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Ali Mogharabi: Alphabet reported better than expected fourth-quarter revenue as the firm continues to grow its advertising business impressively. Similar to Facebook, Alphabet is further monetizing its users and attracting more ad dollars to not only its search but also its YouTube video platform, demonstrating the firm's strong network effect moat source. While Alphabet's operating margin was in line with our internal projection, it was slightly below the consensus. We expect the firm to continue its investments to stay ahead when it comes to innovative tools not just for consumers, but also for advertisers and enterprises, further pressuring margins in 2019.
We look for Alphabet to continue to dominate the online search market, which drives consistent double-digit, top-line growth. While Google is facing more competition from Amazon, we note it is also further investing in making its search and display ad platform more dynamic and easier to use.
We expect revenues from YouTube to drive further growth in Google's top-line. We also remain confident that Google will continue to make progress toward becoming the world's third largest cloud provider.
We are aware that investments to spur growth in YouTube, cloud, and hardware revenue have pressured Alphabet's gross and operating margin. However, there are a couple of reasons why we think margin expansion could resurface in 2020.
First, on the gross margin front, growth in traffic acquisition cost is no longer outpacing ad revenue growth as it did for five straight quarters before turning around in third-quarter 2018.
And second, we expect sales and marketing expenses as a percentage of revenue to begin to decline slightly in 2020 as Google's cloud offering gains a stronger foothold in that market, slowing down headcount growth in the firm's cloud sales. Plus, as Google's YouTube benefits further from the firm's network effect moat source, we expect less sales and marketing spending on YouTube, which could create some operating leverage beginning in 2020.
David Whiston: GM's fourth-quarter results were not a massive surprise given that the company had mostly preannounced results in an analyst event in New York in January. Fourth-quarter EPS did end up beating consensus by about $0.21 per share, which was great to see, mostly on strength in North America, from light truck models and GM Financial, which is a really underappreciated asset, I think, in the new GM and continuing to grow, up to pretax earnings of $2 billion over the next couple years.
All that helped to offset some weakness in China. China automotive equity income was down about $200 million year over year as that market does slow, but Cadillac still remains quite strong there. Cadillac globally was the only brand that grew volume year over year globally for GM, in fact.
GM, back at that analyst day in January, did also give 2019 guidance, which was well above consensus at the time. They confirmed that guidance in their quarterly results of EPS of $6.50 to $7 a share. Assuming a steady macro environment, I think 2019 is going to be a really good year for GM and a very transformative year as they continue to squeeze out more cost and realize the scale that new GM should get while growing GM Financial.
The latest initiative is $6 billion free cash flow improvement coming from $4.5 billion in cost improvements and about $1.5 billion in capital expenditure reduction. This will be going across 2019 and 2020.
On the product side you've got new heavy-duty pickup trucks this year and a new Chevy Blazer, and next year you'll have a new generation of full-size SUVs off the pickup truck platform. So that should help mitigate headwinds from things such as another billion dollar headwind in tariff and commodity costs.
Assuming a steady macroeconomic environment, the future for GM still looks pretty bright. A lot more improvements still coming, a lot more scale to realize. The stock on Wednesday did go over $40 at least for a while, and I think it remains an undervalued stock.
Neil Macker: Disney reported a strong start to its fiscal 2019, as the company beat on both top and bottom lines. However, the really key point for us was more information around the firm's direct-to-consumer efforts including ESPN+ and Disney+. Both of these services will be key to the company as it moves through a transitional year in fiscal 2019and into further growth in fiscal 2020 and beyond.
At ESPN+, Disney's had a strong start with over 2 million paid subs currently. This start was buoyed by the first UFC event in January, which saw over 600,000 sign-ups in the lead-up to the event. While sign-ups were strong, there were technical issues with the stream during the event itself. We expect that Disney will iron out these issues before the launch of Disney+ later this year.
While the studio business was weak in the fiscal first quarter, the company does have a strong slate for the remainder of fiscal 2019, including Captain Marvel in March, Avengers in May, and then Toy Story in June. While the company may not be able to match its 2018 record-breaking at the box office, all of the titles will be available at launch or soon afterward on Disney+, one of the reasons we remain positive on management's big bet on the future of Disney.
