Vanguard Mid Cap ETF: Cheap Valuations And High Quality (NYSEARCA:VO)

In this world nothing can be said to be certain, except death and taxes. – Benjamin Franklin

The Vanguard Mid Cap ETF (VO), a fund that is focused on mid-cap US stocks, has not been loved in recent years. It has had an impressive Covid-recovery, finally turning positive for the year, but remains below all-time highs made in February. Of course, this is not new for mid-cap investors. In the last three years, despite overwhelmingly positive equity markets and a risk-on sentiment, mid-caps have outperformed large caps, as measured by the Vanguard S&P 500 ETF (VOO). And by a significant amount, with a gain of 47.29% for the latter in the last 3 years to a gain of only 29.38% for the former.

Looking at the holdings of the ETF, the top 10 holdings account for only 8.1% of the portfolio, as much of the company-specific risk has been diversified away. Sector-wise, the holdings are balanced, with the top 3 sectors being Technology (21%) Financials (20.6%), and Industrials (15.3%). That gives a nice balance to the ETF in growth industries and value industries, which lets you hedge out the bet on which strategy will win out over the long term after more than a decade of growth stocks flourishing. Eventually, value investing can return, and you will have exposure to those types of companies with this holding.

Source: Vanguard

Thoughtful Selections

While the Covid crisis has many challenges for the mid-cap space, the portfolio has some excellent picks. For example, Lululemon Athletica Inc (LULU) is in a unique position, as their demand has likely increased with more consumers looking for comfort while working from home, a trend that the athleisurewear company has been excellent at capitalizing on. DexCom Inc. (DXCM) recently smashed earnings expectations in late July, with revenues gaining 34%, and earnings up a whopping 541%. SBA Communications (SBAC) managed to keep their dividend and beat FFO by $0.45, also beating on revenues, in their recent earnings report as more internet was used during the stay at home period. These, among other mid-cap plays, are extremely interesting in the ability to pivot and capitalize in a poor economy and should rebound stronger if the economy can continue its up leg.

Potential Risks

  1. If the economic recession is worse than thought, mid-caps may not have enough resources to weather the storm. Bankruptcies have been happening at an increased rate, especially when you go down the capitalization ladder, and could pose trouble throughout the rest of 2020 and into 2021, especially if government stimulus fails to gain traction in Congress. Many of these companies depend on a strong consumer.
  2. The dividend yield of VO could be under pressure here, especially if there is some movement on the political side to halt buybacks and shareholder payouts. While this remains a far-off risk, it is not implausible, and should be discounted as a risk when investing in these companies. With balance sheets that are inferior to larger-cap companies, there could be more pressure to keep free cash flow for future economic pullbacks and/or business pressure, lowering the dividend yield.
  3. This holding has 357 holdings currently, with a median market cap of $18.9 billion. While you are not going to be worried about diversification, you may suffer the effect of over-diversification with that many holdings. There have been studies done that say the proper amount of holdings for accurate diversification should be around 20-50 holdings only – at 357, the number is much higher.
  4. General market risk remains high after a Federal Reserve (Fed) fueled rally in 2020 off the March lows. If the Fed fails to stoke inflation, or they do not provide enough stimulus, stock markets are at risk of another major pullback. We saw some of this in the price action in early September, when tech stocks spurred a significant decline.

The ETF VO, and its underlying holdings, have shown a great ability to weather a downturn in the recent months. Although valuations remain elevated, at 25.3x P/E, the earnings growth rate of 13.7% should make up for that level over time. This is a great fund to get domestic exposure, as its foreign direct exposure remains 0%, and with a relatively low turnover of 15.2%, you should be comfortable holding this ETF long term.

While highly diversified, there are enough excellent ideas within the portfolio that can push the ETF to new highs, eventually. Whether the overall economy and markets remain in their uptrend is a huge question, but if you are looking for a 10- to 20-year investment, VO fits the bill. The nimbleness of mid-caps should allow them to adjust to the new normal economy, and if there is progress on a vaccine in late 2020 or early 2021, many will flourish.

