Need Ideas? Here's Our Lucky 7

10/21/2013


Any honest money manager will admit it's tough to beat the market.

There's a reason many professional investors follow contrarian strategies. Markets tend to outperform after sentiment becomes bearish, suggesting investors frequently sell low when they get nervous and buy high when they get excited. Data collected by Morningstar bears this out. For the 10 years ended 2012, investor timing of U.S. stock-fund buys and sells cost them about 1.2% annually relative to a buy-and-hold strategy.

However, even professionals fall into the same traps. Most actively managed funds underperform their benchmarks, as the managers' skill can't offset the drag of fees. According to Lipper, 63% of large-cap stock funds lagged the S&P 500 Index in the five years ended August.

Against that backdrop, the returns of our Focus List stand out. Since the start of 2004, a period including nine calendar years and most of a 10th, the Focus List has returned 106.2% excluding dividends and transaction costs, twice the S&P 500's 52.7% return. We've outperformed in seven of the last 10 years and four of the last five, including so far this year, when the Focus List has returned 25.7% versus 19.1% for the index.

Do we make mistakes? Certainly. Nobody gets it right all the time. But over most of the last decade, we've picked enough winners to offset the losers.

Of the 15 stocks currently on the Focus List, 11 have outperformed the S&P 500 by at least 1% since their addition to the list, while only four have lagged by more than 1%.

FOCUS LIST
Total Return
Growth, Last 12 Mos.
Est. EPS
--- Growth ---
Company (Price; Ticker)
Since
Added
To Focus
List
(%)
Vs.
S&P
1500
(%)
Date
Added
To Focus
List
Sales
(%)
Per-
Share
Profits
(%)
Oper.
Cash
Flow
(%)
Curr.
Year
(%)
Next
Year
(%)
Quadrix
Overall
Score
Alliance Data
($224; ADS)
143
115
5/26/11
15
9
22
13
21
66
Capital One Fin'l ($72; COF)
4
5
9/19/13
25
54
85
3
(3)
98
Cisco Systems
($23; CSCO)
(5)
(12)
6/20/13
6
14
12
4
7
89
Cognizant Tech.
($86; CTSH)
17
17
8/1/13
18
20
14
23
16
92
DirecTV ($61; DTV)
203
116
10/9/08
8
31
(3)
9
19
93
Dover ($89; DOV)
(3)
(2)
9/19/13
3
14
12
22
11
93
Express Scripts
($63; ESRX)
4
2
5/16/13
68
7
56
15
15
83
Helmerich & Payne
($75; HP)
27
11
1/10/13
11
32
29
9
(2)
99
J.P. Morgan
($52; JPM)
6
(5)
2/14/13
2
37
NA
1
14
91
Kroger ($41; KR)
17
14
5/16/13
6
35
37
7
12
97
Lear ($73; LEA)
5
5
8/1/13
7
15
42
4
25
99
Magna Int'l
($85; MGA)
62
49
1/31/13
11
8
39
9
18
98
Mylan ($39; MYL)
44
23
12/6/12
8
33
34
11
18
90
Qualcomm
($68; QCOM)
4
(8)
2/14/13
27
32
20
22
9
98
Wells Fargo
($42; WFC)
30
2
6/14/12
(1)
19
NA
15
4
94
Focus List Average
37
22
14
24
31
11
12
92
NA Not available.     Notes: Quadrix scores are percentile ranks, with 100 the best.

In the following paragraphs we briefly review our favorites on the Focus List, known as the Lucky 7. For the next 30 days, you can download two-page reports on our Lucky 7 stocks for free .

Over the last 12 months, Capital One Financial ($72; COF) grew sales 25% and per-share profits 54%. That growth didn't go unnoticed, and the shares have returned 25% so far this year. But despite the strong gains, Capital One still looks cheap at just nine times trailing earnings, 22% below the median consumer-finance company in the S&P 1500 and 23% below its own five-year average price/earnings ratio.

In August, Capital One's credit-card balances rose 0.5% from July to 16% above year-earlier levels, while charge-offs declined as a percentage of card balances excluding a one-time accounting adjustment. As consumer confidence improves, we expect spending to trend higher. Capital One was scheduled to release September-quarter results Oct. 17.


