Nearing Halfway Mark With Solid Lead

6/18/2012


Up 10% so far this year, our Focus List has nearly doubled the gain of the S&P 500 Index. That performance extends the Focus List's lead since its launch on Dec. 23, 1994. Returns exclude dividends, taxes, and transaction costs.

The Focus List gives our subscribers a manageable group of stocks to follow. It also forces us to concentrate on our best 12 to 17 ideas for year-ahead gains — stocks with a blend of strong operating momentum, attractive valuations, and high Quadrix scores. Such a small group of stocks cannot offer the full benefits of diversification, so investors should consider using the Focus List as one component of a larger portfolio.

Investors seeking to mimic the Focus List should hold 12.9% of the portfolio in Vanguard Short-Term Investment-Grade ($10.72; VFSTX), a short-term bond fund with relatively low volatility, and divide the rest of the money equally between the 13 stocks currently on the Focus List. That equates to a target weighting of 6.7% for each stock.

Below, we profile five of our favorite picks from the Focus List, including one new Focus pick.

Here are 2012's midyear favorites:

Apple ($576; AAPL) defies its age, blending the explosive growth of a small company with the valuation of a maturing giant. Cash provided by operations has risen by more than 45% in 10 straight quarters, with sales up at least 32%. Yet shares trade at just 14 times trailing earnings, about 10% below the five-year average.

Like clockwork, Apple churns out blockbuster products. At a June conference, the company unveiled its new MacBook Pro outfitted with a thinner case and crisper display. Apple also announced updates to its mobile operating system, including a mapping service and improved functionality of Siri, the voice-activated assistant.

Chatter about an Apple TV is growing louder. But regardless of whether the device eventually reaches the market, other catalysts should extend Apple's operating momentum. Analysts expect Apple to debut a new iPhone model this fall, possibly one that features a larger screen. And the company is boosting its enterprise sales team, as Macintosh personal computers and iPads gain acceptance with more technology managers. Apple is a Focus List Buy and a Long-Term Buy.


Before May, Bed Bath & Beyond ($72; BBBY) had not purchased an entire company since March 2007. But in the span of less than a month, the retailer announced the acquisition of a linens distributor and a specialty retailer for a combined $600 million in cash. With the deals, Bed Bath & Beyond broadens its reach in the retail space and slides up the supply chain.

In the past five years, the retailer has grown its total store count by nearly one-third. Bed Bath & Beyond is seeking more leverage with vendors, and both its size and the recent acquisitions should help. The balance sheet held $1.76 billion in cash and no long-term debt at the end of February, leaving flexibility for additional purchases.

Bed Bath & Beyond shares have responded favorably to the deals, setting an all-time high in May and still up 23% for the year. The next catalyst arrives June 20, when the retailer is slated to report May-quarter results. A serial surpriser, Bed Bath & Beyond has topped the consensus profit estimate by more than 6% in 13 consecutive quarters. That streak elevates expectations, but estimate trends are favorable, with the consensus calling for 17% higher earnings per share on 6% sales growth. Bed Bath & Beyond is a Focus List Buy and a Long-Term Buy.


The largest North American producer of nitrogen fertilizer, CF Industries ($169; CF) says its demand peaks during the spring planting season, followed by a smaller uptick after the fall harvest. Dry soil conditions threaten what had been forecasted as the largest U.S. corn crop in at least 75 years. However, a strong U.S. planting season and global supply constraints have supported fertilizer prices.

Sales gains will likely moderate in coming quarters, following eight straight quarters of at least 30% higher revenue. But weak U.S. prices for natural gas allow CF Industries to keep its costs low (the record-high operating profit margins of 2011 more than doubled those from 2007). In the past 60 days, the consensus for CF's June-quarter earnings has jumped 10% to $8.43 per share, implying 23% growth.

Free cash flow rose 12% to $1.67 billion in the past year. During that period, CF quadrupled its quarterly dividend and slashed outstanding shares by 8%. About $500 million remains on the repurchase authorization, equaling more than 4% of the share count at current prices. Five of six Quadrix scores are 90 or above, contributing to maximum ranks of 100 Overall and for both sector-specific scores. CF Industries is a Focus List Buy and a Long-Term Buy.