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JBS: Consistent Cash Generator Available At Undemanding Valuations (OTCMKTS:JBSAY)

JBS S.A.’s (OTCQX:JBSAY) recent earnings report was certainly one for the ages. The quarter featured a very strong EBITDA beat, driving above-par cash generation as well. Those who argue that Q2 might not be beaten anytime soon could well be right, however, which begs the question – why buy the stock at the peak of the cycle?

Well, I would argue that dynamics in the US beef and pork segments still look very encouraging, with a favorable export market and a sizable hog herd providing tailwinds heading into 3Q. Even assuming a deceleration in margins, cash generation remains strong, providing ample opportunity for JBS to drive growth in processed food. And at c. 5x 2021 EV/EBITDA, shares are attractively priced relative to its underlying cash generation potential.

A Quarter to Remember

On the back of a c. R$68 billion top line, JBS posted record EBITDA growth of 106% Y/Y, driving EBITDA to R$10.4 billion. In turn, the EBITDA margin reached 15.5%, which was also exceptional, considering the headline number was negatively impacted by one-off expenses related to COVID-19.

Similarly, earnings were strong at +55% Y/Y to R$3.4 billion, defying both COVID-19 and unfavorable FX headwinds. At R$9 billion, free cash flow (ex-M&A impact) benefited from both operational strengths and favorable working capital shifts, driving an implied c. 15% FCF yield for the quarter alone. As a result, the leverage ratio also moved closer to investment grade at 2.1x.

(Source: JBS Investor Presentation, Q2 2020)

A Standout US Beef Performance

US beef (60% EBITDA contribution) was the key performer, with segmental margins reaching 20.4% on 20% Y/Y price hikes in the US, along with increased cattle availability. Together, both tailwinds offset any negative volume impact from the temporary shutdown of plants during the quarter.

The production headwinds were apparent at the top line, with net revenues down 1% Y/Y to 5.6 billion. But at the EBITDA line, this was more than offset by the ongoing supply-demand mismatch in the US, which has seen demand remain heated in Q2 despite a shortfall in slaughtering capacity. As a result, despite exports declining on a Y/Y basis, the strength of the domestic market more than offset any weakness overseas.

(Source: JBS Investor Presentation, Q2 2020)

Additionally, I would also point out that the current level of profitability also comes despite one-off expenses associated with COVID-19, along with weakness in Australia and Canada. This points toward the underlying US outperformance likely being even stronger than headline numbers suggest.

US Pork and Seara Also Strong

Within the US, the pork business was also solid, with c. 240bps of margin expansion to 10.5% and segmental EBITDA rising 31% Y/Y. The increase was largely due to increased hog availability as a result of idle industry capacity.

(Source: JBS Investor Presentation, Q2 2020)

Seara also proved resilient in Q2, with its EBITDA margin largely in line with Q1 at c.17%. Strength was broad-based across volumes (+12% Y/Y) and prices (+9% Y/Y), likely reflecting incremental demand for processed foods through the COVID-19 pandemic. I would, however, note that the c. 17% margin was clouded by several one-off costs, and as a result, headline EBITDA margins may understate the segment’s underlying performance.

(Source: JBS Investor Presentation, Q2 2020)

Strengthened Balance Sheet to Fund Incremental Growth Opportunities

Encouragingly, JBS has funneled its incremental cash flow from Q2 largely into debt paydown, driving a sequential decline in net debt of R$2.5 billion (to R$54.5 billion as of end-Q2). This leaves the company with a sizable cash hoard at $4.8 billion (including a $1.6 billion revolver), which leaves it with plenty of headroom with regard to its debt load. It also paves the way for JBS to invest in incremental growth opportunities (either organically or through M&A), such as processed foods and value-added products.

