Motley Fool Hidden Gems Investing - 2 Blue Chips Under Pressure

Episode Date: January 24, 2023

How long will macroeconomic pressures persist in 2023? (0:21) Asit Sharma discusses: - Johnson & Johnson's 4th-quarter profits falling 25% - Why he likes the company's balance of pharma and medtech - 3M's challenges and why an increase in consumer-facing solutions may be a better route (10:40) Alison Southwick and Robert Brokamp answer your questions about saving for retirement, bonds, and more. Looking for stocks trading at a discount? Go to www.fool.com/report to get your free copy of our "5 Stocks Under $49" report. Stocks discussed: JNJ, MMM, BND Host: Chris Hill Guest: Asit Sharma, Alison Southwick, Robert Brokamp Producer: Ricky Mulvey Engineer: Rick Engdahl   Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Chris Hill. You've got questions, we've got answers. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool Senior Analyst Asit Sharma. Thanks for being here. Asit Sharma. Chris, I appreciate you having me on. We've got a pair of blue-chip stocks that are wrapping up their fiscal years. We're going to start with Johnson & Johnson. Fourth quarter profits fell 25%, in part because demand for the company's COVID-19 vaccine

fell. When you throw in the fact that inflation added to J&J's costs, not a great end of the fiscal year. It leads into a very consequential year, because later this year, we're going to get the split, we're going to get the breakup of Johnson & Johnson. But in terms of these results. Was there anything in particular that stood out to you? Chris, to me, the story is, how is Johnson & Johnson going to look going forward? The impact of this year, the way the fourth quarter ended, not great, but next year, they're guiding to pretty decent results. I think the company is looking for some around 5% growth in the next year. Now, where is this going to come from? The pharmaceutical segment

has been doing pretty well, even when you take out those COVID results. The combination of the pharmaceutical division plus the medtech division, these will be what Johnson & Johnson is left with after it spins off its consumer health segment. Those actually grew at an adjusted level pretty nicely last year. The pharmaceutical segment grew at around a 7% rate and the MedTech segment grew at a rate of around 6%. I think what they are doing will help them as they don't have to worry as much about the more volatile and I would say slower growth consumer segment, even though you've got some great brands that will be nestled up in this segment, which, by the way, is going to be called Kenvue. We can scratch our

heads about the brand power of that name, but there you have it. Yeah, there was always going to be the challenge of trying to replace the long-standing brand name of Johnson & Johnson, which really is as solid and as trusted a brand as there is when it comes to home consumer healthcare, that sort of thing. I have to say, as a shareholder, and I don't recommend this for everyone, but maybe it says something about me that as a shareholder of Johnson & Johnson, I now go into every quarter and the thing I'm looking for is some sort of red flag to indicate, hey, when the breakup happens, when they finally split the company up, you're going to want to jump ship on this. Again, not a positive mindset to have. I'm happy to say, however, I don't see any

reason to sell my shares. Like you said, not a particularly strong end of the fiscal year, but there's nothing that they've done to this point and that there's nothing that they are guiding for that makes me think, oh, when the breakup happens, I'm going to have to drop part of this for my portfolio. I agree. Chris, if this were just going to be a pharmaceutical company, I'd worry somewhat because those earnings can be more volatile. You have to keep innovating in that cycle. Patents expire. It's a tough business to be in if that's what you're only focusing on. Of course, being this multinational conglomerate, they've got deep pockets to innovate over time. I like, though, that they have now basically

balanced that portion of the business with MedTech, which is a more, I would say, dependable revenue stream. It's depending on device sales. With recent acquisitions, they've got a specialty in heart devices, which will be for a long time to come. It's a really stable part of the business. I think there's not a huge red flag out there that makes me worried that, man, once they split up this business, we're going to see a sudden deterioration in results. I think the new consumer segment on its own and a spinoff, it looks like it'll be a public IPO, plus the old business, really, it'll just continue to function as the Johnson & Johnson we know, which is very shareholder-friendly, highly cash flow generative.