We are maintaining our $130 fair value estimate for Disney. With shares trading in the 4-star territory, the current price point may offer attractive entry point for investors.
Susan Dziubinski: Investors have until April 15 to make an IRA contribution if they want it to count for 2018. Joining me today to discuss three very different investment ideas for an IRA is Christine Benz, Morningstar's director of personal finance.
Christine, it's a pleasure to be here with you.
Christine Benz: Susan, it's great to be here with you.
Dziubinski: Now, your first pick is a fund that focuses on foreign stocks. Why do you think it's important for investors today to be considering this asset class?
Benz: Well, the main thing is that we've seen foreign stocks dramatically underperform U.S. stocks. I know that a lot of U.S. investors are really feeling impatient with their foreign stock holdings. They have seen them underperform for so long. But anytime you see an asset class underperform, that's oftentimes when you should be topping it up, which is why I'm such a big believer in rebalancing, where you restore order to your asset class exposures. Foreign stocks, I think, are a place to look if you are adding new money to your portfolio at this time.
A fund I like for foreign stock exposure is called American Funds International Growth and Income. A lot of investors say, whoa--American Funds, those are load funds, I'm a no-load, do-it-yourself investor. The good news is that they have some terrific funds and they are available on no-load, no-transaction-fee platforms, like Schwab's and other brokerage firms. That's a good development for investors. This is a fund that our analyst team has given a Gold rating because they like its strategy. It's a disciplined value-conscious strategy that focuses on dividend-paying companies overseas. It has a reasonable price tag, and Americans Funds tends to hang on to its managers for many years. There are a lot of things to like about this particular fund. I have made it the core foreign stock holding in my Bucket portfolios, my mutual fund portfolios, and it's also the core foreign stock holding in my Schwab model portfolios.
Dziubinski: Your second idea is a TIPS fund. Now, who are TIPS funds best for? And why are TIPS funds a good fit for an IRA wrapper?
Benz: TIPS are Treasury-Inflation-Protected Securities. These are bonds issued by the U.S. Treasury. But the neat thing about them is that when we see inflation go up, the TIPS holder gets a little bit of an adjustment in his or her principle to account for that inflation. The reason why I would look to TIPS for older adults, in particular people who are getting close to or are in retirement is that when you are retired, and you are not taking a paycheck from an employer anymore, you are not getting those cost of living adjustments. You may be getting them through your Social Security paycheck, but the portfolio of your portfolio that you are withdrawing to live on is not automatically inflation-adjusted. Adding some TIPS to your portfolio can provide that inflation insulation. The fund that our analysts like or one of the funds that our analysts like in this category is called Schwab US TIPS ETF. It's a very low-priced index-tracking product. When our analysts have looked at this TIPS category, that's one conclusion that they have come away with, that active management hasn't really made a good case for itself here, you're better off indexing, keeping things really cheap and getting pure exposure to the asset class.
Dziubinski: Now, your last pick for an IRA may surprise some viewers, particularly since a lot of our viewers tend to be do-it-yourself investors.
Benz: Right. This is Vanguard Target Retirement--name your target retirement date. I like this suite of funds quite a bit because a lot of us use our IRAs to augment our company retirement plan assets. If you are just sort of stashing money in your IRA every year and don't have a lot of time to pay attention to it, if you have a good target-date fund, it can more or less run itself. That's one reason why I like a target-date fund in this context. The other thing to like about the Vanguard suite in particular is that these are very low cost, very minimalist sorts of products. They are composed of index funds. They are globally diversified, so they are quite global for young investors and even for older investors who have heavier fixed-income allocations, they retain a component of foreign bond exposure as well. I think that they are just great set it and don't-pay-a-lot-of-attention-to-it holdings.
Dziubinski: Christine, these are a lot of really thoughtful ideas today. Thank you for sharing them with us.
Benz: Thank you so much, Susan.
Dziubinski: I'm Susan Dziubinski for Morningstar.com. Thank you for watching.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Legendary bond investor Bill Gross announced his retirement. I'm here today with Sarah Bush. She's the director of fixed-income strategies in Morningstar's manager research group to look at his legacy. Sarah, thanks for joining me.
