We recently made a list of Morgan Stanley’s Best Overweight & Quality Stocks: Top 25 Stocks. In this piece, we will look at where The Procter & Gamble Company (NYSE:PG) ranks on the list of the top overweight and quality stocks.
The close of September has cemented the paradigm shift on Wall Street. With the Federal Reserve’s first interest rate cut being all that investors could hope for as it reduced rates by 50 basis points, since the cut, the flagship S&P stock index and the broader NASDAQ stock index are up by 2% and 3%, respectively. The rate cut has also now moved Wall Street’s focus to the next big catalyst for the stock market, i.e, the third quarter earnings season.
For a market that has touched new highs this year due to artificial intelligence, the second quarter earnings season was nothing short of fireworks. It saw the AI narrative wobble temporarily after mixed results from the world’s leading AI GPU designer and the semiconductor industry reckoned with the fate of the semiconductor manufacturing stock that ranked 5th on the list of Jim Cramer’s Top 12 Must-Watch Stocks.
Starting with the chip maker, its second quarter earnings were nothing short of a bloodbath. They saw the firm’s non GAAP net income drop by a whopping 85% annually and turn a year ago GAAP net income into a non GAAP loss of $1.6 billion. At the same time, its gross margins dropped by 0.4 percentage points, and in the worst example of the cherry on top, the firm also announced that it will be suspending dividends starting from the fourth quarter. As a result, its shares tanked by 30% after the earnings, and since then, we’ve seen multiple reports claim that other companies are interested in acquiring it.
As for the GPU designer, its second quarter revenue jumped by 122% – a no small feat considering that the year ago quarter’s revenue was $13.5 billion. However, even as the Q2 revenue of $30 billion beat analyst estimates of $28.7 billion which was fueled by its AI data center division’s revenue jumping by 154% annually, the shares fell by 6% in extended trading. At the heart of the fall was a tepid third quarter guidance of $32.5 billion (analyst estimates were $31.77 billion), a gross margin miss by 0.1 percentage point, a Q3 margin guidance miss by 0.5 percentage points, and the delay of its Blackwell GPU to the fourth quarter. For investors already worried about the ability of AI to generate a profit, the margin miss in particular wasn’t comforting. Consequently, since the earnings report, the firm’s shares are down by 1%.
However, investment bank Morgan Stanley sent the GPU designer’s shares soaring by 6.8% in September in a bullish note that shared that the firm could earn $10 billion in its fourth quarter alone from the latest Blackwell chips. This upgrade came on the back of MS remaining consistent in its analysis of the stock market this year. The key themes that it has identified are the labor market, commercial real estate, and the split in the stock market between large and small cap stocks.
In July, the bank shared that there was “ample room for equities performance to broaden, but this requires a cyclical recovery.” In simpler terms, it means that MS believed that for small cap equities to catch up to large caps in performance, the economy has to perform well. If you’re wondering how wide this gap is, data shows that for small and medium cap and large cap stocks which are in the top 20% in terms of free cash flow margins, the small and mid caps have a forward price to earnings ratio of 0.74x relative to large caps as of April 2024, which is quite low when compared to the April 2009 peak of 1.62x. MS reiterated this belief in its August report, which shared that small cap outperformance “requires economic growth acceleration with lower interest rates. While recent inflation data and the resulting decline in rates was a lift to small cap, softer economic data may constrain its continued outperformance.”
However, MS’ September report took somewhat of a different tune. It focused on the clean energy and infrastructure investments in the US to share that these could help some segments of the American stock market that are typically dependent on growth in economic activity. Government spending through the Inflation Reduction Act (IRA), the Bipartisan Infrastructure Law (BIL), and the CHIPS and Science Act have led to roughly $500 billion in commitments by the private sector to invest in a diverse set of areas ranging from roads, to clean energy manufacturing and heavy industry.
As per the bank, “Government policies such as the CHIPS Act, the Inflation Reduction Act (IRA), and the Infrastructure Act are sponsoring growth in many areas of U.S. manufacturing. These trends could offer through-the-cycle structural support to areas of the economy that are traditionally very cyclical.” On the data front, MS reveals that while in 2022, US manufacturing capacity as a percentage of 2017 output sat at ~126%, this has jumped to nearly 129% as of 2024.