Chris Hill 3M CEO Mike Roman said that he and his management team expect macroeconomic challenges to persist in 2023. As much as anything, that forecast is why shares of 3M are down more than 5% today. I'll just add in results for the fourth quarter were not particularly strong. The company also announced that it is cutting 2,500 jobs. That's a little over 2.5% of the 3M workforce. Yeah, this is a company that, for better for worse, is spread across many parts of the economy. When that global pressure begins on a macroeconomic level, it slows 3M down. They're really split up between several businesses. Many of us know the consumer side, the adhesive side, but they are in consumer electronics,

providing really specialized coatings and components for consumer devices. When folks stop buying or slow down their buying of phones, tablets, TVs. That hits their P&L. They're in the safety and industrial business, which again, in a slower global economy, can slow you down. They're in healthcare consumer. It's not a company that gets a big lift when a certain sector of the global economy is on fire. There's always something popping up that seems to keep 3M from being this high-growth company, but they have had dependable growth. I think talking about red flags, we looked at Johnson & Johnson as a company that should be fine going forward even after it spins off its consumer business. Here, I'm not so sure about 3M. They have

had a concentration in PFAS chemicals. These are forever chemicals. The company is now going to divest from incorporating these chemicals into its industrial and manufacturing processes in its end products by 2025. But that itself is a big lift. Of their projected capital expenditure for next year, Chris, which is anywhere between $1.5 billion and $1.8 billion, $200 million of that is just going to go on water programs as they transition away from these chemicals. We've got a company that has not been innovating at a fast rate as of late in recent years. Slower growth business, divesting out of some businesses which, if they continued, would have liability for them. When you look at 3M's total picture, there's

no spark one can see on the horizon. As you pointed out, growth is slowing. They're guiding are 6% negative to 2% negative growth on the top line, and that's never good. Shareholders never like to see that. If we're searching for maybe a catalyst for share price appreciation, it may be a few quarters for 3M. They've not really started 2023 out on the best foot. Yeah. I started the show by saying, we've got a couple of blue-chip stocks here. look at the five-year chart of 3M, it's slowly methodically been cut in half over that time period. It really does seem like it has moved to the back burner in terms of what we consider to be those traditional blue-chip stocks that provide ballast for a portfolio, that provide

a steady dividend. They're still paying the dividend, but I don't know. I think if you are looking for that ballast in your portfolio, there are other candidates that seem a lot stronger than 3M. That's true. One thing which shareholders can do or those on the sideline who are maybe looking for those types of blue chips is just to watch 3M for the next year or so. On the plus side for them, they generated $1.7 billion in adjusted free cash flow in the fourth quarter. That's a free cash flow conversion rate of 131%. They are pulling back on inventory levels. They're decreasing their manufacturing proactively for the next few quarters. There could be just a shift in the business over

time where they move their puzzle pieces around, I would say, as much as they can be more of a consumer-oriented business and a consumer electronics-facing business, so supply those components for the end products. Those are places where the cash flows are steady and the liabilities aren't that bad. There's a scenario in which 3M looks a little better for those who are seeking a capital return to shareholders. It's just not a clear picture this year. In my estimation, it'll take four to five quarters before one could look at 3M. As you say, look at that opportunity cost versus many other blue chips out there and make a buy decision. But we shouldn't let my pessimism weigh too heavily. Many times,

my peak pessimism is the perfect time to buy a blue-chip company. I don't know. I look at the commentary, I look at the analysis, and I look at what's happening to 3M stock today. You are clearly not the only pessimist when it comes to this business. Asit Sharma, great talking to you. Thanks for being here. Thanks a lot, Chris. If there's a silver lining to what happened in the market last year, it's the fact that there are a lot of great companies whose stocks are trading down at levels they haven't been at in a long time. Our investing team has put together a report of five companies that have

all fallen below $49 a share, and the report is free. Just go to fool.com slash report, and you get immediate access to the report, which is creatively titled Five Stocks Under $49. I love it when things are straightforward like that. Again, just go to fool.com slash report. You can access it right away. Up next, Robert Brokamp and Alison Southwick take on your questions about saving for retirement, bonds, and whether it's a good idea to cash out your 401k for a Bitcoin trading strategy. Our first question comes from Nate. My portfolio almost entirely consists of U.S. companies. This hasn't been a bad decision to this point as the S&P 500 has handily outperformed international

