What Do You Like?
Ultimately, your allocation to equities should depend on the answer to a fairly basic question: Can you find stocks you like? The trend and valuation of the broad market should figure in your analysis, but so should individual company prospects and the availability of investable themes. Among the themes keeping us nearly fully invested, five stand out.
• The earning power of big banks. Valuation is the main appeal of big bank stocks. Our picks — Fifth Third Bancorp ($20; FITB), J.P. Morgan Chase ($56; JPM), U.S. Bancorp ($39; USB), and Wells Fargo ($44; WFC) — earn Quadrix Value scores above 80. All four are cheap relative to the average U.S. bank stock — and relative to their own 10-year norms for price/earnings and price/book value. All four have yields of at least 2.4% and payout ratios that leave ample room for dividend growth.
Near-term profit comparisons for all four banks will be hampered by the slowdown in mortgage-refinancing volumes, and improving credit quality will provide less of an earnings tailwind next year. But all four seem capable of exceeding fairly modest consensus estimates, especially if rising interest rates key a rebound in net interest margins. J.P. Morgan, reviewed on page 6, and Wells Fargo stand to benefit as fines and compliance costs decline. Even if J.P. Morgan earns $5 per share next year instead of the $6 expected, the stock would trade at $67 in early 2015 if the trailing P/E merely returned to the 10-year average near 13.
• Rebounding demand for automobiles. U.S. auto sales have shifted into high gear, with fairly robust sales in October despite the government shutdown. Pent-up demand should support continued U.S. growth through 2014. Europe's car market is growing again after the longest downturn in several decades, and the unusually high age of the average car suggests pent-up demand will be an even bigger factor in Europe. Helped by a turnaround in China, Asian car sales seem likely to show decent growth in 2014.
Ford Motor ($17; F), rated A (above average), is our favorite among the big automakers. But we prefer to play the industry's rebound through the parts and equipment group, partly because we expect suppliers to benefit from a long-term trend toward more outsourcing. Lear ($79; LEA) and Magna International ($83; MGA), both members of our Focus List, earn Overall Quadrix scores of at least 98, with high Momentum and Quality scores complementing Value scores above 80. Both delivered encouraging September-quarter earnings, leading to upward revisions to 2013 and 2014 estimates.
• Surging U.S. oil and gas production. Among the best reasons to be bullish on the U.S. economy is the revolution in the North American petroleum market, with new drilling techniques keying sharply higher production from shale formations. U.S. oil production seems likely to show double-digit percentage growth for the third straight year in 2014, which would mark the first such three-year streak since 1905.
The production growth is already showing up in employment numbers and lower gasoline prices. Whether the cycle still favors oil and gas producers is an open question, and lately investors have had second thoughts because of concerns regarding lower realized oil prices and a tougher financing environment. But we are inclined to view the recent pullbacks in Continental Resources ($110; CLR) and Whiting Petroleum ($61; WLL) as buying opportunities, partly because both seem cheap relative to expected 2014 earnings — even if consensus estimates are 10% to 20% too high.
Helmerich & Payne ($79; HP), a Focus List member reviewed on page 6, is well positioned in the North American shale-drilling market. Among small-company stocks, Trinity Industries ($53; TRN), a leading maker of railroad tank cars, has pulled back after a strong run and seems cheap considering its profit-growth prospects. The stock, trading at less than 12 times expected 2013 earnings, is recommended in our sister publication, Upside.
• Smartphones and mobile computing. This is not a fresh theme, as analysts have been touting the mobile internet since the 1990s. But investors seem to be undervaluing the long-term growth outlooks of industry leaders Apple ($520; AAPL) and Qualcomm ($72; QCOM), both of which trade for less than 13.5 times expected next-year earnings. Excluding Google's ($1,025; GOOG) cash, the stock trades at 16 times expected 2014 earnings — a reasonable multiple for a fast-growing company with the leading position in internet advertising.
• The resilience of U.S. consumers. At least in part, a lot of our picks are predicated on the underlying resilience of the U.S. consumer. While middle- and low-income Americans are being squeezed because of sluggish wage growth, upper-income consumers account for an outsized portion of total U.S. consumer spending. We're not expecting a sharp increase in consumer spending next year, but growth should be brisk enough to fuel continued growth at such consumer-dependent companies as Alliance Data Systems ($248; ADS), CVS Caremark ($65; CVS), and Kroger ($42; KR).