Three Keys To Focus List Success

4/16/2012


Through April 10, the S&P 500 Index was up 8.0% for the year, its best start since 1999. The Forecasts Focus List — our 12 to 17 best stock ideas for 12-month returns — has gained 15.0%.

The Focus List’s success is not an aberration; it has outperformed the S&P 500 in five of the last eight calendar years. And as the chart above shows, the Focus List has risen 98.5% since 2003, well ahead of the 54.4% gain posted by the index.

We use the Quadrix stock-rating system as a starting point for uncovering attractive investment candidates, drawing on dozens of statistics to calculate percentile ranks for more than 4,400 U.S.-traded stocks. The perfect investment is only a myth, and no stock excels in all of the individual Quadrix variables. But we put a special emphasis on stocks with upward profit-estimate revisions, strong growth records, and modest valuations.

Below, we examine these three key criteria and a pair of Focus List stocks that score especially well in critical components that contribute to the Quadrix category scores.

Earnings Estimates

Upward revisions of analyst profit estimates tend to signal that a company is exceeding expectations. The Quadrix Earnings Estimates score has been among the most effective in the last 12 months, with the top fifth of our research universe based on that score outperforming the average stock by an average of 3.3%. We also prefer stocks with operating momentum, such as strong growth in earnings per share, sales, and cash provided by operations — the kind of growth that can spur positive estimate revisions. All four of the stocks in the table above score at least 80 in Earnings Estimates. Below we profile two stocks with both strong profit-estimate revisions and solid operating momentum.

MOMENTUM LEADERS
90-Day % Change
------ In EPS Est. ------
---------- 6-Month Growth ----------
Company (Price; Ticker)
Curr.
Qtr.
(%)
Curr.
Year
(%)
Sales
(%)
EPS
(%)
Cash
Provided By
Operations
(%)
Apple ($628; AAPL)
23
24
58
89
81
Cisco Systems ($20; CSCO)
4
4
8
23
27
Qualcomm ($66; QCOM)
8
5
40
9
215
Wyndham ($45; WYN)
2
4
11
33
294

Qualcomm’s ($66; QCOM) year-to-year sales growth has accelerated in each of the last six quarters, while cash provided by operations has risen more than 33% in four consecutive quarters. Analyst profit estimates continue to climb, with the consensus projecting 11% higher earnings per share in the March quarter and 22% growth in the June quarter. These trends help Qualcomm score in the top 5% of our research universe for Momentum and top 10% for Earnings Estimates.

As attention spans shrink, the appetite for mobile data seems to swell, with consumers demanding faster speeds for surfing the Web on portable devices. Qualcomm figures to be a leading player in the migration toward fourth-generation networks. More than a dozen companies license Qualcomm technology to connect to 4G networks. The value of Qualcomm’s chip in 4G models of Apple’s ($628; AAPL) new iPad is reportedly more than 50% higher than the 3G chip. Qualcomm should benefit from the high-profile debuts of several 4G smartphones in 2012, including the forthcoming iPhone and Windows-powered phones. Qualcomm is a Focus List Buy and a Long-Term Buy.


Wyndham Worldwide ($45; WYN) shares have rallied 18% this year, ahead of the 8% gain posted by the S&P 500 Index and the 12% advance of the consumer-discretionary sector index. The rally reflects outstanding operating momentum, with revenue growing at least 7% in every quarter last year while operating profit margins widened to 19.3% in 2011 from 17.7% in 2010. As a result, Wyndham has produced record year-over-year operating cash flow in each of the last four quarters. Buybacks have carved 18% off the share count in the past six quarters.

Wyndham operates midrange hotels and vacation timeshares. The improving economy should spur more travel. Profit estimates are marching higher, with the consensus calling for per-share earnings to rise 22% in the March quarter. Wyndham is a Focus List Buy and a Long-Term Buy.

Quality

A strong track record is no guarantee of future growth, but it can help investors identify well-managed companies. The top one-fifth of Quadrix scorers for five-year sales and five-year earnings growth topped the average stock’s return by at least 3.9% over the past 12 months. Also important is return on investment, which measures the profitability of a company by dividing income by total invested capital. Two Quality leaders are discussed below.

