See Ya Dimon, Hello Fink: Top 10 XOUT’s for Q1 2020
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As the pace of technological change accelerates, new companies will find themselves vulnerable to disruptive challenge. When yesterday’s titans can rapidly become today’s bankruptcies, the XOUT Index continually looks to identify potential market laggards, aiming to leave them out of the portfolio.
The latest XOUT rebalance gives fresh insight into the pulse of disruption, and significantly, the players who are falling behind in the race to innovate effectively. Here we examine the 10 largest companies XOUT eliminates this quarter—the roughly $3 trillion in market cap vulnerable to secular decline. Too often human judgement is swayed by anecdote and emotion, which is why the dispassionate, and indeed unapologetic approach of XOUT may carry such potential.
XOUT Index Q4 2019 Recap
Over the strategy’s Q4 rebalance cycle, the 10 largest X’ed OUT companies together underperformed the market by a whopping 5.49% as indicated in the chart below.[i] Moreover, fully nine of the ten names suffered underperformance—even Disney amidst the enthusiasm surrounding the launch of its streaming platform still managed to underperform.
| X’ed OUT Company | Ticker | Sector | Market Cap ($B) |
| JP Morgan | JPM | Financials | 430.5 |
| Visa | V | Info. Tech | 395.6 |
| Walmart | WMT | Consumer Staples | 328.8 |
| Bank of America | BAC | Financials | 306.8 |
| Exxon | XOM | Energy | 291.2 |
| AT&T | T | Communications | 277.8 |
| Verizon | VZ | Communications | 246.8 |
| Coca-Cola | KO | Consumer Staples | 243.4 |
| Chevron | CVX | Energy | 221.0 |
| Wells Fargo | WFC | Financials | 203.6 |
Quite simply, eliminating companies at risk of long-term secular decline may be an easier way to outperform the market than trying to chase the winners. Becoming disenfranchised by technology is not merely a possibility, it is a defining reality of the current market regime. In layman’s terms, try to find a basket of steady underperformers, and just don’t own them.
XOUT Breakdown for Upcoming Quarter
Drawing on the latest available data, here are 10 largest stocks X’ed OUT for the upcoming quarter—they inhabit a multitude of sectors (even Information Technology), and encompass both oil majors. Quantitatively scored across 7 metrics—revenue, employment growth, R&D investment, gross profitability, earnings expectations, buybacks and management—these 10 companies collectively represent the 10 largest potential losers we all know and love, but may be better off withOUT.
1) JP Morgan (JPM) Are Dimons truly forever? JPM was X’ed OUT this quarter due to the combination of low deposit growth and poorly financed buy backs. For any market watcher, this elimination will certainly be a focal point as not only is it 1) the single largest XOUT, 2) it is the largest of the U.S. Banks, 3) it has been the most successful of banks in the post crisis era, 4) CEO Jamie Dimon is respected as one of the most venerated business leaders of our generation, 5) JP Morgan has been recognized for making heavy investments into technology, and 6) JPM had record profits in the latest quarter (Q4 2019).
The bottom line, however, is that deposit growth decelerated by 8.5%; such is the fundamental backbone of any financial institution’s growth, akin to subscriber growth for social media platforms. Moreover, its buy backs are not supported by cash flow- ask any analyst what JPM’s free cash flow over the last year was: negative $77 billion! This is why Jamie Dimon recently stated on CNBC his only concern about the economy is the potential for negative interest rates; they can eat banks alive from the inside out. Particularly compelling is that JP Morgan’s exodus from the XOUT index is paired with BlackRock’s reentry. Goodbye Dimon, hello Fink?
Source: Bloomberg data, 10 largest holding of XOUT Index from 10/17/19 to 1/16/20.2) Visa (V) Why is Visa excluded, and why now? True, the company features steadfast management and a history of scaling revenue, but the intractable problem for Visa is that growth expectations are less than half as positive as they were even a quarter ago—a 58% decline to be precise. Furthermore, while their management remains in the second highest quintile, there are signs the dynamism relative to the market is atrophying. Specifically, their quantified leadership score declined from 2.7 times the average S&P 500 management team to 1.4 times—still highly capable but a marked deterioration.