Sarah Bush: Thanks for having me.
Glaser: You've looked at his career over the years, and you really think there's three big pieces of legacy that he leaves. What's the first one?
Bush: The first one is that he really was responsible for pioneering at PIMCO Total Return, a total return focus to bond investing. That means moving away from just thinking about what kind of income a bond investor's going to get in a portfolio, which is obviously very important, but also thinking about that total return experience, when you look at income and what kinds of returns you get over time, make sure you're not eroding principal and that you are taking opportunities to capitalize on value opportunities in the bond market.
Glaser: What's the second major piece here?
Bush: I think the second major piece is that he really was successful at making a transition from a bottom-up corporate bond-picker when PIMCO Total Return was very small, to a world-class macro investor. PIMCO Total Return assets swelled over the time that he was running it, and he was successful at beating--there were exceptions--but for the most part, beating the index and generating really strong returns for a lot of people as those funds grew.
Glaser: The third piece of his legacy really is around the structure of the organization that he built at PIMCO. Obviously, his departure was marked with maybe not the smoothest transition in the world at first, but how do you think about his legacy at Pimco?
Bush: His departure and some of the nastiness that follows are definitely a blemish on his career. But if you look at what PIMCO is today, he clearly laid a very strong foundation for the growth of the firm and for some of the successes that have followed even in his absence. He was able to build around him a really exceptional bench of top-notch investors, and many of those investors continue to this day.
Glaser: After he left PIMCO, he landed at Janus Henderson. That's where he's retiring from. What impact would this have for, let's say, someone in a Janus bond fund, or how should we think about that piece of it?
Bush: I think the impact overall for Janus is that it probably won't be a very strong impact. When he left, when Bill Gross left PIMCO for Janus, there was a lot of speculation that he would see huge inflows to his fund, and that really didn't happen. The fund struggled to gather assets and his performance was also poor. When you look at other Janus funds that we cover, he was not involved in the running of those funds. One interesting side note of his time at Janus was we did see Gibson Smith, who had built the bond business there from the bottom up, he did depart in 2016. And so, those funds are run by his successor, but Gross' departure would not have an impact on those.
Bush: Thanks very much for having me.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
R.J. Hottovy: We see Starbucks as the most attractive investment opportunity in the restaurant category heading into 2019 as it continues to adjust its stores to better address convenience and experience need states, embrace emergent technologies and platforms to reach consumers outside its stores, and solidify its first-mover advantage in several key geographies around the globe.
In fact, heading into Starbucks' fiscal first quarter 2019, we were looking for three things: One, evidence that the in-store experience, beverage innovation, and digital engagement improvements driving recent U.S. comps had continued; two, an update on the consumer and competitive environment in China; and three, any changes to the algorithm that makes Starbucks one of the more intriguing long-term shareholder return stories in the consumer sector.
With respect to the United States, we've been encouraged by a back-to-basics approach to store operations as well as an automated inventory system--which should allow for greater customer engagement--and a beverage pipeline that should drive increased frequency. Recent sales trends have also been helped by cold beverages, which are helping to improve afternoon daypartm which has been a weakness for the company, but also improving transaction growth. We are also optimistic by several new store layouts that better isolate and address consumers' "convenience and experience" need states.
China remains competitive, but we are optimistic about Starbucks' long-term potential there due to the unique Alibaba partnership that unlocks new growth avenues and the brand's ongoing connection with younger Chinese professionals. Although early, it appears Starbucks in China is benefiting from higher transactions through this delivery partnership, and we expect transaction trends to steadily improve as heavily promotional competitors are forced to raise prices.
Management's ongoing long-term growth algorithm--7% to 9% revenue growth and EPS growth of "at least 10%"--strikes us as reasonable assumptions over the next two years but conservative over a longer horizon due to efforts in the U.S. and China as welk as its Global Coffee partnership with Nestle. We believe shares are undervalued and remain confident in the assumptions underpinning our $74 fair value estimate with several potential catalysts in the pipeline.
