thereby increasing earnings per share growth significantly from the projected growth levels of 4.6% in 2022 ($5.92) and 7.4% in 2023 ($6.36).

P & G has warned that higher input and freight costs are expected in 2022. However, it has strong pricing power due to its massive product range. This is illustrated by the increase in net profit margin from 14.6% in the year ended 29th June 2018 to 18% in 2021.

The fourth stock selected above is the investment bank, Morgan Stanley. This banking stock is set to benefit if interest rates rise in 2022. This should enable banks to increase their net interest margins, being the difference between interest charged on loans versus interest paid on deposits.

The forecast dividend yield is 2.85% and the P/E is the lowest of the seven stocks selected at 12.8. The earnings per share for 2021 are expected to be $7.83, up 19.5% on 2020. Investment banks typically trade on low price to earnings ratios, due to the volatile nature of earnings in that sector.

As at 30th September 2021, the total assets were $1.1 trillion (including $137 billion of loans to clients) and total liabilities of $1.01 trillion (including $310 billion deposits from clients). The ideal scenario for Morgan Stanley is that interest rates rise in 2022, but this does not derail the bull market. Therefore, underwriting fees from initial public offerings (IPOs) and other market sensitive earnings continue to grow. That is a distinct possibility for 2022, as rising interest rates are expected by most market participants and so may be largely priced in to the market.

Morgan Stanley has a duopoly with Goldman Sachs in the investment banking business. There are huge barriers to entry to this sector, created unintentionally by regulators who have imposed a massive burden of additional reporting requirements on firms in this sector since the 2008 financial crash. Smaller firms can not afford to absorb this cost, leaving all of the most lucrative business in the sector to these two behemoths.

The three growth stocks selected, Accenture, Amazon and Qualcomm all have the high P/E ratings typical of that sector of 38.5, 65 and 23 respectively and low dividend yields of 1%, nil and 1.5%. However, these high rating are justifiable, on a review of the fundamentals.

Accenture's high price to earnings ratio is justified by the earnings per share growth of 19.8% expected for 2022, and 10% for 2023. The firm has made a few upward revisions to current year earnings, indicating robust growth. Growth is being driven by acquisitions, and there is a mountain of net cash on the balance sheet. The total cash and equivalents is $5.64 billion, with long term debt of only $55.9 million.

Accenture provides consulting services and has a commanding position in the sector, as it is much larger than rivals Deloitte and BCG. The firm provides consultancy services in the fast growing IT areas of digital, cloud and security. It announced new contracts at the end of 2021 with the US Patents & Trademarks Office and Spanish bank BBVA.

A recent survey by the firm predicted that social media e-commerce spending will grow three times faster than 'traditional' e-commerce by 2025. Generation Z (born post 2005) and Millennials (born from 1995 to 2005) account for over 60% of this spending. Accenture is well placed to benefit from the scramble by businesses worldwide to access this demographic, which is often described as being 'hard to reach' as these young people don't tend to consume the traditional media of tv and newspapers.

Amazon's P/E of 65 is justified by the fact that it has exposure to the three rapidly growing sectors of e-commerce, cloud computing and streamed content. In addition to this, the company is relentlessly searching for new markets and products. It recently announced a collaboration with car maker Stellantis (Fiat & Chrysler) for the use of its software in the dashboards and the use of its delivery platform.

Amazon is one of the top four holders of a 'cash mountain' in its balance sheet. The other three are Apple, Microsoft and Alphabet. A company with a high P/E rating and huge reserves of cash, is better value than a similar company with the same P/E and a weaker balance sheet.

Amazon is one of the leading companies in the cloud computing sector. Cloud infrastructure spending in Q3 of 2021 grew a massive 37% over the same period in 2020. Just three companies control 63% of this rapidly growing sector, Amazon, Microsoft and Alphabet.

That fact alone, justifies the high P/E ratio of 65. The large smile on the face of Jeff Bezos will probably get even wider, as we are likely to see the same old story of the rich getting richer, in 2022.

And finally, to Qualcomm, more modestly rated than the other two, trading on a P/E ratio of 23. This semi-conductor maker sells a system called Snapdragon that provides essential computing power in smartphones. Samsung is a big customer. Samsung's rival, Apple, is trying desperately to reduce its reliance on Qualcomm and recently bought a part of Intel, with the intention of developing its own chips. In addition, Apple has for years been engaged in litigation with Qualcomm alleging patent infringements.

Nvidia is also trying to muscle in on the action by buying ARM Holdings, and presumably disrupt the licensing deal between ARM and Qualcomm.

These potentially aggressive actions on the part of Apple and Nvidia, initially caused Qualcomm shares to drop sharply. However, they have since rebounded strongly and recent reports from the UK indicate that the Competition and Markets Authority will stop Nvidia's takeover of ARM.

If Apple does get the upper hand on Qualcomm in this high stakes battle over Snapdragon, any fall off in revenue for the latter could be compensated by the new and growing market in virtual reality that Facebook is so excited about, it renamed itself Meta. Snapdragon is used in the virtual reality headsets made by Meta Platforms.

Qualcomm has recently done a deal with General Motors for the software required for the artificial intelligence that will allow 'hands free' driving.

Qualcomm is right at the centre of the upgrade to 5G with Snapdragon, and in addition it is likely to generate earnings from new markets in virtual reality and automobile technology. That P/E of 23 could look very cheap two years from now.

"US stocks are very expensive, and there is better value in European stocks" is the call of many commentators in the financial sector. Most of these commentators are in the financial media, and if they were working instead as fund mangers, the majority would have been in the lowest quartile of performers every year for the past ten years. Not seeing beyond the "high" P/Es and failing to understand the new products and markets that 'Big Tech' is either creating or accessing, is the weakness in much of their analysis.

In contrast, my fundamental analysis of the leading US stocks indicate that their premium rating over European stocks, and the Rest of the World, is well deserved.

The above combination of seven stocks, three being defensive, three being high growth and one set to benefit from higher interest rates, is what emerges from a rigorous analysis of both the technicals and fundamentals, as we begin 2022.

P & G's long term debt to equity ratio is less than 0.5 to 1. Therefore it could increase debt by $70 billion and do a massive share buyback, thereby increasing earnings per share growth significantly from the projected growth levels of 4.6% in 2022 ($5.92) and 7.4% in 2023 ($6.36).

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P & G has warned that higher input and freight costs are expected in 2022. However, it has strong pricing power due to its massive product range. This is illustrated by the increase in net profit margin from 14.6% in the year ended 29th June 2018 to 18% in 2021.