Barron's Streetwise - Why Boring Stocks Are Booming. Plus, Beer.

Episode Date: January 15, 2022

Jack talks with a pair of top Wall Street strategists and the CEO of the world’s largest brewer. Learn more about your ad choices. Visit megaphone.fm/adchoices

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Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard is Michel Dukaris. He's the new CEO of Anheuser-Busch InBev, the world's largest brewer. Now, just a few weeks ago on this podcast, we heard from a spirits executive, but that's okay because if I remember the rule of thumb from college, it goes liquor to beer, never fear. In a moment, Michel will tell us about his growth strategy at Anheuser. But first, we'll talk with a money manager and Wall Street strategist about how best to invest

for rising interest rates. Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack. I'm glad to hear you sounding so upbeat after the great investment panic of 2022 this past week. Did you buy low or what happened? I mean, I went to Costco and they had a sale on couch cushions. So you don't know what I'm talking about. They look great. I bought three. That's good that you weren't sweating your investments because I am, of course,

overstating things just a bit. I received a report from a big investment bank at the start of the week titled, Buy the Dip. And my first thought was, what dip? The S&P 500 index at the time was down 2% for the year. And that's after a 29% return last year and an 18% return the year before and 31% the year before that. The index is riding one of the longest and strongest bull markets in history. I'm not sure a 2% decline constitutes a dip. I call that something between a shimmy and a bob. And by all means, buy the shimmy if you want,

but keep a few things in mind. First, I'm not aware of a reliable way to predict short-term market returns, which means trying to time the market is futile. Hopefully, you've had an appropriate stock allocation all along, in which case buying the dip is unnecessary. If you have been underweight stocks and holding out for a buying opportunity, I'm not sure the 2% markdown would have been enough of a sweetener to change your mind. You might have said, I'll focus my buying on the assets that are being hit the hardest. But to my eye, there were two main groups and neither is super appealing right now.

The first was pricey growth stocks. The first was pricey growth stocks, solid companies whose market values have run up to levels that seem to anticipate shocking success and then some. Those didn't fall to inexpensive levels. The second group is financial mystery meat. These are things like cryptocurrency that don't produce cash flows or dividends, never will, and aren't backed by underlying asset values. I have no way of telling you when those things have gotten cheap because I can't explain why they trade at the prices they do to begin with beyond momentum chasing. And no, it's not because I haven't sat through enough conversations about distributed ledgers and decentralized finance.

Dogecoin is the dollar, digital dollar. I've been saying this. Bitcoin is digital gold. Dogecoin is the dollar, digital dollar. I've been saying this. Bitcoin is digital gold. Dogecoin is digital dollar. Now, there's reason to believe that investment markets are going through an important shift in how stocks perform. For going on 13 years now, near zero interest rates have helped fuel enormous gains for stocks. And a buy the dip mentality has served investors exceptionally well. Over that stretch, there's been only one bear market, if we define it as a decline of 20% or more for the stock market, and that was a 34% drop near the beginning of the COVID-19 pandemic. That sounds bad, but that bear

market was also the shortest one in history, lasting just 33 days from top to bottom. At the same time, growth stocks have trounced value stocks. To see what I mean, consider an exchange-traded fund called Invesco S&P 500 Pure Value. It tracks S&P 500 members whose share prices are low relative to measures like earnings, sales, and the book value of assets. Top-weighted stocks in the index recently included Berkshire Hathaway, Prudential Financial, ViacomCBS, the television and movie company, and CVS, the drug chain. Over the past 10 years, Invesco S&P 500 Pure Value has returned 261%, which is a wonderful return. But its sibling ETF, Invesco S&P 500 Pure Growth, has returned 364%, which means

growth investors have beaten value investors by more than 100 percentage points. Not only that, if you look at five years instead of 10, the annualized returns for the growth ETF are even better, and those for the value ETF are worse. One other observation, returns for the plain old S&P 500 index are much closer to those of the growth ETF than the value ETF. And that makes sense when you consider that Invesco S&P 500 pure growth tracks companies with strong earnings growth and price momentum. So over the years, it's had exposure to big tech stocks like Apple, Microsoft, Amazon, Alphabet, Tesla, Nvidia, and Meta Platforms, which is a new name for Facebook. Those are also the most heavily weighted companies in the S&P 500 index because it weights companies by stock market

