Portfolio Review

8/25/2014


While there is no shortage of ways to underperform in the stock market, letting the fear of looking stupid drive your decision-making is among the more consistent.

Have you ever felt reluctance to sell a stock because you could have sold it much higher? Have you ever been hesitant to buy a stock that you once sold at lower prices?

If you answered yes to either of these questions, you're perfectly normal. But perfectly normal sentiments can lead to subpar investment returns, so try to clear such concerns from your head when reviewing your portfolio.

Instead, ask yourself a simple question: Does a stock rank among your favorite picks for the time frame in question? If the answer is yes, own it. If the answer is no, don't own it.

While this approach is easier said than done, our disciplined, by-the-numbers approach can help put things in perspective. For example, Apple's ($101; AAPL) Quadrix Overall score of 98 is fourth-highest on our Buy List, while its Value score of 75 ranks No. 15. The company has impressive sales, earnings, and cash-flow momentum, and its profit estimates are moving higher. The stock recently hit two-year highs but remains reasonably valued at 16 times expected current-year earnings.

Even though Apple has been on our Buy and Long-Term Buy lists without interruption since 2010, we risk getting egg on our face by putting it back on the Focus List, as the stock has gained 41% since we dropped it from the list on the Jan. 29 hotline. Still, Apple clearly qualifies as one of our top 12 to 17 picks for year-ahead returns, so it is back on the Focus List.

Based on Quadrix scores, June-quarter results, and our outlook for the year ahead, we make several rank changes in the following paragraphs. Aetna ($79; AET), reviewed in Quadrix Spotlight, is being added to the Buy List.

Jones Lang LaSalle ($136; JLL), a provider of services and investment management related to real estate, is being added to the Buy and Long-Term Buy lists. Fees related to real-estate services reached a second-quarter high in the June period, with a 23% year-to-year increase in leasing fees and a 22% increase in property and facility management. LaSalle Investment Management, the asset-management division, reported a 6% increase in advisory fees. 

Jones Lang has reported four straight quarters of at least 16% revenue growth, and cash flow has shown encouraging growth in the last three quarters. Profit estimates have jumped since the company reported June-quarter results, yet the company seems capable of exceeding the 2014 consensus of $7.65 per share. At 18 times that estimate, the stock seems reasonably valued considering the double-digit profit growth likely in 2015. Jones Lang is a Buy and a Long-Term Buy.


Lam Research ($71; LRCX), a leading maker of semiconductor equipment, is being added to the Buy and Long-Term Buy lists. The company's products help build smaller and more powerful microchips.

Like other semiconductor-equipment suppliers, Lam must endure boom-and-bust cycles. In fiscal 2014 ended June, per-share earnings nearly doubled. Just two years earlier, earnings tumbled 65% on an 18% sales decline. For fiscal 2015, the consensus calls for per-share-earnings growth of 5% to $4.65 — a conservative target given recent operating momentum. Shares seem modestly valued, with a cash-adjusted forward P/E ratio of 12.

Over the past year, the company spent $716 million on research and development, or about 16% of total revenue. During the June quarter, the company initiated a quarterly dividend of $0.18 per share and authorized an $850 million share-repurchase program. The stock, yielding 1.0%, is a Buy and a Long-Term Buy.

Downgrades

We are removing Helmerich & Payne ($100; HP) from the Buy and a Long-Term Buy lists. Up 81% since we first recommended the stock in December 2012, H&P shares now trade at 16 times trailing earnings, more than 20% above their five-year average and 28% above the median for S&P 1500 oil and gas drillers. But the stock no longer warrants a premium after H&P's June-quarter results fell short of analyst expectations, and management conceded that weakness in operating profit margins could persist for the next several quarters.

Consensus profit estimates for the September and December quarters have slipped in the past 30 days. Also troubling, cash from operations is down in three of the past four quarters. Reflecting these headwinds, the stock's Overall score is down to 82 from 96 at the end of June. H&P is being dropped from coverage and should be sold.


Qualcomm ($76; QCOM) is being removed from the Buy list but remains a Long-Term Buy. The Overall rank of 83 has been dragged down by fading scores for Earnings Estimates (30) and Performance (32), which combined with a middling Momentum rank (54) make the stock less suitable for investors focused on 12-month returns.

Uncertainties on multiple fronts threaten to pressure shares in the near term. The company remains under investigation by Chinese regulators. Additional concerns center on Qualcomm's ability to collect royalties from Chinese manufacturers and slowing smartphone growth.

However, the stock's valuation looks cheap for investors with longer time horizons. At less than 16 times trailing earnings, Qualcomm shares trade 26% below their five-year average.


We have been patient with Cisco Systems ($25; CSCO), which has made inroads in new business segments. However, the company faces both competitive and pricing pressures with its core networking business. Companywide revenue has declined in three consecutive quarters.

Profitability is also eroding. Operating margins dipped to 28.0% in the year ended July from 28.8% in the year-earlier period. Returns on equity, investment, and assets have also fallen.

While the shares remain cheap at just 12 times trailing earnings, that valuation reflects weak growth. The consensus projects per-share-profit growth of 5% in the next 12 months and 7% annually over the next five years, and we don't see many catalysts for outperformance. Subscribers should sell Cisco, which is being dropped from the Long-Term Buy List to a rating of B (average) on our Monitored List.


Rank Changes

Jones Lang LaSalle ($136; JLL) and Lam Research ($71; LRCX) are being initiated as Buys and a Long-Term Buys. Aetna ($79; AET) is being added to the Buy List. Apple ($101; AAPL) is being added to the Focus List. Helmerich & Payne ($100; HP) is being dropped from coverage. Qualcomm ($76; QCOM) is coming off the Buy List but remains a Long-Term Buy. Cisco Systems ($25; CSCO) is being dropped from the Long-Term Buy List. Vanguard Short-Term Corporate Bond ($80; VCSH) ETF now accounts for 2.4% of the Buy List and 7.4% of the Long-Term Buy List.


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