(Source: JBS Investor Presentation, Q2 2020)

Interestingly, management outlined that COVID–19 has accelerated demand in ready-to-eat, easy-to-cook, along with healthy food products, which highlights the bright outlook ahead for processed foods. Therefore, although processed foods contributed c. 20% of total revenue pre-COVID-19, I expect the contribution to increase going forward. This would be a key positive – a mix shift toward processed foods will likely prove accretive, considering it tends to command a higher multiple relative to fresh food players.

Compelling Even if Margins Set to Normalize

The key question following a record quarter is whether, and by how much, margins will normalize relative to other protein producers. US beef margins will likely normalize to year-ago levels over time, with a cattle cycle downturn likely in time, as industry capacity utilization normalizes. But in the near term, segmental margins should remain high in light of shortages triggered by plant shutdowns throughout the industry.

Similarly, segments such as Seara and US pork, which have also benefited from margin expansion tailwinds, should eventually see a normalization, while Pilgrim’s Pride (PPC) should, instead, see margins rebound following a challenging Q2. But even in a margin normalization scenario, JBS still boasts industry-leading FCF conversion, with a healthy 5-10% FCF yield likely through the cycles.




FCF Conversion (% Sales)




FCF Yield




(Source: Company Data)

Yet, the valuation remains at c. 5x EV/EBITDA, which I think is far too low relative to its underlying cash generation potential. Additionally, JBS now has a more balanced capital structure, which adds to the overall resilience, while potential upcoming catalysts such as a US listing will also be worth keeping an eye on.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Asian shares start cautiously amid elevated valuations, oil skids By Reuters

© Reuters. People wearing protective masks, following the coronavirus disease (COVID-19) outbreak, are reflected on a screen showing stock prices outside a brokerage in Tokyo

By Swati Pandey

SYDNEY (Reuters) – Asian shares started Monday on the backfoot as investors grapple with sky-high valuations against the backdrop of a global economy in the grip of a deep coronavirus-induced recession while oil prices dropped sharply.

was down 0.4% ahead of a heavy week of macroeconomic data with figures on household spending, current account and gross domestic product due on Tuesday.

Some analysts expect a fresh dose of fiscal stimulus in the country before the year-end while predicting ‘Abenomics’ will be retained even after Japanese Prime Minister Shinzo Abe steps down from the helm.

Australian shares slipped 0.4% while South Korea and New Zealand’s benchmark index were off 0.1% each.

That left MSCI’s broadest index of Asia-Pacific shares outside Japan barely changed after two straight days of losses toppled it from a 2-1/2-year peak last week.

World shares hit a record high last week as central bank stimulus drove asset valuations to heady levels. The rally cooled late last week as tech stocks sold off while worries over patchy economic recovery dogged investors.

The immediate focus on the day will be on China’s exports and imports data for August, due later in the morning.

China’s exports are expected to have posted a second month of solid gains in August as more of its trading partners relaxed coronavirus lockdowns and reopened their economies, a Reuters poll showed.

U.S. stock futures opened in the red, with E-minis for the S&P 500 down 0.3% and Nasdaq futures sliding 1.1%. U.S. markets will be closed on Monday for Labor Day.

Nasdaq futures were dragged lower by the exclusion of Tesla (NASDAQ:) from a group of companies that were being added to the S&P 500.

Analysts at Jefferies (NYSE:) expect the equities market correction to extend further.

“Our risk indices have begun to turn from their euphoria highs,” Jefferies said.

“It is not unthinkable that global equities are set to churn in a range for a while as some of the orphan sectors/countries are refranchised while the richly valued sectors pause or unwind,” it added.

“On the balance of probabilities, last week’s correction has further room to go.”

Jefferies said it was switching its weighting on MSCI All World index to “tactically bearish” in the short term.

It noted that a gauge of volatility has nudged higher in the past three months alongside a steepening in U.S. 10-year to 5-year Treasury yield curve as well as the 30-year to 5-year curve.

“We wonder how much moves in both would upset the equity market,” Jefferries said.

Later this week, investors will look for data on U.S. inflation with both producer and consumer prices expected to remain mostly steady.