value. And all of those companies now have giant market values. In other words, if you invest in a basic S&P 500 fund, you look a lot like a growth investor. And that brings me to the potential market shift. When you start seeing a shift where interest rates are rising, that basically compresses the value of growth companies much faster. And that's what basically we're seeing. That's Salida Marcelli. She's the chief investment officer for the Americas at UBS Global Wealth Management. And she says the divide between growth and value stocks has gotten particularly wide since the beginning of the pandemic. One reason is that many growth stocks happen to be the types of software businesses that are fared well while people aren't going out as much. But another reason is that the Federal Reserve made massive purchases of bonds during the pandemic to push yields even lower than they were, which was designed to stimulate the economy.

But low yields also happen to give a boost to growth stocks. Here's Salida. Growth companies are those where they generate most of their cash flows well into the future. These companies are much more sensitive to changes in the discount rate, in the interest rates, that investors use to drive the net present values. That's complicated, I know. The basic idea is that much of investing is based around the decision of how much to pay today for the money a company is likely to make in the future. And whatever the answer is to that question,

future dollars are worth less than dollars you're already holding. Because you can take dollars you're already holding and say, stick them in the bank and earn interest. But you can't stick future dollars in the bank. Now, I know what you're thinking. My bank pays next to nothing for interest on savings, so why should I care? And that's exactly the point. Under normal conditions, investors would like the growth potential of growth stocks, but not like they have to wait so many years for the cash flows to roll in. But with interest rates so low, they don't care as much about whether the cash flows are coming right now or many years from now. Here's Salida. When we look at the valuation metric, like price to earnings ratio, since the beginning of the pandemic, growth companies went from 22 times a ratio to 31 times,

whereas value companies went from 13 times to 16 times. So 31 times earnings for growth stocks and 16 times earnings for value stocks. That's a difference, let's see, 31 minus 16. Jackson, my hard thinking music, please. You borrow from the three and you move it to A squared plus B squared equals PEMDAS divided by HAGNDAS to the cosine of the hyperfactorial. I'm getting 15. Almost ran out of toes there.

So the difference between the price to earnings ratio for growth stocks and value stocks is 15. Salida says the average historical difference is just six. In other words, either the expensive stocks are really expensive or the cheap stocks are really cheap, or both. For that to change, conditions have to change. Interest rates would have to rise, and that now seems likely because one potential danger of keeping interest rates too low for too long is stoking inflation. And this past week, we learned that consumer prices in December were up 7% from a year ago. And that's the fastest inflation since E.T. was trying to phone home back in 1982. E.T. Exactly, E.T. There's been an ongoing discussion about just how much of inflation is caused by temporary factors like supply chain constraints.

But investors seem to be coming around to the view that at least some of the faster price growth will stick around for a while. And so there does seem to be kind of a slow realization that inflation is becoming more structurally embedded. That's Edmund Bellard, a portfolio manager at an investment firm called Harding Lovner. The question, I think, is really, are four interest rate hikes really going to be enough or anywhere near enough to kind of slowly bring down inflation? Now, we could very well see supply chains getting kind of unblocked and driving prices down. But, you know, that tends to be, as we've seen, it's a much longer term process than kind of was expected earlier in the year when it was just supposed to

be a few quarters. It now looks like a multi-year process. The problem is, as that inflationary mindset gets embedded in prices and in wages, you know, the Fed has to respond with kind of hitting the economy over the head with a brick. As economic metaphors go, hitting over the head with a brick does not sound like a pleasant one. But Edmunds says the starting point for rates is so low, sharply negative after subtracting for inflation, that a rise in rates from here doesn't have to be disastrous for stocks.

