Ruth Saldanha: It’s raining income for retirees—what should you do with all this extra yield? New drugs are driving a weight-loss trend—how can investors make money? And with an impressive quarter behind it, Salesforce remains a top pick. We’ll tell you why. This is Investing Insights.
Welcome to Investing Insights. I’m your host, Ruth Saldanha. Let’s get started with a look at your Morningstar headlines.
Salesforce’s Successful Quarter
Salesforce posted an impressive quarter. The cloud-based software company’s revenue and profits came in ahead of Morningstar’s expectations. First-quarter revenue grew 11% year over year to $8.25 billion. Salesforce’s IT automation platform, MuleSoft; international orders; and a more buoyant core business drove the strong performance. Management also noted most cloud products saw year-over-year growth of at least 50% in annual recurring revenue. The sales tied to subscriptions or long-term contracts tend to be more reliable. However, Salesforce’s professional services struggled, and the overall demand remains weak. Profitability is a bright spot. The analyst is predicting them to rise higher next year despite artificial intelligence investments. Morningstar is sticking with its $245 estimate for Salesforce shares. The stock remains a top pick.
HP’s Sales Fall
Weakening demand for PCs is weighing on HP. The tech company’s fiscal second-quarter revenue fell 22% year over year. Competitors are pressuring HP on price, and a lot of its unsold goods are piling up on the shelves of resellers. Macroeconomic headwinds are still a concern, but HP believes that it is at a turning point. It plans to reduce inventory backlog, watch costs, and take advantage of better seasonal buying patterns to bolster its second-half results. Management predicts improved sales in the third quarter. The firm has narrowed its full-year earnings-per-share range to $3.30 to $3.50. Morningstar thinks these targets are achievable but remains cautious of macroeconomic factors affecting demand. The analyst is maintaining his estimate of HP’s stock worth of $30 a share. Shares currently appear fairly valued.
Macy’s Misses the Mark
Macy’s came up short of sales expectations in the first quarter. Weather and economic issues along with uneven consumer spending hurt apparel demand. The retailer reported an 8% dip in sales, landing below Morningstar’s forecast. Despite the sales miss, gross margins rose and beat expectations. That shows progress in managing inventory and costs, although Morningstar thinks Macy’s needs more work in this area. Morningstar anticipates stronger results in the second half of the year. Our analyst plans to slightly trim the $27 estimate of Macy’s stock, but we still considers the shares undervalued.
Diabetes Drugs Take Over
There’s a lot of conversation on social media and elsewhere about the weight loss drug trend. The chatter has been around semaglutide, sold under brand names like Wegovy or Ozempic, but who is making them? And can you make money by buying the manufacturers of these hot drugs? Karen Andersen is a biotechnology strategist for Morningstar Research Services, and she just published a report about these drugs. She’s here today to talk about it.
Ruth Saldanha: Karen, thank you so much for being here today.
Karen Andersen: Oh, thanks for having me.
Saldanha: Let’s start with the basics. Why is everyone talking about these drugs?
Andersen: We’ve been in a situation for the past couple of decades where there just really haven’t been a lot of good treatments, and there’s a history with obesity drug therapies of side effects that have taken drugs off the market. There have been drugs that have failed while still even in clinical trials, and then the drugs that were on the market were only leading to something like 5% weight loss, which is not really a significant enough level to really make a difference, I don’t think, in patient lives. So, when we started seeing this next generation of drugs getting to market, and so this would be, for example, Novo Nordisk Wegovy approved in 2021, 15% average weight loss is much more significant for patients. And so I think with more than 40% of Americans falling into the category of being obese, I think that’s going to be really just a significant driver of patients starting to take these therapies.
And one other thing is that I think that this could even become, there could be even more buzz around this category, if that’s even possible, if the data that Novo Nordisk is expecting for Wegovy for cardiovascular outcomes is positive. So that data could be coming any day now, and they’re going to be seeing if patients taking Wegovy actually see lower rates of heart attacks and strokes. And so if that’s true, then I think that’ll really solidify the case that some patients need this sort of therapy. It’s not a cosmetic thing; it’s more of a medical issue where these drugs can really help.
Saldanha: Now, you cover biotechnology and the companies that innovate in this space. In fact, in the past, you’ve also covered the race for the COVID-19 vaccines. What can you tell us about some of the front-runners in this space? Are there any clear favorites at this point?
Andersen: Yeah, sure. So there really are two front-runners. So I mentioned Novo Nordisk. They did just get Wegovy approved. They’ve actually been an obesity drug market player for years. They have an older drug called Saxenda that’s still on the market, but that doesn’t work quite as well, but it’s been a leading drug and about a $2 billion obesity market. But we think with Wegovy, we think Novo is going to grow to $6 billion in obesity sales just in 2023 and eventually lead to $20 billion in annual peak sales in obesity. Eli Lilly is the other company that is really one of the key players here. They have a drug called Mounjaro that is approved in diabetes and likely to get approval in obesity by the end of the year.