Christine Benz: Hi. I'm Christine Benz for Morningstar.com. IRS Publication 590 tells you everything you need to know about IRAs: contributing to them, withdrawing from them, and rolling over to them. Joining me to highlight some useful but little-known IRA rules is retirement expert Ed Slott.
Ed, thank you so much for being here.
Ed Slott: Thanks, Christine. Great to be back.
Benz: Good to have you. You know the tax code cold and especially as it relates to …
Slott: I wouldn't go that far.
Benz: Well, as it relates to IRAs. IRAs, you know this stuff. You say, though, there are some little-known rules regarding IRAs, that even sometimes advisors aren't familiar with. Let's cycle through a few of them. Starting with some that are related to contributions. And you say one that sometimes comes up is people say, well, I'm contributing to a company retirement plan, so I can't do an IRA. Not the case.
Slott: That's the most common question of all of these I get from advisors and accountants. They say they can't do a Roth, he's in a 401(k)--it's not true. Roth contributions, eligibility is only on having the income--and, obviously, if you're working for a company, you have the earnings--and income limit. But being active in a company plan does not stop you from contributing to a Roth. You know something else, it doesn't even stop you from contributing to a traditional IRA. It just may mean if income is high enough, it may not be deductible.
Benz: A related point of confusion relates to people who are later in life, they say, I'm too old to contribute to an IRA. Not the case with the Roth IRA.
Slott: That's right. It's an anomaly. We've talked about this before, where somehow when they created the IRA and Roth IRA rules, the tax writers for some reason say, let's do the opposite. Like everything's opposite. IRAs have no income limits; Roths do. IRAs have an age limit. You can't contribute to an IRA after 70 1/2; but Roths have no age limit, they have an income limit. If somebody is working at 75, they can still--if they have the earned income and they don't make too much money, enough but not too much--they can still contribute to a Roth even after age 70 1/2. Most people miss that. Not only that, you can do the spousal contribution even if the spouse is not working.
Benz: If you have one spouse working, the other one is fully retired, as long as the working spouse has enough to cover the contributions, we're good.
Slott: Right. They can each do $6,500.
Benz: One point of confusion you say comes up, this is a little bit of a head-scratcher for me, but this idea of deceased individual's family members wanting to make contributions from the deceased person's assets. Let's talk about that. Not allowed, basically.
Slott: A question does come up every year, normally from an accountant or advisors doing somebody's tax return, and the question is posed: My dad died last year, but he was working. He had the earnings. We have till April 15, can we still contribute to an IRA for him, because …
Benz: To try to reduce the tax?
Slott: Yeah. For whatever reason. The answer is no. IRS ruled on this many years ago back in the '80s, and they said you can't do it, and their reason really made sense. They said, we see no reason for a deceased person to fund for their retirement, which kind of makes sense. But here's the oddball thing. Let's say, if it was a self-employed person that had a SEP or a SIMPLE, those can be funded after death, but not IRAs. Just a strange twist of rules.
Benz: One interesting point is that in the case of a deceased military service person, there is an opportunity for the family to fund a Roth IRA. Let's talk about that.
Slott: This is not well-known. Military servicemen, who are deceased in service, they get either military death benefits or Servicemembers' Group Life Insurance, SGLI. When, let's say, a widow gets those benefits, that money, no matter how much it is, can be put right in a Roth IRA regardless of income or contribution limits, it doesn't even affect those, can be put right in a Roth IRA. Most people don't know that. It can be put in a Roth IRA and grow tax free.
And another good point about that--because people say, well, if the widow puts it in a Roth IRA, maybe she's young, what if she needs the money--that money can always be withdrawn. It's treated like contributions, tax-free. So, it's just something--everybody knows somebody, and if you pass this little tidbit on to somebody, it could really help.
Benz: Another point that you say trips people up a little bit is contribution amounts; people say, there are Roth IRAs and traditional IRAs and the contribution limit is $5,500. Can I put that in both account types?
Slott: No. The overall limit is an aggregate limit. If you put $5,500 in an IRA, you cannot also put $5,500 in a Roth. Now, if you want, you could put $2,000 in an IRA and, say, $3,500 in a Roth, but the overall limit is for IRAs and Roth IRAs.