It just might cool off some of the elevated valuations. And so even quite a bit of tightening could still leave rates negative, which wouldn't be that bad for the equity market. But any significant increase in real rates, I think you've got to believe that current valuations are going to mean revert, if not to kind of long-term averages, at least to averages that have kind of applied over the last sort of 30 or 40 years. Back to Salida at UBS. I asked about moments during the past decade when other strategists said a rotation into value stocks looked imminent. There have been many such calls and they've generally fizzled out and growth stocks have kept right on outperforming. So why should we be so confident now? Salida says it's not an all or nothing bet that investors shouldn't be out of growth stocks altogether. Consumer spending is solid, and we're probably going to see an uptick in business spending.

So there's still potential there, but value has underperformed significantly. I mean, last week it did really well. And as we pass through this Omicron variant and economies continue to fully open, I think the parts of the economy that is much more geared to economic growth is going to continue to perform. To Salida's point, a recent report from Credit Suisse predicted that earnings growth for value stocks will beat earnings growth for growth stocks in 2022, which sounds counterintuitive. Fast earnings growth is a key reason investors buy growth stocks to begin with. But value stocks can produce fast earnings growth when they're bouncing back from sharp economic downturns, like now. Here's Salida. Are we saying value is going to outperform growth for the next five years?

Not necessarily. But I think that, you know, as interest rates continue to rise, that gives more momentum for that valuation discrepancy to adjust itself. Thank you, Salida. Coming up, beer and bar taps in homes. And what the heck is brutal fruit? That's next after this short break. TD Direct Investing offers live support. So whether you're a newbie or a seasoned pro,

you can make your investing steps count. And if you're like me and think a TFSA stands for Total Fund Savings Adventure, maybe reach out to TD Direct Investing. Welcome back. We were talking earlier about inflation. Here's someone who says he's seeing a lot of it. I think that the inflation at this moment is uncharted territories.

Inflation at this moment is uncharted territories. And then we've been implementing our plans very thoroughly. Some price increase, some cost measures, and a lot is still unknown. That's Michel Ducaris, a longtime executive at Anheuser-Busch InBev, who was promoted to CEO last summer. He says that because AB InBev operates all over the world, it has experience managing inflation as high as 80% in some countries. It's developed sophisticated technology tools for planning, and it hedges the price of its raw materials an average of 12 months in advance. Even so, he says he's feeling the cost pressure and the pressure between brewers and retailers, who ultimately have to pass higher prices along to customers. AB InBev's best-known brands in the U.S. are Budweiser and Bud Light, the country's top-selling

beer. Budweiser is 146 years old, and that's nothing compared with some other members of the company's family tree. Belgium's Stella Artois dates back to a 1366 tavern that made beer for hunters. Another Belgian brand called Leffe was made by monks starting in 1240. If the full company name Anheuser-Busch InBev sounds awkward, it's because it's the result of many years of beer marriages, some of which were actual marriages, like when a wholesaler named Bush married the daughter of a soap maker named Anheuser who had bought a struggling brewery and then the son-in-law pioneered pasteurizing and bottling beer and transporting

it in refrigerated rail cars, which made Budweiser the first national U.S. beer. Anybody want to hear the short version of why Bud is now owned by a Belgian company with a second consecutive Brazilian CEO? Okay, I won't tell you about how Belgium's Inner Brew merged with Brazil's Ambev in 2004 and called it InBev and then bought Anheuser-Busch in 2008. And in 2016, it bought a company called SAB Miller. The SAB stands for South African Breweries. That's the company that bought Miller Brewing and sold some stuff too, you know, U.S. distribution for Canada's Labatt, Mexico's Corona, and it sold Molson Coors and it sold its theme park operations, Busch Gardens and SeaWorld. I won't tell you about any of that. Instead of saying all that stuff, I'll just tell you there's been a lot

of deal making and not a lot of return for investors. I asked Michel, what do you think you have to do to get investors more excited about the stock? He talked about three main things. First, while the industry was consolidating, there was too little focus on organic growth, and now it's time to grow. Second, AB InBev has a vast beer ecosystem and can develop new ways to make money from it. And third, the company hasn't done enough to bring down its debt, which is something Michel wants to prioritize now. He shared these goals with investors in December. something Michel wants to prioritize now. He shared these goals with investors in December. Leading grow beer, digitize and monetize our ecosystem, and optimize our business.