“With slack in the labor market and broader economy to remain for years, it’s hard to see where sustainably higher inflation will come from,” Brown Brothers Harriman said in a note.

“That said, the bottom line is that U.S. rates will stay lower for longer. Full stop.”

In commodities, oil prices dropped more than $1 a barrel, hitting their lowest since July, after Saudi Arabia made the deepest monthly price cuts for supply to Asia in five months.

Fading optimism about demand recovery amid the coronavirus pandemic also weighed. fell 2% to $38.97 a barrel. skidded 1.9% to $41.85.

Policy meetings at the Bank of Canada on Wednesday and the European Central Bank (ECB) the following day are also on investors’ radar, with both expected to keep policy steady.

Action in the forex market was muted.

In currencies, the dollar was flat against the yen at 106.27 while the euro held at $1.1838.

The British pound was a shade weaker at $1.3248 ahead of a new round of Brexit talks with the European Union on Monday.

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Rationalization: Low Rates Justify High Valuations

The “rationalization” that low rates justify high valuations is but one of several arguments used to justify overpaying for value in a late-stage bull market.

As discussed previously, one of the “bullish spins” for the market has been that “earnings are cheap” based on 2- and even 3-year forward estimates. As noted in “Justifiable Bullishness Or Is It Willful Blindness?“:

In 2020, investors are again chasing “growth at any price” and rationalizing overpaying for growth. Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today, even riskier.”

Such is also why there is the most significant disparity between growth and value on record.

This Time Is Different

The belief that this time is different from the past has always been the most dangerous of phrases for investors. However, this is where participants exist today. While it is true the excessive monetary liquidity has certainly changed short-term market dynamics, there is no evidence that it has mitigated long-term consequences.

Moreover, investors are also relying on the belief that low interest rates justify overpaying for earnings and sales.

“Valuations don’t matter as much as they did in the past because ‘this time is different’ in that interest rates are so low.”

The basic premise of the interest rate/valuation argument has its roots in the “Fed Model” as promoted by Alan Greenspan during his tenure as Federal Reserve Chairman.

The Fed Model states that when the earnings yield on stocks (earnings divided by price) is higher than the Treasury yield, you invest in stocks, and vice-versa. In other words, disregard valuations and buy yield.

There is a critical disconnect that needs to be understood.

Earnings Yield

You receive the income from owning a Treasury bond. However, there is no tangible return from the earnings yield.

For example, if I own a Treasury bond with a 1% coupon and a stock with a 2% earnings yield, if the price of both assets doesn’t move for one year – my net return on the bond is 1%, while the net return on the stock is 0%.

Which one had the better return from 2000 to the present?

Yet, analysts keep trotting out this broken model to entice investors to chase an asset class with substantially higher volatility risk and lower returns.

Low Rates Don’t Justify High Valuations

An offshoot of the Fed Model to rationalize overpaying for assets is that low interest rates justify high valuations.

However, is the recent decline in interest rates, driven by massive global Central Bank interventions, really providing valuation support? The premise is that cheaper borrowing costs boost bottom line earnings. The problem is that over the last decade, low rates have led to a deterioration in economic growth and prosperity.

The chart below takes the interest rate argument from a little different angle. I have capped interest rates from their “low point” of each interest rate cycle to the next “high point” and then compared it to the S&P 500 index. (The vertical dashed lines mark the peaks in the S&P 500 Index.)

In the majority of cases, the market tends to peak between the low point interest rates for each cycle and the next high point. In other words, a period of steadily rising interest rates is not conducive to higher equity prices.

Discounting The Discount

The primary argument is that when inflation or interest rates fall, the present value of future cash flows from equities rises, and subsequently, so should their valuation. While true, assuming all else is equal, a falling discount rate does suggest a higher valuation. However, when inflation declines, future nominal cash flow from equities also falls, and this can offset the effect of lower discount rates. Lower discount rates are applied to lower expected cash flows.

In other words, without adjusting for inflation and, in no small degree, economic growth, suggesting low rates justify overpaying for cash flows is a very flawed premise.

