Day Hagan Smart Value Strategy Update May 2025
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Summary
The DH Smart Value Portfolio continues to invest in companies producing excess returns through positive economic profitability, supported by solid balance sheets (quality), significant cash generation (profitability), and trading with considerable margins of safety (valuation). We believe these factors will continue to provide rational opportunities for the foreseeable future.
Strategy Update
Let’s just say it upfront: April provided a wild ride for equities. The S&P 500 was down -9.8% during the first five trading days, but the markets recovered and the index ended up being down only -0.68% for the month. Perhaps more surprising is that the Nasdaq Composite was up +0.85%. Value indexes across the capitalization spectrum (large-, mid-, and small-cap) significantly underperformed their growth counterparts during the month. Internationally, Japan, Germany, and Canada were also up (0.37%, 2.17%, and 0.15%, respectively). Fixed income also increased, with the Barclays Capital Aggregate Bonds Total Return up 0.42%. All of this occurred with the U.S. Dollar Index down -4.36% for the month, and -8.16% YTD. All in all, a fairly impressive performance for global financial assets given the heightened uncertainty around geopolitical risks.
Sector performance for April was also, shall we say, varied. The Information Technology sector was up +1.58%, compared to the Energy sector, which was down -13.73%. It would be easy to simply say that defensive holdings outperformed, but the reality was that Info Tech, Consumer Staples, Communications Services, Utilities, and Industrials were all positive in April. The Energy, Health Care, Materials, Financials, Real Estate, and Consumer Discretionary sectors were down. There really wasn’t a single broad-based theme driving the markets’ gyrations (that includes tariffs). Investors’ attention was drawn to whatever “scare of the day” was trending in the media. I’m almost sure I heard CNBC’s hosts shout “squirrel” a few times.
The S&P 500 bottomed on April 7 as tariff tensions eased. As we noted in our April Smart Value update (coincidentally released on April 7), “The most important question going forward is ‘Is this the peak for U.S. tariff levels?’ We suspect that it is very close, meaning that, potentially, most of the bad news related to the U.S. enacting tariffs and the levels is out. That implies that the market is primed for good news should countries acquiesce and begin to lower their tariffs on U.S. goods and services. When the news came out on April 2 (Thursday), we noted at the time that equities, while down significantly, performed better than we would have expected given the magnitude and ‘shock value’ of the announced actions. It wasn’t until China retaliated that the decline of the equity market accelerated. This epitomizes the binary outcomes expected relative to ‘tariff retaliation’ versus ‘coming to the table.’ It’s important to recognize that over the past three weeks (to the April update), prior to the announcements, equity markets have spiked higher each time a major trading partner has announced that they will work with the U.S. to lower barriers to trade. Several outlets suggest that further escalation is possible, as numerous countries are reportedly actively discussing retaliatory tariffs. However, we’ve heard this before, and so far, other countries have relented. President Trump retains the authority to enhance tariffs in response to international retaliation, which is both a wildcard and a deterrent to escalation.”
The volatile markets provided us with opportunities to upgrade our portfolio. For example, on April 4, as market internals started to weaken, we sold our holdings in Terex (TEX), PayPal (PYPL), and Nike (NKE), and trimmed J.P. Morgan (JPM). Each holding had unique risks associated with potential tariff escalation and negative earnings revisions. Our reasons were as follows:
Terex, a global heavy machinery manufacturer, relies on international supply chains and exports. Tariffs on steel, components, or finished goods from key markets like China or Vietnam—now facing 34% and 46% duties, respectively—could inflate costs and squeeze margins. Demand may also falter if trading partners retaliate, hitting Terex’s revenue.
PayPal, a digital payment giant, isn’t directly tied to physical goods but isn’t immune. Tariffs could dampen global e-commerce, a core driver of PayPal’s transaction volume. Higher consumer prices from tariffs on countries like Vietnam or Indonesia (32% duties) might reduce online spending, slowing PayPal’s growth and pressuring its stock. We also have concerns around the continued deterioration in lower-income households, formerly a sweet spot for PayPal’s revenue growth.
Nike, heavily dependent on Asian manufacturing, faces the starkest threat. With Vietnam producing half its footwear and now hit by a 46% tariff, alongside China’s 54% total levy, production costs could soar. Passing these to consumers risks demand, while absorbing them erodes profits, making Nike’s stock a tariff casualty. We used April 4’s rally in the stock (due to Vietnam expressing an interest in reducing tariffs) to exit the position and move into more defensive holdings.