3) Walmart (WMT) Many investors will instinctively look to Walmart as company that has made valiant strides to counter the rise of digital commerce, pointing to the acquisitions of Jet.com and Flipkart. Why is this responsive company eliminated? While these anecdotes may resonate on an emotional basis, the mathematical reality is these actions have yet to move the needle to any meaningful extent; Walmart is simply massive. Walmart cannot even grow its revenues at the pace of inflation— on a real basis, the company’s sales are actually going backwards. Quite simply, the question is not who will merely tread water in an age of digital disruption, but thrive instead.
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4) Bank of America (BAC) While deposit growth decelerated by 30% and revenue growth by nearly 60% this quarter, the key factor that eliminated Bank of America is that the company’s buy backs outpaced its cash flows. In fact, their buy backs are twice as large as their cash flow is negative! This dynamic is the classic case of a bank going to the bank to appease shareholders on a basis its cash flows are unable to justify.
5) Exxon (XOM) Not only is Exxon the fifth largest XOUT, but it is also ranked in the bottom 2% of the model overall. For perspective, GE was the only other company over $100 billion to score worse on vulnerability to disruption, a company that lost up to 90% of its peak market cap. Not only are revenues contracting over three and a half times faster than they were a quarter ago, but the company is suffering from chronic under investment and what may generously be described as inattentive management. In fact, our analysis finds that the management is not only non-additive, but actually destructive to shareholder value, and this score became 55% more negative quarter over quarter.
Source: Bloomberg data, as of 1/16/20.6) AT&T (T) While AT&T’s revenues are growing, this is predominately due to their acquisition of Time Warner; tellingly, their sales growth is decelerating rapidly- 40% over the last quarter! From a standpoint of financial health, buy backs, management and profitability are all relegated to the second-lowest quintile.
7) Verizon (VZ) Despite the top marks for management, consistently flat revenues and a remarkable deflation of earnings expectations have imperiled company’s technological positioning. The fundamental difficulty for telecommunications, despite the interest in the emotion-ridden “race for 5G” is the digitalizing economy is transforming the nature of services telecom companies provide. Importantly, these changes are prompted by other actors, and not the telcos themselves; the 7% divesture of human capital on the year bears out this reality powerfully.
8) Coca-Cola (KO) While the soda giant features lackluster management and lagging reinvestment in R&D or share repurchases, the fundamental challenge is the continuing deflation of forward earnings expectations, which fell into the lowest quintile. It appears Steve Jobs was correct on the prospects of selling sugar-water in a digital era.
9) Wells Fargo (WFC) The once prominent but now scandal-ridden bank was eliminated only days before former CEO John Stompf given the Jordan Belfort treatment—heavily fined and barred from ever working in banking again! The key factors were slight deposit growth and a history of unsustainable revenue metrics. Wells Fargo is actually an example where the anecdotal evidence and the hard data are surprisingly consistent.
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10) Chevron (CVX) This energy major scored in the bottom 5 percentile on revenue growth and the bottom 2 percentile on gross profitability—revenue declined by over 8% last year in a strong economic environment. Moreover, Chevron was beset by unresponsive management, scoring in the lowest quintile, and a contracting base of human capital.
Flipping the Investment Paradigm
Innovation is occurring faster than the market can fully appreciate, and no company or sector is immune against this risk. A key theme unifying these top 10 XOUTs is that technology is decoupling their business models from the client value chain, both in the scale of revenue and the value emanating from it. This phenomenon is precisely the aim of XOUT Index, using a seven-point model looking to capture the pain points of disruption.
Rather than seeking to pick a select few winners, a greater potential may rest in the power of exclusion. By seeking to avoid losers, not only may such a strategy hedge its disruption risk, but it may also be on the path to sustainable outperformance potential. The aforementioned $3 trillion in excluded market cap may be a valiant starting point.
[i] Based on a market weighted basket of Berkshire Hathaway, Walmart, Proctor & Gamble, Exxon, MasterCard, AT&T, Verizon, Disney, Coca-Cola and Chevron as of 10/17/19.
Past performance is not a guarantee of future returns. One cannot directly invest in an index.
The XOUT U.S. Large Cap Index utilizes a proprietary, quantitative methodology developed by XOUT Capital, LLC designed to identify companies that have a risk of being disrupted and as a result could underperform their relevant sector. The companies identified are then excluded from the index selection.
The securities referenced are not a recommendation or solicitation to buy, hold or sell. There are no guarantees that a strategy of holding or nor holding certain securities will produce favorable results.