Cognizant Technology Solutions ($86; CTSH) has delivered double-digit growth in sales and per-share profits in every quarter for at least 10 years. We expect that streak to continue. The consensus projects sales growth of 19% and profit growth of 13% in the second half of 2013, followed by 16% sales growth and 18% profit growth in 2014.

Demand for consulting services remains high despite the lackluster economic recovery. Rising labor costs in India and weakness in European demand could pose problems, but nothing Cognizant hasn't dealt with in the past. At less than 18 times expected 2014 earnings, Cognizant trades at a well-deserved premium to its peers. But Cognizant looks cheap relative to its own three- and five-year averages based on several valuation ratios.


Oil prices remain above $100 per barrel and natural-gas prices have risen 14% over the last year, both trends favorable to Helmerich & Payne ($75; HP), a contract driller focused on the U.S. market. H&P's high-tech FlexRigs offer greater speed and flexibility than most rigs, particularly when it comes to horizontal drilling into shale formations. This technological differentiation has driven strong market-share gains in recent years.

Despite weak industry growth, over the last year H&P grew sales 11% and per-share profits 32%. The consensus projects per-share-profit growth of just 2% in the second half of this year and a 2% decline next year. The 2014 target seems conservative.


Lear's ($73; LEA) sales growth has accelerated in each of the last four quarters, reaching 12% in the June quarter. Per-share profits rose 15% over the last 12 months, and profits topped estimates by 18% in the March and June quarters. Analysts expect roughly flat profits in the September and December quarters, then a 26% jump in 2014. Lear is slated to report quarterly earnings Oct. 25.

While Lear has returned 57% so far this year, it still trades at just 10 times the 2014 estimate, 36% below the industry median. Lear, which makes seats and power-management systems, generated 39% of 2012 revenue in North America, versus 35% in Europe, 17% in Asia, and 6% in the rest of the world. Going forward, Lear expects to generate a greater portion of its income overseas.


Despite sales growth of 11% and operating-cash-flow growth of 39% over the last year, Canadian auto-parts maker Magna International ($85; MGA) trades at just 14 times trailing earnings. Magna sports a discount of at least 30% to its peer-group median based on price/earnings, price/sales, and price/book ratios.

Wondering why we include a second auto-parts company in the Lucky 7? The answer is because the Lucky 7 features our very favorites and is not designed as a diversified portfolio. Besides, we see a lot of reasons for optimism about auto-parts makers.

According to the International Organization of Motor Vehicle Manufacturers, auto sales in the first half of 2013 rose 7% in the U.S. and more than 5% in emerging markets. Plenty of pent-up demand still remains among consumers in emerging markets. As these economies improve, sales growth should continue next year even as U.S. sales growth slows. In addition, while European auto production is expected to decline this year, it should pick up in 2014.


Few companies stand to gain more than Mylan ($39; MYL) from health reform's influx of new patients. Regardless of how the federal government changes the rules, saving money with generic drugs will remain in style. In addition, generics are still gaining acceptance in Europe, a market with huge growth potential.

Mylan's per-share-profit growth has topped 17% in each of the last 17 quarters. That trend likely ended in the September quarter, with consensus estimates projecting a 5% decline in per-share profits on 2% sales growth. But analysts expect profit groowth of 22% in the December quarter and 17% next year. At 14 times trailing earnings, the stock is 16% cheaper than the median drugmaker. Mylan is slated to release September-quarter earnings Oct. 31.


Qualcomm ($68; QCOM) has managed at least 23% sales growth and 30% per-share-profit growth in each of the last three quarters. Despite the growth, the shares have lagged the S&P 500 over the last year and trade at 16 times trailing earnings, 20% below the median communications-equipment stock and 24% below the three-year average P/E ratio.

The company's Snapdragon 800 has apparently become the standard application-processing chip for high-end smartphones from LG, Samsung Electronics ($1,310; SSNLF), and Sony ($20; SNE). Other new chips have helped Qualcomm build its position in LTE (Long Term Evolution), technology becoming the standard for high-speed data networks worldwide.

Want more on your stocks?

You can download two-page statistical reports on our Focus List stocks, plus all of our other monitored stocks, for free at www.DowTheory.com/Go/Lucky. For a small fee we also provide reports on several hundred other stocks, including every component of the S&P 500 Index.


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