We reduced exposure to JPM by repositioning the overweight holding to limit individual company risk. We still see value in the holding; however, geopolitical volatility and concerns that M&A activity, as well as debt and equity issuance, may stall in the near term due to the extreme levels of uncertainty and plummeting business and consumer confidence.
With the proceeds, we purchased two quality companies with defensive characteristics, Berkshire Hathaway (BRK.B) and J.M. Smucker (SJM). Our rationale:
Berkshire Hathaway: As markets declined over Trump’s tariff plans, BRK.B fell only slightly, outperforming plunging global indexes. Its mix of defensive businesses (insurance, utilities) and cash hoard cushions it against trade war fallout. Unlike pure manufacturers or retailers, BRK.B’s insurance and energy segments are less tariff-sensitive, and its U.S.-centric operations (e.g., BNSF, GEICO) limit overseas exposure. Buffett’s aversion to overvalued stocks—he’s been a net seller—positions BRK.B to capitalize on market dips. BRK.B isn’t immune to tariffs, but its diversified portfolio and massive cash reserves make it less vulnerable than many peers. It’s a compelling buy now for investors seeking stability amid tariff uncertainty, with upside potential if Buffett leverages a downturn. Berkshire Hathaway’s expected economic profitability expectations are within historical ranges, sales and profitability trends are positive, cash margins continue to expand, and SG&A (selling, general, and administrative) costs have been reduced.
J.M Smucker: SJM operates in the consumer staples sector, producing well-known brands like Folgers coffee, Jif peanut butter, Smucker’s spreads, and Uncrustables. These are everyday essentials with steady demand, even in economic downturns. Amid tariff-induced market volatility, SJM’s defensive nature offers a buffer. SJM’s latest earnings (reported February 25, 2025, for the quarter ending January 31) showed adjusted EPS of $2.61, beating estimates of $2.37, with net sales of $2.23 billion slightly above the $2.21 billion expected. Uncrustables and pet foods (e.g., Meow Mix, Milk-Bone) drove growth, up 11% and 8%, respectively, offsetting coffee segment weakness. This resilience suggests operational strength despite macro pressures. SJM generated $1.2 billion in operating cash flow in 2024, supporting debt reduction (net debt at $7.8 billion) and modest share repurchases. With coffee prices stabilizing, margins could improve, freeing capital for shareholder returns. Higher tariffs on unrelated goods (e.g., apparel, electronics) could reduce consumer spending power, nudging cost-conscious buyers toward cheaper private-label alternatives over SJM’s premium brands. However, staples like peanut butter and coffee tend to retain loyalty. Only 10-15% of SJM’s sales are international (primarily Canada), minimizing retaliation risks from trading partners. Expectations for SJM’s economic profitability are at the low end of the 10-year range, indicating that investors are rationally pricing SJM’s prospects. Gross margins are increasing, profitability is good, and a forward price/earnings ratio of just 11.8x is appealing.
On April 8, as the markets were gaining footing, we fortuitously purchased Hershey (HSY) and added to our Zoom (ZM) position. Our rationale:
Hershey:
The Hershey Company stands as a preeminent leader in the confectionery industry, holding a commanding 36% share of the U.S. chocolate market. Its portfolio of iconic brands, including Hershey’s, Reese’s, and Kit Kat, fortifies a robust competitive moat, underpinned by enduring brand equity. This strength affords Hershey significant pricing power and resilience against short-term commodity volatility. With over a century of heritage as a household name, the company is strategically positioned to maintain its dominance within the $36 billion U.S. confectionery market.
Hershey consistently generates substantial free cash flow, exceeding $1.5 billion annually in recent years, which supports a reliable program of dividends and share repurchases. In 2024, despite elevated cocoa costs, the company reported adjusted earnings per share of $2.69 in Q4, surpassing analyst expectations, while achieving full-year net sales of $11.202 billion. Management’s emphasis on operational efficiencies, such as supply chain optimization, combined with a planned $432 million capital expenditure in 2025, reflects a proactive commitment to sustaining profitability.