stocks in the time that I've been investing, about five years. Do you expect this trend to continue? Would you recommend more international exposure perhaps by adding an ETF like the Vanguard Total International Stock Market ETF? Or would I simply be dragging down my portfolio's return by investing in these companies? Well, for the past decade or so, international investing has been a tough sell as U.S. stocks have outperformed by a pretty wide margin. And really, if you look over the last 120 years or so, you'll see that the U.S. stock market is pretty close to being the best performer in the world. On top of that, if you own a diversified portfolio of U.S. stocks, you likely own many companies that make a lot of

money from international sales. Approximately 30% of the revenue from the companies in the S&P 500 come from outside the U.S. So, some people are pretty comfortable sticking with U.S. stocks. However, I think you should have some exposure to international stocks for a few reasons. So, first off, history shows that no country stays on top forever. And there have been long stretches of time when international stocks outperformed, such as the 1980s and the first decade of this century. Also, because the U.S. stock market did so well since around 2010, they are much more expensive than most other markets nowadays. So, I think most people should have some exposure to international stocks, and that Vanguard ETF is a fine choice. But the amount

of the allocation is up to you. I think 10% is a good start. But up to a third of your equity allocation in international stocks isn't unreasonable. That's the average non-U.S. stock allocation in target date retirement funds these days. In fact, some of Fidelity's target date funds have actually higher allocations to international stocks, I'm guessing, based on valuation. And then finally, I'll point out that over the past three months, the S&P 500 is up 9%, but that Vanguard International Stock Index ETF is up 22%. I don't know if this is the start of a longer trend, but I'm certainly happy to see my international funds finally doing so well. Our next question comes from Jeremy. I started options trading in Bitcoin the past

few months. I think Jeremy just gave me a little bit of a heart attack. Okay, let's reset. I started options trading in Bitcoin the past few months, and by chance, I have the opportunity to invest into a process with a trade signal and make 10% on a one-minute lock-in with virtually 100% accuracy. Buy long or sell short. My advisor slash instructor is telling me to withdraw the money in my 401k and use it as new principles so I can maximize returns per trade signal instead of continuing to lose through my current retirement investing. After two years of constantly adding to my 401k, I'm down $6,000. Would it be better to take this opportunity and take the hit on withdrawing my retirement. Also, is this legal? I still am having just a little bit of heart

palpitations here. Yeah. If you wanted to put two words together to make me the most absolutely skeptical of an investment, I think combining Bitcoin and options would be a good candidate. And then if you wanted to add two more words to make me think this is a really bad idea, those would be 401k withdrawal, right? So you take that money out, you'll pay taxes on the money, plus a 10% penalty if you're not 59.5%, all to pursue a strategy that I very, very much doubt will earn an almost guaranteed 10%. Jeremy asked if this is legal. It's not illegal to take money from your 401k and invest it in options. However, this quote-unquote advisor might actually be acting illegally by recommending something that is almost definitely very bad

advice and perhaps outright fraud. So I'd search the internet as well as websites of the SEC and your state securities regulator to see if there are already complaints about this advisor slash instructor. As for your 401k, just stick with a diversified portfolio of stocks and index funds, as well as maybe some cash and bonds as you get closer to retirement. I know this last year or so has been tough, but stock market declines are just part of the game. Don't let them scare you out of stocks and into something even riskier. Our next question comes from Dallas. I should probably have some bonds in my retirement savings since I'm in my 40s now. I try to be more of a passive investor and don't want to analyze the debt structures of different companies.