In May, Intel ($27; INTC) shrugged off concerns about weakness in Europe and soft business spending, projecting profit margins near the high end of its historical range. Intel has shown that growth in emerging markets and data centers can offset soft markets elsewhere. And manufacturers are trotting out a parade of new products — ultrabooks and tablets — powered by Intel semiconductors.

Seeking to add to its already prodigious production, the semiconductor giant targets capital spending of roughly $12.5 billion in both 2012 and 2013, more than double its five-year average of $6 billion. For context, Intel spent more on capital projects in the past five years than any technology company in the S&P 500 Index. Intel has generated $19.92 billion in cash from operations over the past year, up 20%.

Shares have climbed 9% this year but still trade at less than 11 times trailing earnings, 33% below the five-year average and 35% below the semiconductor industry median in the S&P 1500 Index. For 2012, the consensus calls for per-share earnings of $2.49, implying 4% growth. Yielding 3.2%, Intel is a Focus List Buy and a Long-Term Buy.


Already a Long-Term Buy, Wells Fargo ($31; WFC) is being added to the Buy List and Focus List. The bank's primary customers are U.S. consumers and smaller companies, limiting exposure to the slowdown in investment banking. By taking share in the home-mortgage market from rivals including Bank of America ($7; BAC), Wells Fargo appears positioned to benefit from another wave of refinancing — and any pickup in the sale of homes. In the past two months, full-year profit estimates have risen for Wells Fargo, and for the S&P 500 financial sector as a whole. Wall Street expects the bank to grow per-share profits 16% to $3.28 in 2012.

Wells Fargo shares, at just 11 times trailing earnings, trade well below the five-year average P/E ratio of 16. Even if the P/E holds at 11, should Wells Fargo merely match the 2012 consensus per-share-profit estimate, the stock stands to advance 13% by early 2013.

A solid balance sheet should let the bank keep rebuilding its quarterly dividend. Wells Fargo yields 2.8% — among the largest U.S. banks, only J.P. Morgan ($34; JPM) offers a higher yield. Wells Fargo earns above-average scores in all six Quadrix categories, an Overall score of 92, and 87 or higher in both sector-specific ranks.

FOCUS LIST
YTD
Total
Return
(%)
Price
Change
Since
Addition
(%)
---- 12-Mo. Growth ----
Sector Scores
Company (Price; Ticker)
Date
Added
To List
Trailing
P/E Ratio
5-Yr.
Avg.
P/E
EPS
(%)
Sales
(%)
Operating
Cash Flow
(%)
12-
Factor
Sector
Reranked
Overall
Quadrix
Overall
Score
Sector
Aetna ($43; AET)
2
2/2/12
(4)
8
10
23
1
158
72
90
85
Health Care
AGCO ($41; AGCO)
(4)
11/10/11
(9)
8
17
60
26
29
100
99
97
Industrials
Agilent Technologies
($39; A)
13
1/6/11
(5)
13
22
30
10
32
96
93
91
Health Care
Alliance Data Systems
($125; ADS)
20
5/26/11
35
16
20
37
16
15
83
86
82
Technology
Apple ($576; AAPL)
42
9/9/10
119
14
23
96
63
100
100
100
100
Technology
Bed Bath & Beyond
($72; BBBY)
23
7/28/11
24
18
16
32
8
24
94
95
93
Cons.
Discret.
CF Industries
($169; CF)
17
9/15/11
(4)
7
12
136
39
11
100
100
100
Materials
DirecTV ($43; DTV)
1
10/9/08
115
12
19
35
13
13
62
65
95
Cons.
Discret.
Intel ($27; INTC)
11
9/22/11
23
11
15
7
17
20
89
94
89
Technology
Macy's ($37; M)
15
3/29/12
(8)
12
14
29
5
33
81
72
85
Cons.
Discret.
Qualcomm
($59; QCOM)
9
2/2/12
(2)
17
23
17
39
75
76
77
71
Technology
Wells Fargo
($31; WFC)
15
6/14/12
NA
11
16
15
(4)
NA
87
97
92
Financials
Wyndham Worldwide
($51; WYN)
36
12/22/11
40
19
12
35
11
52
95
94
87
Cons.
Discret.
Focus List Average
16
27
13
17
42
19
47
87
89
90
Notes: Quadrix and sector scores are percentile ranks, with 100 the best.    Year-to-date returns and price change are through June 12.    NA Not Available.

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