Hershey’s stock has declined nearly 40% from its 2023 peak, a correction largely attributable to transient cocoa price concerns rather than any fundamental weakness. Presently, the stock trades at compelling valuations, as indicated by its price-to-earnings and price-to-cash-flow ratios, which are notably attractive relative to historical benchmarks. Bolstered by a dividend yield of 2.8% and a 14-year record of consecutive dividend hikes, Hershey presents a strong case for income-focused investors.
From an economic value added (EVA) standpoint, Hershey’s management has delivered positive economic returns for shareholders for over 15 years. Furthermore, based on current adjusted cash returns and the prevailing stock price, the market appears to be embedding expectations significantly below the company’s historical performance. This discrepancy suggests a meaningful margin of safety based on our work.
Zoom:
Over the past year, Zoom Video Communications, Inc. (ZM) has delivered a share price increase of approximately 12.92%, outperforming the S&P 500, which has remained essentially flat, and slightly exceeding the 10.66% average gain of the “Magnificent 7” stocks. Amid the most recent market pullback, Zoom’s stock has experienced a decline broadly in line with the broader market. We view this correction as an opportune moment to augment our existing position in the company.
Currently, Zoom trades at a forward price-to-earnings (P/E) ratio of 12.58x, significantly below its long-term median of 30.86x. Beyond the forward P/E, the stock also presents compelling valuations based on additional metrics, including price-to-cash-flow and enterprise value ratios, further underscoring its attractiveness at current levels.
When evaluated through an Economic Value Added (EVA) framework, Zoom continues to generate double-digit margins for shareholders, reflecting its robust profitability. Forward-looking expectations, based on prevailing market prices, suggest an appealing risk-to-reward profile, enhancing the stock’s investment merit.
Our original investment thesis for Zoom remains firmly intact. We believe the company retains its position as a market leader, and we are leveraging the recent market volatility to increase our stake in this high-quality asset strategically.
On April 16, following President Trump’s announcement of a “90-day” pause on most tariffs (excluding China), but during a down day for equities due to announced new restrictions on semiconductor exports to China (in response, Nvidia reported a potential $5.5 billion charge related to the export limitations), and in the midst of Federal Reserve Chair Jerome Powell stating that tariffs could slow economic growth and increase inflation, we took the opportunity to upgrade our holdings once again, electing to redeploy capital into higher-quality companies exhibiting stronger fundamentals, greater resilience to macroeconomic uncertainties, and more compelling growth prospects. We sold LyondellBasell Industries (LYB) and Target (TGT).
LyondellBasell Industries grappled with persistent macroeconomic and operational challenges that significantly undermined its near-term investment merit. Those pressures, coupled with financial strain, warranted a cautious outlook and supported the strategic reallocation of capital to more resilient opportunities. Weakening global demand across key end-markets, including construction, automotive, and packaging, continued to suppress sales volumes and pricing power. These dynamics, compounded by broader economic deceleration, could potentially constrain cash flow generation, with no immediate catalysts to reverse this trend.
Target had previously demonstrated resilience in managing inflationary pressures and optimizing inventory levels, as evidenced by a 3.7% year-over-year inventory reduction in Q3 2024. However, recent tariff announcements, including potential U.S. import tariffs of up to 34% effective April 2025, threatened to increase costs for Target’s significant imported product lines, particularly private-label goods. Concurrently, weakening consumer demand, driven by declining U.S. consumer confidence and cautious spending amid high interest rates and economic uncertainty, is eroding sales momentum. Target’s Q3 2024 comparable sales declined 0.3%, reflecting softer store traffic and reduced demand for discretionary categories such as apparel and home goods, which are critical to profitability. The combination of tariff-related cost pressures and deteriorating consumer demand presented significant near-term headwinds that could further compress Target’s operating margins.
With the proceeds and some of our available cash, we purchased Cabot Corporation (CBT), Salesforce (CRM), Dropbox (DBX), and added to Qualcomm (QCOM) and JM Smucker (SJM).
Cabot Corporation:
Cabot Corporation is a leading provider of high-performance materials, focusing on sectors with substantial growth, including electric vehicles (EVs), battery storage, and advanced industrial applications. The company generated over $700 million in cash flow from operations in the past year, highlighting its operational efficiency and strong demand. With total debt at approximately $1.19 billion, only about $100 million is due in the next twelve months, giving Cabot ample financial flexibility to pursue growth initiatives and return capital to shareholders, as underscored by a recently authorized buyback program for up to 10 million shares. Currently trading at a forward P/E ratio of 10.5 and a price-to-free cash flow ratio under 10, Cabot’s stock appears undervalued compared to industry peers. The company boasts a return on invested capital (ROIC) of around 18%, surpassing its weighted average cost of capital (WACC) of 10%, reinforcing its position as a solid investment opportunity.