Weight loss with Mounjaro looks even better, potentially 20% weight loss, and so we think sales of that could even be stronger than what Novo Nordisk is going to see with Wegovy. Both of these companies also have very strong pipelines that I think will keep them relevant in the long term, so eventually, hopefully seeing weight loss closer to 25%, which is approaching the levels that we’ve seen historically with more-aggressive therapies, things like bariatric surgery.
Why Is Pfizer Underperforming?
Saldanha: Some of these stocks, like Pfizer, for example, have been underperforming for a while now. Why is that?
Andersen: Yeah. So Pfizer, specifically—they’re a company that they’re a little bit late to the game in obesity relative to Novo Nordisk and Eli Lilly. They have a couple of oral obesity drugs that they’re trying to pick from, and one of these will likely move into the final stages of clinical trials next year. So they’re in a position where they might reach the market by around 2026, a little bit delayed. I think the shares of Pfizer, though, it’s a much more diversified company. The shares are impacted by a lot of different things, and I think specifically this year, one of the reasons why they’re underperforming is because of the huge drop in COVID vaccine sales and demand as well.
Saldanha: What are some of the risks that we are facing with these medications?
Andersen: That’s a great question given all of the enthusiasm over their efficacy, and the obesity space historically has had a bit of a checkered past when it comes to drugs. We had the fen-phen issue with damage to heart valves back in the ‘90s. There have been other drugs since then that have had cardiovascular problems or even cancer risks, and so this is definitely an area that we’re watching. The encouraging news is that Ozempic and Wegovy, which is basically this single active ingredient from Novo Nordisk, has been on the market as a diabetes therapy for the past several years. So patients are taking this chronically, and there haven’t been any red flags coming up in terms of serious safety issues. The main issue has been tolerability, so a lot of patients do have issues with things like nausea or diarrhea, but not to the level typically where it’s considered just a serious side effect.
I think that with Mounjaro, Lilly’s drug, it operates in a little bit of a different way, and it hasn’t been on the market as long. So even though there hasn’t been anything concerning bubbling up yet, that’s definitely something that we would watch as more and more patients are interested in taking it. But one of the bigger risks, actually, that’s still not sure how this is going to play out, is what about the risk of regaining weight? So it seems so far from what we’ve seen that if patients do stop taking therapy once they achieve their goal weight, they’re very likely to regain the weight. And so I think we’re going to see a lot more information about whether patients could continue taking this chronically, whether their insurance companies are willing to pay for it chronically, and potentially, hopefully, some good news on the cardiovascular benefit front that should further support being able to use these drugs chronically if needed.
Biotech Stock Picks
Saldanha: With all that in mind, what is your favorite stock pick in this space and why?
Andersen: One of my favorite names is actually Amgen. So Novo Nordisk and Lilly, yes, they’re the leaders in the space, but even assigning them about 75% of a potential $60 billion obesity market by 2030, we’re still not getting a forecast for free cash flows that’s getting us to a price that’s above where it’s trading, so they actually do look a little bit overvalued at recent prices. Amgen, on the other hand, is a company that, there have been some uncertainties recently regarding a bigger acquisition that they’re doing of Horizon Therapeutics. They’ve also faced some pricing pressure for some of their existing drugs that they’re marketing, so it’s actually an opportunity to get exposure to a company that has an obesity drug in development at a fairly decent price. Their drug, there isn’t much data on it. It’s in a midstage study right now, but it looks like it could be differentiated. So far, the data are showing efficacy that looks similar to Wegovy over only a short three-month period, actually, and the drug is moving into, it’s currently in phase 2 trials and could be administered as infrequently as once every quarter. So there could be some potential for differentiation from the leaders there.
Saldanha: Thank you so much for being here today, Karen.
Andersen: Thank you.
What Higher Yields Mean for Retired ‘Bucket’ Investors
Saldanha: For the first time in a very long time, thanks to higher interest rates, bond yields are proving attractive again. What does this mean for retirees who want income? To talk about cash yields, bond yields, and yes, dividend stocks, Morningstar Inc.’s director of personal finance, Christine Benz, sat down with the director of content, Susan Dziubinski. Here’s what they had to say.
Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Thanks to higher interest rates, a balanced portfolio of stocks and bonds is once again offering a reasonable yield. Joining me to discuss what that means in practice for retirees using a Bucket strategy for their retirement income is Christine Benz. She’s Morningstar’s director of personal finance and retirement planning. Nice to see you today, Christine.
Christine Benz: Hi, Susan. Great to see you.
Dziubinski: Let’s talk about the prevailing interest-rate environment, and if someone has that balanced 60/40 portfolio, what kind of income is that generating and throwing off today?
Benz: It’s gotten much better due mainly to the fixed-income piece. So, if we look at a very plain-vanilla U.S. stock/bond portfolio today, it’s yielding about 2.7%. If we look at my minimalist Bucket portfolio, which would just include a dash of cash, as well as a dash of international equities, you can nudge that up to closer to 3.0%, like 2.9% for a portfolio that’s slightly more diversified. That is miles ahead of where we were a couple of years ago, where you were lucky to wring like 2% from your balanced portfolio.