Shifting gears, the third quarter earnings season will soon start to shape how investors view the market. Data from LSEG shows that the flagship S&P index is expected to deliver 5.4% annual earnings growth during Q3. FactSet is more cautious, as it shares that the index should grow earnings by 4.6% annually to mark its sixth straight quarter of growth. MS is of the view that the economy has to continue to deliver on the data front if the stock market is to perform well.
In a recent podcast, the bank’s chief investment officer and chief strategist, Mike Wilson, shared that “the unemployment rate will need to decline and the payrolls above 140,000 with no negative revisions to prior months. Meanwhile, I am also watching several other variables closely to determine the trajectory of growth. Earnings revision breadth, the best proxy for company guidance, continues to trend sideways for the overall S&P 500 and negatively for the Russell 2000 small cap index. Due to seasonal patterns, this variable is likely to face negative headwinds over the next month.”
Our Methodology
To make our list of Morgan Stanley’s best Overweight and quality stocks, we ranked the bank’s recent list of 66 stocks with Overweight ratings, a higher than median quality score, and one month upward EPS revisions by their percentage one month average analyst revisions. The average EPS data was sourced from Yahoo Finance as of September 26th 2024, and the top 25 stocks with non zero percent revisions were selected.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).
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The Procter & Gamble Company (NYSE:PG)
Number of Hedge Fund Holders In Q2 2024: 64
Average Analyst EPS % Revision: -0.5%
The Procter & Gamble Company (NYSE:PG) is one of the biggest consumer goods companies in the world. It serves consumers all over the world through a portfolio of more than 80 brands which include well known ones such as Gillette and Oral-B. Its global presence and sizeable portfolio have enabled The Procter & Gamble Company (NYSE:PG) to develop a fortress balance sheet as evidenced by cash and equivalents of $9.5 billion. The Procter & Gamble Company (NYSE:PG)’s biggest business divisions in terms of revenue are its home care and fabric businesses. During the 2024 fiscal year, the division generated $29.5 billion in revenue which accounted for 37% of The Procter & Gamble Company (NYSE:PG)’s revenue. Overall, the company’s revenue during fiscal years 2022, 2023, and 2024 was $80 billion, $82 billion, and $84 billion. This shows that The Procter & Gamble Company (NYSE:PG) has managed to grow its revenue consistently in an economy that has been constrained by inflation. This has primarily come through price increases, but as inflation drops, further growth might prove evasive right when The Procter & Gamble Company (NYSE:PG)’s expenses have also grown.
The Procter & Gamble Company (NYSE:PG)’s management shared details for pricing and volume growth during the Q2 2024 earnings call:
“Moving onto fourth quarter results, organic sales rounded down to 2%, volume was up 2%, solid sequential progress. Pricing was up 1% and mix was in line with prior year. Growth continues to be broad-based across categories and regions.
Nine of 10 product categories grew or held organic sales in the quarter. Home care, hair care, grooming and oral care were each up high single digits, feminine care up low singles, skin and personal care, fabric care, personal health care and family care were each in line with prior year, and baby care was down mid singles. Five of seven regions grew organic sales with focus markets up 2% and enterprise markets up 2% for the quarter. Organic sales in North America grew 4% with four points of volume growth and price mix, in line with prior year. European focus markets organic sales were up 2% against a strong 12% comp in the base period. Volume was up 3%. Price mix was down a point as the region has now fully annualized prior year inflation-driven pricing.
Latin America organic sales were up 8%, including high singles growth in Brazil. Of note, Argentina’s overall contribution to organic sales for the region and the company were lower than the last two quarters due to the divestiture of a portion of the business in March and a notable decline in shipment volume for the remaining categories.”
Overall PG ranks 20th when we look at Morgan Stanley’s top overweight stocks. While we acknowledge the potential of PG as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than PG but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey. All investment decisions should be made after consulting a qualified professional.