Salesforce:
Salesforce holds approximately a 20% share of the global CRM market, far ahead of competitors like Microsoft, Oracle, and SAP. The CRM sector is projected to grow at a compound annual growth rate (CAGR) of 12%, potentially exceeding $140 billion by 2030. In Q4 FY2025, Salesforce reported $9.99 billion in revenue, an 8% year-over-year increase, along with $3.24 billion in free cash flow, highlighting its strong liquidity. A recent 32% drop in stock price has resulted in below-average forward price-to-earnings (P/E) and price-to-free cash flow ratios, indicating a potential buying opportunity. With positive economic value added and increasing profit margins, Salesforce’s current valuation does not fully reflect its financial strengths. The company’s $10 billion share repurchase program and new dividend also signal a commitment to enhancing shareholder value, positioning it well for long-term growth amid market corrections.
Dropbox:
Dropbox continues to assert its leadership in the competitive cloud storage market with a robust subscription-based business model that caters to diverse sectors, including technology and education. With approximately 18.22 million paying users and a strong global footprint, it enjoys high customer retention and scalability, driving its revenue streams. Over the past twelve months, Dropbox has generated around $900 million in cash flow from operations, reflecting solid operational efficiency. The company is aiming for $1 billion in annual free cash flow, a target that seems achievable based on its current growth trajectory. Management has introduced a $1.2 billion share repurchase program, indicating confidence in the stock’s valuation and a commitment to shareholder returns. Despite consistently improving its Economic Value Added (EVA) margins and delivering approximately 10% annual returns since its IPO in 2018, Dropbox’s stock trades at low valuations, with a forward price-to-earnings (P/E) ratio near 10x. This underpricing suggests that the market is undervaluing Dropbox’s growth prospects. With a strong balance sheet and a focus on operational efficiency, Dropbox is well-positioned for strategic investments that enhance its collaboration tools, making it an attractive option for value-focused investors.
Qualcomm:
Qualcomm’s current stock, trading at a forward P/E of approximately 12.35 and a price-to-free cash flow ratio of about 15.49, is undervalued compared to historical norms. In Q1 FY2025, the company reported revenue of $11.7 billion, an 18% increase year-over-year, alongside a non-GAAP EPS of $3.41, outperforming projections. With a positive Economic Value Added (EVA) and recent growth rates of 61% in automotive and 36% in IoT (Internet of Things), Qualcomm’s substantial cash reserves of $14.31 billion present a strategic opportunity for investment in this leading semiconductor firm.
Turning to equity sectors for a moment, our largest sector allocations are Financials, Information Technology, Communication Services, and Consumer Staples. Our target weightings versus the Russell 1000 Value Index are as follows: Information Technology 17.5% vs. 8.8% benchmark, Healthcare 1.2% vs. 14.0%, Financials 15.7% vs. 23.6%, Consumer Discretionary 5.7% vs. 5.9%, Communication Services 13.6% vs. 4.4%, Industrials 6.7% vs. 14.6%, Consumer Staples 8.5% vs. 8.4%, Energy 5.5% vs. 6.4%, Utilities 4.9% vs. 4.9%, Materials 4.1% vs. 4.2% and Real Estate 6.3% vs. 4.8%.
The Smart Value portfolio strategy utilizes measures of economic profitability, balance sheet sustainability, cash flow generation, valuation, economic trends, monetary liquidity, and market sentiment to make objective, rational decisions about how much capital to put at risk and where to put that capital.
Please let us know if you want to discuss the portfolio in more detail or learn more about our approach.
Sincerely,
Donald L. Hagan, CFA®
Regan Teague, CFA®, CFP®
Disclosure: The aforementioned positions may change at any time.
Disclosure: *Note that individuals’ percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. Returns are based on a representative account. The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, any of its affiliates or employees, or any third-party data provider shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. Day Hagan Asset Management accounts that Day Hagan Asset Management or its affiliated companies manage, or their respective shareholders, directors, officers, and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
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