This is what investors want. Growth and value creation. Let's take a quick look at each of those three things, starting with growth. We've talked on this podcast about the rise of hard seltzer, which is generally a malt beverage, and more recently of ready-to-drink cocktails, some of which are made with real spirits. Spirits have been gaining share from beer during the pandemic. I asked Michel about that, and he calls both seltzer and canned cocktails a new fourth category of drinking, along with beer, wine and traditional spirits. He says it's an opportunity for AB InBev, whose brands include Bud Light Seltzer and Cut Water Spirits. You see beer players getting a higher size of the pie on this fourth category than other players.

And then it's not by coincidence that you see very developed markets like Canada and the US where beer was growing revenues, but no longer growing volumes, now growing volumes in the last two or three years and accelerating the pace of growth in revenues because of the fourth category. Some of these new fourth category drinks are not so easy to categorize.

There's a drink in South Africa made by AB InBev's SAB unit. It's called Brutal Fruit. It was marketed as a fruit drink, but a court there said it's not a fruit drink, it's an ale, which is a type of beer, and that SAB would have to change the label. And SAB said it would comply with a labeling requirement, but that Brutal Fruit isn't a beer because it doesn't contain malt. It's made from sparkling water and fruit flavoring and maize. Michel says AB InBev hasn't until now capitalized on its worldwide scale, which, as you might imagine, is vast. We have breweries, production assets, distribution assets

in more than 100 countries. We do have 6 million customers globally that we do 10 million transactions with them each and every week. And for the last years after building this ecosystem, what we've been doing is purely selling beer in a very transactional way with these people. As we invest in technology and we start to digitize our ecosystem, a lot of opportunities emerge. opportunities emerge. One of those opportunities is delivering cold beer to homes in 30 minutes or less in some markets. Another is selling bar-type tap systems that can go in customers' homes. Michelle says that the United Kingdom now has more home taps than it has pubs. Look at you, UK.

now has more home taps than it has pubs. Look at you, UK. AB InBev can also sell supply chain and distribution services and software and financial services to smaller players. And it wants to turn its spent grains into protein and fiber to be sold as ingredients. Around two-thirds of analysts who cover AB InBev stock are bullish. Around two-thirds of analysts who cover AB and Bev stock are bullish. The bear case, articulated by JP Morgan, is that the company will be hurt by inflation and that it doesn't have enough exposure yet to what the bank calls beyond beer, or this fourth category of convenience drinks that are selling well, and that it has too much debt.

The bull case is, I suppose, that Michel will address these things and return the company to sustainable growth. We shall see. I asked Michel if supermarket beer coolers have gotten too crowded. He says that's mostly in developed markets with easy access to startup capital for small brewers, but yes. And finally, I asked him about product successes. And he said a low-calorie beer called Michelob Ultra is selling well overseas. And he talked about Brutal Fruit and the home beer taps, which he says he's testing in Miami, and the continued success of Corona. But he also said that Americans would be proud to know how highly Budweiser is regarded in many overseas markets, like Tibet. If you are hiking the mountains and you happen to be in the border of China and India,

you will see the soldiers exchanging gifts and the Chinese soldiers that protect the Tibetan border, they give Budweiser to the Indians as a gift. In China, Budweiser is already bigger in volume and revenues than it is in the U.S. today. Thank you, Michelle and Edmund and Sabrina, and thank all of you for listening. If you have a question you'd like answered on the podcast, just tape on your phone, use the voice memo app and send it to jack.how. That's H-O-U-G-H at barons.com. Jackson Cantrell is our producer. Any parting words, Jackson?

Bye. Gonna work on that. There's a guy on TikTok who does like pizza reviews. And when he's done, he says, hey, take care. Brush your hair. I feel like you could use a catchphrase like that. We'll think of one. Subscribe to the podcast. You can follow me on Twitter if you want. That's at Jack Howe, H-O-U-G-H. See you next week. Be nice. Don't get lice. That got weird, but it was a good effort.