Benz: Let's segue to talk about rollovers and transfers and so forth. You say that there's now this once-per-year IRA rollover rule that applies to spousal rollovers. Let's talk about that and talk about a work around or way that people can get away from that one-time, once-per-year rule.
Slott: Several years ago, IRS tightened up, and actually the courts based on a famous case, tightened up what's called the once-per-year IRA rollover rule. Now, this only applies when you take out the money and want to roll it over to another IRA in 60 days. You can only do that once per year, and its not a calendar year, its 365 days. There's no way out of this. So, if you do one, you can't do another one for 365 days. If you do, then that's taxable.
In a recent ruling--now it's not in the law, but it's the only guidance we have--is a recent private letter ruling. It actually came out from IRS a few years ago, said that it also applies to spousal rollover. Let's say the husband dies and he has an IRA and a Roth IRA, and the wife is the beneficiary, if she does both rollovers, one's no good because you can only do one.
So, what's the answer? Don't do rollovers. I say this in every one of my classes, my programs: Do direct transfers, direct trustee to trustee transfers where you don't touch the money in between. Because let's say in that situation, let's say there's two IRAs and one's no good, one rollover is no good. Now you don't have an IRA anymore. If it's a traditional IRA, all of that income is taxable. Just do direct transfers, especially after death. If you're a spouse inheriting from say your husband or your wife, you can do the spousal rollover, but do it only with direct transfers, then this is not an issue at all.
Benz: Is there any tax disadvantage, with the rollover versus the direct transfer, or am I missing anything?
Slott: The direct transfer is the way to go, it happens automatically. No, the problems happen when you take a check, now you have the 60-day rule, the once per year rules, too many bad things can happen. But people do it a lot, that's why I always make the case, whatever you have do because people tell me, I went to the bank, they said they'll only issue a check. No, you've got to go up the ladder and push for a direct transfer.
Benz: Let's talk about health savings accounts, HSAs. I wrote about this rule last year where we talked about what's called an HSA funding distribution. This is a once-in-a-lifetime way of funding an HSA, a health savings account with IRA assets. Let's talk about that, who might use it and when you might think about it?
Slott: People love HSAs and rightfully so, they're triple tax-free. You get a deduction when the money goes in; as the money grows, it's not taxable; when it comes out, if you use it for qualified medical expenses, also tax-free. But let's say, you don't have the money to make a contribution, whatever the limit is, you get one chance, a once in a lifetime, called a qualified HSA funding distribution, to take from your IRA and do a rollover to the HSA.
Now that is not taxable, and even though you may have received a deduction on the IRA, maybe it's pretax funds on the way in, it's not taxable going to the HSA, and you can go up to whatever the limit is, but it's a one and done. Once you've maxed out the limit, that's all and you can never do it again, but just something good to know, if you're short and you want to fund an HSA.
Benz: It's subject to the annual limit for the HSA amount that I can …
Slott: That's right. And your annual limit, whether you have a single or family plan, there are different limits.
Benz: One other point related to contributions is if someone is making a Roth IRA contribution, you're not going to find that flagged on the tax return, but you say it's still important to take note of that because it could trigger eligibility for another credit. Let's talk about that.
Slott: Right. That's the old trick question. The question is, where do I enter my Roth contribution on the tax return? And the answer is nowhere, it's invisible. That's what I love about Roth.
Benz: You'll see a traditional IRA contribution.
Slott: But not a Roth, it doesn't go on there. But anybody who does a tax return--pretty much everybody, I guess, there's some people do it by hand--but pretty much everybody uses a computer now. There's an entry point, an input to put in that Roth contribution, so if doesn't go on the return, why would you do it? Because there's something called a Retirement Saver's Credit. It doesn't apply to a lot of people. It's a low-income people, but here's who it might apply to.
Somebody who just got on their own, graduated college, has their first job, maybe didn't even work a whole year, has low income, but they're on their own, they no longer on their parents. They do a Roth contribution or maybe somebody put a contribution in for them because they have no money. They might qualify for up to $1,000 credit that otherwise would be missed if the Roth contribution wasn't entered. It's a great deal. You're making a contribution, you get no deduction for it, but you're building a tax-free account and getting a tax credit for it. Not for everybody, but if you don't put it in the software, in the program as you enter, you definitely won't get it.