Since I-bonds are yielding about 7%, should I just load up on those? Or is there an advantage that I'm missing to buying the Vanguard total bond ETF that's only yielding 4%? Well, so as always, the amount you have in bonds and stocks really depends on your risk tolerance, time horizon, all that good stuff. Assuming you have around 20 years until retirement, you can have the vast majority of your money in stocks, assuming you can stomach the ups and downs. Again, looking at just typical target date funds, the average allocation for a fund with a retirement date of 2045 has around 10% to 15% of its assets in cash and bonds. That sounds like a reasonable place to start to me. I bonds are definitely worth considering, though you can't

really load up on them because you can only purchase $10,000 worth a year plus another $5,000 if you use your federal tax refund to buy some more. The rate on I-bonds adjusts every six months based on inflation. That's what the I stands for, which is why their current yield looks so good. But if and when inflation comes down, and I certainly hope it does, they won't look nearly as attractive. I still think, though, that they make sense as part of a diversified bond portfolio. I do like the Vanguard Total Bond Market ETF. I own it myself. Also, check out target date bond funds, which are offered by Invesco and BlackRock. They only own bonds that mature in a certain year, so they offer a bit more predictability

than what you'd get from a typical bond fund. And then finally, any money you need in the next few years, stick with cash, CDs, short-term bond funds, or treasury bills, which are currently yielding almost 5% and are free from state income taxes. Our next question comes from Dana. I just started a new job. Right now I'm saving 8% in a 401k and my employer matches 3%. Should I put in more? Also, how often should I check the investments in my 401k to make sure they're doing okay? Thanks for the great podcast and Fool on. Thank you, Dana. So the amount you should be saving really does depend on your age and how much you've already accumulated. Dana's overall savings rate is 11% when you combine her

contributions with the employer match. If you're in your early 20s, maybe just starting out in your career, that could be fine. However, I think nowadays, most guidelines suggest that folks start with a savings rate of 15% for retirement. If you're reaching maybe your later 30s or even 40s and you haven't started yet, you need to bump that up to 20%, 25%, maybe higher if you want to retire by your bid to late 60s. As for how often to check on your investments, once a quarter or even once a year is plenty, especially if you just own mutual funds. But the more you move into individual stocks, the more you probably should stay on top of your portfolio. Our next question comes from Patrick. I'm a longtime Fool from the mid-90s when I read actual paper newsletters. I really

miss Hidden Gems and I enjoy the podcast. I've been finding that I'm suffering from what I think is anchor bias. Stocks that I purchased years ago based on Fool recommendations are at such a low cost basis that as they are re-recommended, I hesitate to consider them for additional investment. I tend toward purchasing other stocks that I think may have much more room for growth. I have close to 50 stocks, so I'm not in danger of over-concentrating. I realize this can lead to always chasing riskier investments and spreading investments too thinly rather than the foolish approach of buying your winners. Any advice or perspective on this? Yeah, Patrick, so many of the Fool stock picking services will re-recommend companies. Sometimes

many times over many years. And like Patrick, many of our members wonder how much they should keep buying of the same stock, especially after it's run up. But even if you don't belong to our services, you may find yourself sort of in the same dilemma, right? You look at a stock or an asset class, think it might be attractive, but then you see that it's already gone up quite a bit. So you wonder whether you've kind of missed the boat. So I would start by thinking about how it fits into your overall portfolio, right? You don't want too much into a single stock or even a single industry or sector. But as long as you wouldn't be over-concentrating your portfolio, then I would say go ahead and buy the investment, even if you already own it. Because every great

stock, or even the U.S. stock market as a whole, has posted excellent returns in the past. That doesn't mean they couldn't have excellent returns in the future. All that said, if there are other stocks that you think have more room for growth, then go ahead and buy those, especially if you've demonstrate over time that you're a pretty good judge of such things. Finally, I'm a big fan of diversification. To me, 50 stocks or even many more doesn't sound like too many to me, as long as you can stay on top of all of them. Our next question comes from Corey. My wife and I have no kids ourselves. Her best friend has a young child who we're sort of non-religious godparents for. We would like to set up an account to start investing for the child.