Dziubinski: What do you suggest investors do with these now higher income distributions they are receiving? Should they be reinvesting those, or should they be spending them?
Benz: I like the idea of retirees coming into the process with a formulated strategy about how they will deal with this. Really, there are two ways to think about it, and if I’m thinking about the Bucket portfolios that I often talk about, you could either maintain what I think of as a pure total-return strategy, where you’re reinvesting all of your income and dividend distributions right back into the portfolio and then periodically you’re taking a look at whether your portfolio needs rebalancing. So, in a period like 2019 through 2021, for example, most portfolios had appreciated equity holdings that retirees could use to fund their cash flow needs. That would be the pure total-return approach. I think if we were to ask our more academic colleagues around here, that’s probably what they would recommend.
Another strategy, though, that you could use is to pull those income distributions that are coming off of your stock and bond holdings, and just have them spilled over into your cash bucket—if you’re using this Bucket strategy, you’ve got a cash bucket that you’re spending from on an ongoing basis. Your portfolio’s income distributions will help refill that cash bucket as you’re spending from it. That’s an alternative method if you needed additional sources of cash flow, you could use rebalancing to help make up the difference. So, if you think about that 60/40 or minimalist Bucket portfolio that’s getting you about three fourths of the way to a 4% portfolio withdrawal, with that 3% organic yield. That’s another strategy. I think of it as a hybrid strategy.
Dziubinski: What are the pros and cons of these two approaches, of reinvesting all that income or using it to help provide some of the cash flow?
Benz: Sure. If you think about the pure total-return strategy, the beauty of that is that you are periodically reviewing your portfolio’s asset allocation, getting it back in line, and using the selling proceeds to fund your cash flows on an ongoing basis. The downside is that there may be years when there’s nothing to rebalance, right? Think about 2022, there was not a great source of rebalancing proceeds in most of our portfolios. So, there will be those dry years. And then the other downside of that strategy is that your portfolio is not supplying you any income distributions whatsoever. You have to go in and do the work to get the cash flows out of the portfolio. Those are the major pros and cons of the pure total-return strategy.
In terms of the hybrid strategy, I think there’s a lot to like about it. And when I talk to retirees using this Bucket approach, they often tell me that they’re using some version of that approach where you are getting that source of cash flows on an ongoing basis coming from the portfolio. I don’t know that there’s a major downside, I suppose a big one would be if you’re automatically harvesting the income distributions. You’re not putting money back to work in your portfolio in a year like 2022 when ideally you would be reinvesting your income distributions right back into the portfolio to put more money to work in a declining market.
Dziubinski: Let’s talk about dividend stocks as an option. We know that’s a popular source of income, particularly among a lot of readers of your content on Morningstar.com. How reasonable is it to be using dividends to supply your living expenses in retirement?
Benz: I think it’s perfectly reasonable. In fact, I think it’s fine if retirees want to nudge up the focus on income production within their portfolios. I’ve not really done that when I’ve created the model portfolios, but I don’t see that there’s anything wrong with someone using like a Vanguard High Dividend Yield for their U.S. equity exposure. I would tend to want to augment that with a little bit of total stock market exposure because it’s going to give you exposure to other parts of the market. But if retirees want to dial up the dividend production, I think there’s nothing wrong with that. I would also note that international dividend-payers tend to have higher yields than U.S. today, so I wouldn’t just focus on the U.S. component in terms of nudging up my dividend yield. I’d also look overseas.
Dziubinski: And then lastly, we’ve talked a little bit about cash yields being very attractive, and we’ve also seen indications in the market that investors are actually increasing their cash holdings. Is that a defensible strategy today? Are you going to be able to generate enough cash for your income needs through an approach like this?
Benz: Well, the risk is that current cash yields, as attractive as they are, may prove ephemeral, especially if we do head into a weakening economic environment, the Fed will probably step off the gas in terms of these interest-rate increases and may even cut interest rates. Well, as a short-term investor, as a cash investor, that is not your friend, right? You’re having to put your money to work in lower-yielding securities, typically. So, even though it might provide some peace of mind to know that more of your cash flows are just coming from your cash yields today, just know that the good times that cash investors have may not last. And also bear in mind the role of inflation, which is the natural enemy of anything with a fixed payout attached to it.
Dziubinski: Christine, thank you for your time today and for talking us through retirement income against today’s backdrop. We appreciate it.
Benz: Thank you so much, Susan.
Saldanha: Thank you, Susan and Christine! That’s all for this week’s episode. Don’t forget to subscribe to Morningstar’s YouTube channel to see new videos about market news, personal finance, and investment picks. Thanks to podcast producer Jake VanKersen, who puts this show together. I’m Ruth Saldanha, an editorial manager at Morningstar. Thank you for tuning into Investing Insights.
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