“Instead of regarding stocks as a fixed-rate bond with known nominal coupons, one must think of stocks as a floating-rate bond whose coupons will float with nominal earnings growth. In this analogy, the stock market’s P/E is like the price of a floating-rate bond. In most cases, despite moves in interest rates, the price of a floating-rate bond changes little, and likewise the rational P/E for the stock market moves little.

– Cliff Asness

Historically, when interest rates or infla­tion are low, the stock market’s E/P is also low, as shown in the chart above.

But when isolating the times when interest rates were meager, that has occurred twice; in the 1940s and currently. In the 1940s, stock valuations were low, along with interest rates. Therefore, the statement that low interest rates cause high valuations is a .500 batting average, which is the equivalent of a coin-flip.


  • Exceptionally high interest rates, which have occurred twice, coincided with low stock market valuations. This fact does not prove that high interest rates “cause” low stock valuations. But at least the historical record is consistent with such a statement.
  • Extremely low interest rates, which have occurred twice, have coincided with high stock market valuations only once: today. The historical record (1/2 probability) does not validate the highly confident mainstream narrative that low interest rates “cause” or extremely high stock market valuations.
  • Extremely high stock valuations have occurred three times. Only once (1/3 probability) did high stock valuations coincide with low interest rates: today.
  • If extremely low interest rates do not cause extremely high stock market valuations, then a rise in rates should not necessarily cause a decline in stocks. That is, the historical record does not support the near-certain mainstream narrative that an increase in rates will torpedo stock prices.
  • To demonstrate the ability of a consensus narrative to overwhelm analysis of historical facts and even current reality, consider that the Fed has hiked short-term interest rates five times since December 2015. Also, long-term rates bottomed in mid-2016 and have moved more than a full percent higher. Yet, the S&P 500 index has risen more than 30% since the lows in short-term and long-term rates.

As noted in “Why This Isn’t 1920. Valuations & Returns,” the highest correlation between stock prices and future returns comes from valuations.

Rationalization Low Rates, Rationalization: Low Rates Justify High Valuations

Forward Returns Suffer

There is little support for the statement that low rates support high valuations, as noted by Cliff Asness previously.

So, when pundits say it is a good time for long-term investors to buy stocks because interest rates are low, and then show you something like chart above to prove their point, please watch the tense of what they say, as what they often really mean is that it was a good time to buy stocks ten years ago, as investors are now paying a very high P/E for the stock market (perhaps fooled into doing so by low interest rates as I contend), and the story going forward may be painfully different.

– Cliff Asness

The last point is crucially important. The chart below compares earnings yield (inverted scale) to forward 5-year real returns. When E/Y has been near current levels, the performance over the next 5 years has been quite dismal.


It is imperative to remember valuations are very predictive of long-term returns from the investment process. However, they are horrible timing indicators.

Beware the investment advisor, pundit or superstar investor who is sure that extremely low rates cause incredibly high stock valuations. Or, that a rise in rates from extremely low levels will cause a decline in stock prices. Stocks may fall, and interest rates may rise, but the historical record disagrees that one causes the other.

There is much to debate about the current level of interest rates and future stock market returns. However, what is clear is the 40-year decline in rates did not mitigate two extremely nasty bear markets since 1998, just as falling rates did not mitigate the crash in 1929 and the subsequent depression.

Do low interest rates justify high valuations?

History suggests they don’t.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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… But Valuations Remain Compelling

Top 10 Reasons To Dump Growth Stocks

We have compiled this week our “hit list”, or Top 10 signs that technology stock euphoria is now present. Here we go…

Number 10. The Dow Jones Industrial Average shake-up. Following Apple’s (NASDAQ:AAPL) stock split, the folks at S&P Dow Jones felt the need to increase the weight of technology in the price-weighted Dow (Apple’s split reducing its weight in the index). So, they decided to add (NYSE:CRM), a likely bubble stock. The low-life energy stock Exxon Mobil (NYSE:XOM) was booted from the Dow. But there is historical precedent for this Dow rebalancing. In 1999, near the peak of the tech bubble, they decided to remove an energy company (Chevron (NYSE:CVX)) and add a tech company (Microsoft (NASDAQ:MSFT)). Hmm… past is precedent.