QUALITY LEADERS
5-Year Annualized
------ Growth Rates ------
-- Return On Investment --
Company (Price; Ticker)
Sales
(%)
EPS
(%)
Recent
(%)
Quadrix
Rank
Apple ($628; AAPL)
41
65
42
98
CF Industries ($179; CF)
26
105
24
92
DirecTV ($48; DTV)
13
25
24
91
Intel ($27; INTC)
9
23
25
93

U.S. growth is proving elusive for DirecTV ($48; DTV) and other pay-TV providers. About one million pay-TV subscribers dropped their service last year in favor of online alternatives, according to a survey conducted by Convergence Consulting Group. An estimated 930,000 subscribers are expected to cut the cord this year. Complicating matters, DirecTV expects programming costs to rise at roughly twice the rate as subscriber fees this year.

DirecTV hopes to counter the constraints of the mature U.S. market by pushing further into Latin America (19% of 2011 revenue, 37% of subscribers). The company expects both subscribers and revenue in Latin America to double in the next five years. Compared to the U.S., Latin America enjoys lower programming costs and virtually no retransmission fees. DirecTV satellites can beam services to rural areas where building out cable networks is prohibitively expensive. Brazil’s emerging middle class is embracing pay-TV, now in 22% of households, up five percentage points in the past year. DirecTV controls 30% of Brazil’s market. The company also plans to expand its wireless Internet services in Brazil and Argentina, which it could potentially bundle with its TV services, emulating a model that has worked in the U.S. DirecTV is a Focus List Buy and a Long-Term Buy.


Intel ($27; INTC) withstood the weak U.S. personal-computer market of the past couple of years by expanding its presence in emerging markets and corporate data centers. As a result, Intel’s return on investment neared 25% in 2011, the highest in more than a decade.

More than 60% of the Quadrix factors that comprise Intel’s Quality score rank in the top one-fifth of our research universe. Per-share earnings climbed at an annualized rate of 23% in the past five years. Annualized dividend growth closely followed cash provided by operations, with both rising at an annual rate of more than 14%.

Ultrabooks, extra-thin notebook computers that use Intel chips and offer touchscreens and longer battery life than traditional laptops, could help jumpstart the U.S. PC market. Intel calls Ultrabooks more functional than Apple’s ($628; AAPL) iPad and better values than the MacBook Air. The consensus calls for just 1% higher per-share profits this year on 5% revenue growth, though analyst estimates have risen over the past 60 days. Intel is a Focus List Buy and a Long-Term Buy.

Value

It can be difficult to cut bait on stocks, especially proven winners. A victim of its own success, MasterCard ($425; MA) soared 61% during its nearly yearlong stay on the Focus List. Partly because of its valuation, the stock no longer qualifies as one of our very best picks for 12-month returns, so it was removed from the Focus List in the April 2 issue. In the following paragraphs, we present two bona fide values.

VALUE LEADERS
---------- Discount To 3-Year Average ----------
Company (Price; Ticker)
Price/
Earnings
(%)
Price/Sales
(%)
Price/
Cash Flow
(%)
AGCO ($44; AGCO)
42
5
48
Cisco Systems ($20; CSCO)
33
20
15
DirecTV ($48; DTV)
25
11
11
Intel ($27; INTC)
21
8
22

Farm-equipment maker AGCO ($44; AGCO) ranks among the cheapest 3% of stocks in our research universe. At six times trailing cash flow, shares trade 48% below their three-year average. The stock is discounted 42% relative to its three-year average price/earnings ratio and 36% versus the median for makers of construction equipment, farm machinery, and heavy trucks.

The stock exemplifies our strategy of buying growth at a good value. The consensus projects profit growth of 5% for the March quarter and 13% for the full year. Shares trade at just nine times estimated 2012 earnings, 29% below their peer-group median. AGCO, slated to declare March-quarter results May 1, is a Focus List Buy.


Cisco Systems ($20; CSCO) shares look cheap from virtually every angle. At less than 12 times trailing earnings, Cisco’s P/E hovers near its lowest level in more than a decade. The shares trade 33% below their three-year average P/E and 30% below the median for communications-equipment stocks in the S&P 1500 Index. Cisco also trades at double-digit discounts relative to historical averages for sales and cash flow.

Cisco has more going for it than just valuation. Both of our sector-specific scores exceed 90, while all six Quadrix category ranks top 65. Cisco CEO John Chambers concedes that spending from the public sector — about one-fifth of the company’s revenue — will likely remain weak in coming quarters. But despite public-sector weakness, per-share earnings are projected to rise 14% in fiscal 2012 ending July. Cisco Systems is a Focus List Buy and a Long-Term Buy.


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