Benz: Ed, great advice as always. Thank you so much for being here to discuss it with us.
Slott: Thanks, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
Christine Benz: Hi, I'm Christine Benz from Morningstar.com. How should investors expect actively managed funds to behave during market downturns? Joining me to discuss that topic is Russ Kinnel. He's director of manager research for Morningstar.
Russ, thank you so much for being here.
Russ Kinnel: Glad to be here.
Benz: Russ, we had a little bit of a shakeout in the fourth quarter of 2018. We wanted to regroup and talk about how investors should approach market downturns--if they have actively managed equity funds in their portfolios. One question I'd like you to cover is if I have an active equity fund, should I expect it to get defensive somehow in preparation for a tough time? Should I expect it to move a portion of the portfolio into cash? Do funds even do that anymore?
Kinnel: Very few funds try to make those market calls, and the reason is it's really hard to do. Generally most fund managers have found that it's better to keep doing what they are doing not try and make a market call and merely make the money back up in a rebound. So barring a few funds, you really don't want to go in expecting them to make this brilliant market call. Most active equity fund managers are stock-pickers. They are not market callers. You could go to a tactical allocation fund if that's what you want but even there it's just really hard to do.
Benz: The tactical asset allocation category is where we house that group of funds that are more active in terms of their asset allocations. But if I own, say, domestic equity large-cap blend fund, I should expect it to be more or less fully invested most of the time.
Kinnel: That's right. If the market goes down 30%, a typical active fund is going to go down about 30%.
Benz: That's a related question. If people have actively managed funds, is it realistic to expect them, even if they are fully invested, to hold up better on the downside than passively managed products?
Kinnel: We see index funds typically have about average performance compared with their peers or maybe slightly better. Which means active, also therefore is about average. What we can expect really depends on fund's strategy.
For instance, if a fund has some defensive characteristics then it will probably do better depending on where the bear market hits. For instance a fund that emphasizes high quality companies--these are companies that are generally much less hurt in recession and therefore generally do better in bear market. Or a fund might have other defensive characteristics, for instance a fund that maybe has some gold holdings, maybe they hold more in cash, do other things that give it defensive characteristics. So those kinds of funds are going to do better in some downturns, not all of them. But then your more standard fund, that's simply seeking to maximize returns over a full market cycle, there is no real reason to expect them to lose less in a down market.
Benz: If I am looking to put together a portfolio that will at least have a reasonable shot of not getting decimated in market correction or even a major downturn, how should I build a portfolio that will hold up reasonably well?
Kinnel: I think it's in that portfolio-building process where you are really going to build that defense. What you can do is have a variety of strategies, asset classes, and industry exposure because often bear markets and recessions hit one or two industries. In the '08 market it was financials. In the 2002 market it was tech. Having an active manager who stays disciplined and keeps doing what they are doing, that can really help you to stay diversified, just as it will with a passive fund as well.
That's really the way to address that, and diversification often helps to reduce the blow--it doesn't spare you any losses. But in, for instance, that 2002 bear market it really hit growth much harder than value, and so that diversification really paid off. In the '08 bear market just about all equities got hit, but fixed income at least did a lot better. Diversification helps, and that's really what to focus on.
Disciplined managers help because you don't want all your managers rushing to the hot dot, because then if that area gets hit, then you are really in trouble.
Benz: I am seeking diversification at the asset allocation level--make sure that I'm in a sane asset allocation framework given my age, my proximity to retirement--and then also, within asset classes, within equities I want to be well-diversified, within bonds I want to be well-diversified?
Kinnel: That's right. If you've done that, then you are in a much better position to ride out the down market and make money in the rally. It's the people who really haven’t taken care of that plan who have the hardest time.
Benz: Russ, great insights as always. Thank you so much for being here.
Kinnel: You are welcome.
Benz: Thank for watching. I'm Christine Benz from Morningstar.com.
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