Looking Ahead To The New Year

1/2/2012


The Mayan calendar predicts the world will end on Dec. 21, 2012. While few bears see the future as quite that dire, there is plenty of negative sentiment in the market right now — despite a number of positive indicators. Here are some of the key arguments for both sides.

Bullish case

Bulls note that 12-month earnings per share for the S&P 500 Index eclipsed prerecession levels to hit a record high in the September quarter. And profits are expected to keep rising through the end of 2012, with consensus forecasts projecting a 10% gain for the year on growth in nine of 10 sectors.

In the September quarter, profit margins at nonfinancial U.S. companies reached their highest level since 1969, according to Moody's. Companies are wringing higher earnings from low labor costs and more efficient technology, two trends that seem unlikely to change in the near term.

Better yet, many stocks, especially large-caps, look cheap relative to earnings. As of Dec. 27, the S&P 500 Index traded at 13 times estimated 2011 profits. Since 1989, the S&P 500 has averaged a quarter-end trailing P/E ratio of 19. With all that money on the sidelines and bond yields very low versus historical norms, investors will be looking for a point to re-enter the stock market.

Bearish case

Bears view analyst profit forecasts, notoriously optimistic, as fiction. Moreover, estimate-revision trends can be more important than the estimates themselves, and expectations for 2012 profits have steadily deteriorated since July.

December-quarter profits for the S&P 500 are on pace to lag September-quarter profits, the first sequential earnings decline in three years. As of Dec. 23, negative preannouncements of December-quarter results for S&P 500 companies outnumbered positive preannouncements by a ratio of 3.6-to-1, the highest since the middle of the 2001 recession.

Underlying causes for the pessimism include Europe, which continues to suffer from its credit squeeze, and a quicker-than-expected slowdown in growth in India and China. Spending by governments in the U.S. and overseas, which has supported corporate profits in the last few years, seems likely to slow as lawmakers grapple with budget deficits. And Oracle's ($26; ORCL) weak November-quarter results suggest companies are becoming more cautious about technology spending.

Looking ahead

Both the bulls and the bears make good points. Consensus estimates seem somewhat optimistic, but we still see many companies positioned for growth, yet with modest valuations.

SECTOR TRENDS
Since July 1, consensus profit-growth estimates for 2012 have trended downward for all sectors in the S&P 500 Index.
Estimated 2012
EPS Growth
Sector
As Of
July 1
(%)
As Of
Dec. 27
(%)
Cons. Discretionary
16.4
13.2
Consumer Staples
10.1
8.9
Energy
10.2
2.0
Financials
29.4
22.5
Health Care
6.1
4.5
Industrials
18.4
13.2
Materials
13.6
9.7
Technology
11.9
9.2
Telecom
14.2
8.7
Utilities
0.3
(1.9)
S&P 500 Index
14.3
9.9
Source: Thomson Reuters.

We recommend investors hunt for growth opportunities one company at a time. The table below shows recommended stocks with 2012 profit estimates that have risen in the past 60 days. All are projected to deliver 5% higher profits in fiscal 2012 and enjoy a track record for beating expectations. Four of these stocks are reviewed below.

AGCO ($43; AGCO), a maker of agricultural equipment, is projected to increase profits 13% to $4.89 per share on 12% sales growth in 2012. Analyst revisions have pushed the 2012 consensus up 10% over the last two months. That leaves the shares at just nine times projected 2012 earnings, 34% below the median for S&P 1500 Index companies that make construction equipment, farm machinery, or heavy trucks.

Global trends should help AGCO achieve double-digit profit growth over the long haul. In the U.S., farm incomes hover near record levels, increasing the likelihood of continued reinvestment in AGCO's tractors, combines, and other agricultural vehicles. However, emerging markets represent AGCO's best growth driver. In Brazil, AGCO stands to benefit from the robust sugar cane industry and bio-diesel program. And over the next five years, AGCO plans to pump $200 million into Chinese manufacturing plants. AGCO is a Focus List Buy.


Agilent Technologies ($35; A) keeps one foot in the technology sector and the other in health care. It designs electronic tests for microprocessors and consumer electronics and also makes instruments used by academic researchers and drug companies to study diseases and evaluate experimental treatments. That two-pronged approach produces remarkably consistent growth. Wall Street projections call for per-share-earnings growth of 15% in the January quarter and 7% in fiscal 2012 ending October.

Risks to reaching those profit targets center on the cyclical nature of electronics testing and potential government cutbacks to academic funding. But Agilent has less exposure to the European Union and government spending than most of its life-science peers.

Plenty of worry is already built into the share price. Relative to five-year average valuations, the stock trades at discounts of 50% on trailing earnings, 16% on sales, and 47% on operating cash flow. Agilent is a Focus List Buy and a Long-Term Buy.


