Portfolio Review

4/16/2012


List review

No stock is without flaws. But in many cases, news headlines or a surface analysis will paint a company in an overly negative light. Below, we review three recommended stocks for which first impressions may not reflect the entire picture.

EMC ($28; EMC) sports a Quadrix Value score of 46 and a reasonable — if not overly appealing — trailing P/E ratio of 19. But dig a little deeper, and you find an interesting value play. EMC owns 80% of VMware ($110; VMW), a high-flying seller of software used for cloud computing and storage. EMC's stake in VMware is worth more than $38 billion, or 62% of EMC's total market value of $61.7 billion. Excluding the value of its VMware stake, EMC trades below $11 per share — at less than 10 times trailing earnings from non-VMware operations.

EMC appears cheap considering its underlying operating momentum. In 2011, per-share profits jumped 20%, while earnings excluding contributions from VMware rose a healthy 15%. Total sales increased 18%. For 2012, Wall Street expects 15% higher per-share earnings, partly reflecting a 20% increase in VMware's profits. Excluding VMware, core per-share earnings should increase about 14% on 11% revenue growth.

With VMware shares up nearly 90% over the past 24 months, versus 48% for EMC shares, EMC's non-VMware operations seem underappreciated on Wall Street. EMC, a Buy and a Long-Term Buy, would be especially attractive on a dip to $26 or $27.


Last year, J.P. Morgan Chase ($43; JPM) spent $9 billion buying back shares, reducing the share count by more than 3%. But while the Federal Reserve last month approved the bank's plans to boost the dividend 20% and authorize another $15 billion in buybacks, CEO Jamie Dimon says J.P. Morgan will cut back on the repurchases after the shares top $45, limiting buybacks to retiring shares paid out to employees.

The $45 cut-off is not arbitrary, as Dimon suggests the target price could change as the company's tangible book value changes. It seems likely that J.P. Morgan will boost buybacks if its share price declines, or if its book value rises more quickly than the share price. When the bank decides to step up repurchases, it has the flexibility to buy big.

In the Federal Reserve stress tests, J.P. Morgan boasted the lowest loan-loss rate among large money-center banks. J.P. Morgan says it can distribute $27 billion in dividends and buybacks by the end of 2013 while still boosting its capital ratio. The indicated annual dividend of $1.20 per share equates to about $4.6 billion.At 0.9 times book value, J.P. Morgan trades slightly below its five-year average and 34% below the median for diversified financials. The bank also trades at a discount of at least 27% to its peers as measured by price/sales and price/earnings. While no bank balance sheet is pristine, J.P. Morgan's performance on the stress test suggests it is stronger than most, minimizing the risk of large write-downs in the future. J.P. Morgan, which is scheduled to post results April 13, is a Long-Term Buy.


Awash in negative publicity, St. Jude Medical ($39; STJ) shares have slumped 11% so far in April. The device maker has adopted a combative stance to defend its reputation. St. Jude attacked the accuracy of a study conducted by Dr. Robert G. Hauser and published in Heart Rhythm Journal. Hauser found that when St. Jude's Riata defibrillator leads — wires that connect pacemakers to patients' hearts — failed, the majority had multiple defects. He also cited 22 times when short-circuiting wires caused death, but said the trouble was apparently not caused by the leads' defect.

Hauser based his research on a database of adverse events for medical devices. The database itself cautions that reporting of these events is voluntary and uneven. St. Jude says its own analysis of the database found that two of the deaths were double counted and uncovered six times more deaths associated with a rival Medtronic ($37; MDT) lead than Hauser reported. The medical journal refused St. Jude's request to retract the article.

Hauser's study awakened concerns about defective St. Jude leads. The exposed wires, protruding from insulation frayed by years of the heart's beating, have only been found in older brands of leads that St. Jude no longer sells. So far, the problem has primarily surfaced in leads five to six years old, meaning it could become more pervasive as leads age. Researchers have found wire protrusions in up to 30% of their tests, well above St. Jude's original estimate of 0.47% in late 2010, reported The New York Times.

Even if it wins the battle, St. Jude may lose the war. Safety concerns could hurt sales of St. Jude's newer leads (which have a different insulation design), prompt stricter regulatory oversight for the entire industry, or ultimately trigger a shift toward alternative drug therapies. More data on St. Jude leads will probably be released at the Heart Rhythm Society meeting in early May. St. Jude Medical remains a Long-Term Buy. Medtronic is rated B (average).

Microsoft buys AOL patents

Microsoft ($30; MSFT) agreed to pay $1.1 billion for 1,100 patents held by AOL ($25; AOL), outbidding the likes of Amazon.com ($187; AMZN), eBay ($35; EBAY), and Google ($627; GOOG). With legal warfare rife in the technology sector, Microsoft has assembled a patent trove covering such areas as online communications, search engines, and multimedia. Microsoft is a Buy and a Long-Term Buy. Google is a Long-Term Buy. eBay is rated B (average). Amazon.com is rated C (below average).

Corporate roundup

Macy's ($39; M) said same-store sales jumped 7.3% in March, exceeding the consensus estimate of 4.8% growth. The retailer expects same-store sales to climb 1% to 1.3% in April. Macy's is a Focus List Buy and a Long-Term Buy.


Abbott Laboratories' ($60; ABT) experimental treatment for hepatitis C performed well in two small, midstage studies. The drug cured at least 90% of patients with no prior treatment and nearly half of those who had been unresponsive to earlier treatments. Abbott said the drug could hit the market by 2015 and eventually generate annual revenue of more than $2 billion. Abbott also won approval from the European Commission to widen the use of its blockbuster drug Humira to treat ulcerative colitis. Abbott is a Long-Term Buy.


An Arkansas judge ordered Johnson & Johnson ($64; JNJ) to pay a $1.2 billion fine after a jury found the company violated state laws in the marketing of anti-psychotic drug Risperdal. J&J is appealing fines totaling $585 million from similar cases in two other states. J&J is rated B (average).


In an antitrust lawsuit, the U.S. accused Apple ($628; AAPL) and five publishers of colluding to set the retail prices of e-books. Although three of the publishers have agreed to settle the suit, Apple is preparing to fight the charges. Apple is a Focus List Buy and a Long-Term Buy.


Aetna ($48; AET) and UnitedHealth Group ($58; UNH) were two of five companies selected for a $592 million Medicaid contract in Ohio. Aetna is a Focus List Buy and a Long-Term Buy. UnitedHealth Group is a Buy and a Long-Term Buy.

Rank Changes

No changes were made this week in Dow Theory Forecasts.


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