Number 9. Federal Reserve members are oblivious to the asset bubble they are blowing. This week, St. Louis Fed President James Bullard side-steps the question of inflated asset prices saying, “I don’t really think this is about monetary policy… I think our monetary policy is just right for this situation. We have a low policy rate, and we’re going to stay low for a long time.” No, James, the asset price bubble is not about monetary policy. Or is it?

Then we have super-sleuth Cleveland Fed President Loretta Mester saying this week that “I don’t feel right now that we are engendering an asset bubble. I do feel we are supporting the economy and we’re doing what we can to make sure financial markets continue to function” (in response to the question if equities are too highly priced).

Regular readers and students of the market will know that the historically the Federal Reserve has been dead wrong at most major market turning points.

Number 8. S&P 500 market cap-to-GDP ratio. Oh no, never mind this chart. Valuations remain compelling because of… interest rates. Yes that’s it, low interest rates.

Number 7. Sentiment. We have been hearing people cite individual investor surveys that suggest we are not yet at an extreme in sentiment. We beg to differ. Two exhibits. First, the Citi Research Panic/Euphoria Gauge. Since 1987, a long time ago, we only had one period in which euphoria was greater. You guessed it.

Exhibit 2, the WMA Market Sentiment Indicator. The economy is not as robust (by far) as it was last January. But investors are just as giddy.

These sentiment readings are reinforced by empirical evidence. Talking heads are still parading on CNBC and Bloomberg TV telling the public that “technology stocks still offer good value for long-term investors”. What? Just how long are they talking? #greatcontrarianindicator

Number 6. Jim Cramer keeps telling his audience over the past weeks to “own Apple, don’t trade it”. Falling in love with bubble stocks. Oh, by the way, Cramer also said a few months ago NOT to buy Apple when it was at $310. Sounds like our loquacious cheerleader is feeling euphoric.

Number 5. While we hear so many market participants cite reasons why “traditional valuation metrics” should not be a concern today (low interest rates, central bank liquidity, etc.), seeing the P/Es on the following market-leading stocks (over 50% of the Nasdaq index) DOES make us worry.

Number 4. Tesla (NASDAQ:TSLA). The electric car maker has surpassed Walmart (NYSE:WMT) as the 9th largest stock in the U.S. Walmart’s annual revenue is $523 billion. Tesla’s annual revenue is $25 billion.

Number 3. While there are many laggard stocks in the S&P 500 far from highs, the reality is that the S&P 500 is dominated by a handful of mega-cap tech stocks. And these stocks have pushed the S&P 500 price to its greatest spread with its 200-day moving average of all time. The word begins with an “O”, ends with a “T”, and in the middle is “VER-BOUGH”.

Number 2. The Put/Call Ratio. The S&P 500 put/call ratio is near historical lows. Why waste option premium buying a put when stock prices only rise?

Meanwhile, the mega cap stocks are seeing lots of option activity on the call side. Keep up those leveraged bets to the upside!

Number 1. Shorts are currently at more than a 15-year low. Enough said.


If it walks like a duck, quacks like a duck, and looks like a duck… We find human psychology amazing. Bubbles have formed continuously in asset prices throughout history. Yet each time humans are able to find the necessary excuses to convince one another that this time, the price rises are justified and it’s not a bubble. Sort of like convincing poor Charlie Brown that Lucy will finally let him kick the football. One might wonder if tech stock buyers today “must be the most stupid people alive” (in Charlie Brown’s words, not ours). While our Top 10 list may or may not convince readers of an equity bubble in formation, how can investors dismiss these infamous parabolic run-ups in technology stock price charts? Get ready, speculators, because more intelligent investors are going to yank that football away!

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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