Few companies have benefited more than Google ($640; GOOG) from the increase in online activity in recent years. Its share of the U.S. search market exceeds 65%, and about 53% of the 115 million smartphones shipped in the September quarter ran on Google's Android operating system. Google estimates that 700,000 new Android-based devices are being activated each day.

Going forward the company will face stout competition from Apple ($407; AAPL) and Facebook, among others, but Google remains a core holding for investors seeking exposure to the Internet's growth. Wall Street targets 19% higher per-share earnings for Google in 2012, versus just 9% for the S&P 500 Technology Sector Index. Driving that growth should be higher demand for online advertising, as well as expansion overseas.

At 15 times estimated 2012 earnings, Google shares trade at a modest 8% premium to the median for the technology sector. Google, scoring above 70 in five of six Quadrix categories, is a Focus List Buy and a Long-Term Buy.


Health insurers' profitability has improved during the downturn and muted recovery, as Americans delayed doctor visits and medical procedures. That trend probably won't last much longer, but UnitedHealth Group ($51; UNH), the largest publically traded managed-care company in the U.S. by revenue, still sees strong growth ahead. Management projects earnings per share will increase 13% to 16% annually over the next five years. Analyst estimates for 2012 have risen in the past month, but expectations appear manageable with the consensus calling for 5% profit growth on 7% higher revenue. The company has topped the consensus profit estimate in four straight quarters by an average of 23%.

As of Dec. 27, UnitedHealth had rallied 42% in 2011, outpacing the average gain of 4% for health-care stocks in the S&P 1500 Index. Yet the shares trade at less than 11 times Wall Street's 2012 profit forecast, an 17% discount to the sector median. Earning a 96 Quadrix Overall score and 97 for both sector-specific ranks, UnitedHealth Group is a Buy and a Long-Term Buy.

EARNINGS-REVISION LEADERS
The 15 recommended stocks below are projected to grow fiscal 2012 earnings at least 5%, and the consensus has ticked higher in the past 60 days. In recent quarters, all 15 stocks have delivered high-quality profit growth, as sales and cash from operations rose as well. Most of the stocks also look cheap versus their history and peers.
Outlook
Operating Momentum
Value
Company (Price; Ticker)
Est.
Fiscal
2012 EPS
Growth
(%)
Est.
Fiscal
2012 Sales
Growth
(%)
60-Day
Chg. In
Next-Yr.
EPS Est.
(%)
No. Of
Surprises,
Last 4
Qtrs.
12-Mo.
Sales
Growth
(%)
12-Mo.
EPS
Growth
(%)
12-Mo.
Oper.
Cash Flow
Growth
(%)
Trailing
P/E
5-Yr.
Avg.
P/E
P/E On
Est. 2012
EPS
Sector
P/E On
Est. 2012
EPS
Sector
Abbott Laboratories
($56; ABT)
8
4
(0.1)
4
13
11
20
12
16
11
13
Health Care
Advance Auto Parts
($71; AAP)
12
5
5.4
3
5
28
2
15
15
13
14
Cons. Discret.
AGCO ($43; AGCO)
13
12
10.3
4
28
111
36
11
19
9
13
Industrials
Agilent Technologies
($35; A)
7
5
1.3
4
21
47
75
12
24
11
13
Health Care
Alliance Data Systems
($106; ADS)
13
9
0.6
4
19
52
30
14
20
13
13
Technology
Apache ($91; APA)
7
9
1.0
3
42
34
43
8
13
7
12
Energy
Apple ($407; AAPL)
26
29
1.1
3
66
83
102
15
25
12
13
Technology
Dover ($59; DOV)
9
7
1.0
4
22
34
49
14
15
12
13
Industrials
Google ($640; GOOG)
19
23
0.6
3
30
25
38
18
30
15
13
Technology
IBM ($185; IBM)
11
3
0.2
4
9
19
2
14
14
13
13
Technology
MasterCard
($375; MA)
16
13
4.3
4
19
36
96
21
23
17
13
Technology
Qualcomm
($55; QCOM)
11
23
3.2
4
33
24
20
17
24
14
13
Technology
Rogers Commun.
($38; RCI)
5
3
1.3
3
3
9
5
13
21
12
14
Telecom Svcs.
UnitedHealth Group
($51; UNH)
5
7
0.4
4
9
16
44
11
11
11
13
Health Care
Wyndham Worldwide
($35; WYN)
16
5
4.2
4
9
33
49
15
12
13
14
Cons. Discret.
Note: The 2012 fiscal year ends in September for Apple and Qualcomm and in October for Agilent. 

 


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