small amount each month into an S&P 500 fund or ETF and eventually gift it over when he's older. Since we have no legal relationship to the child or mother, what's the best way for us to do this? Well, Coraline, that's very thoughtful of you. And you have a few choices. First of all, you could just open a custodial account for the child. You should get the parent's buy-in on this probably. And then the child actually owns the account but won't have control over it until he reaches the age of majority in his state, at which point he gets control and then he can spend it however he wishes. It's an irrevocable gift, no take-backs, and the money can only be used for the benefit of the child. There are some tax benefits to this, since a certain

amount of earnings would be tax-free, but then above a certain amount, the earnings would be taxable to the parent. Plus, this would be considered an asset of the child, which could reduce financial aid eligibility when he goes to college. You might just want to open a brokerage account in your own name and then just keep control of it until you think the kid is ready for the money, at which point you gift the investments to him and all the cost bases will carry over to him. The downside to this is that you'll owe any of the taxes on the earnings until you gift the account. I'll offer a couple of other thoughts here. If your intention is that this money will be used for college, then consider opening a

Coverdell or 529 account so the money will grow tax-free as long as it's used for qualified educational expenses. And then finally, I'm just going to bring up gift taxes. In 2023, each individual can give anyone $17,000 or less, and the IRS doesn't care. If you give above that amount to someone this year, then you have to file Form 709 with your tax return. You won't owe any taxes, but you'll eat into your lifetime gift and estate tax exclusion. It may sound scary, but it actually doesn't matter to most people because that exclusion is several millions of dollars and most people don't give away or die with that much money. But I just want you to be aware of if you give over that amount, you do have to file that

extra form with your tax return. And we have another investing for kids question. Based on a recent episode, I decided to open an investment account for my son who is two months old. My wife and I decided to start off with a relatively small amount of money and then contribute annually. Additionally, we're going to deposit any monetary gifts and half of any of his earned wages until he is 18. My initial plan was something along the lines of putting a third of the account into the S&P 500 and the rest into individual stocks. The initial amount won't be nearly enough to diversify into the recommended 25 plus stocks. But is this a good plan? Love the podcast and hope you're doing well. Writes Jonathan. Oh, thanks, Jonathan.

So a good bit of my answer to the previous question applies here as well. But I'll also add that once the kid begins earning an income, Jonathan and his wife might consider opening up a Roth IRA for their son. That way, the money grows tax-free as long as they follow the rules, it'll give their son a head start on saving for retirement. And if he needs the money before then, he can withdraw the contributions, not the earnings, tax and penalty-free at any time. As for how to invest the money, I love the idea of having both an index fund and individual stocks. It's partially because I just love index funds. And you might even want to add a small cap index fund and maybe an international stock index fund to the mix. Jonathan touches on our foolish advice

of owning at least 25 stocks, which is a bare minimum goal to shoot for. But I understand this can be a challenge when you're just starting out, whether it's starting out investing for your kid or maybe you're just starting out investing for yourself. So I think it's fine to gradually build up to 25 or more stocks. Fortunately, given that most discount brokers don't charge commissions and many allow investors to buy fractional shares, so half a share or a quarter of a share, It actually doesn't take a whole lot of money to have small stake in many companies. And our last question comes from Brian. I heard a quote on another investing podcast. Wait, you're seeing other investing podcasts? What?

I didn't know we had an open podcast relationship. I didn't think we did either. We're poly podcast amorous, something like that. All right, Brian. Brian would love to hear our thoughts on this idea that he learned from another podcasting relationship. Okay. 5% of your portfolio should be in something volatile because losing 5% will not ruin your portfolio, but could be life-changing. Well, Brian, I suppose it depends on how you define volatile, right? So the stock market is volatile, but most people should have more than 5% of their portfolios in stocks. I think what

Brian is getting at is limiting the amount you invest in really, really risky investments, things that have a low probability of success, but if they succeed, could really pay off. So things like startups, young companies that are working on a single technology or drug that they hope will revolutionize the world. But if it doesn't work out, then the company may be pretty much worthless. And I suppose you could also throw cryptocurrencies into this category as well. I actually know some experts and financial advisors who are diehard indexers, but they do have a small account in which they buy individual stocks. They call it their play money or something like that. And I think it's all fine. And I think that 5% limit that Jonathan brings up is a pretty

good guideline. I would just keep track of your record on these types of investments. If you're regularly losing money, then maybe limit the size of the discount to less than 5% or maybe just give it up altogether because you really don't have to take extraordinary risks to do well in the stock market over the long run. If you've got a question about investing, drop us an e-mail at podcasts at fool.com. That's podcasts at fool.com. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.