Portfolio Review

11/10/2014


Buy List gains show consistency

We've committed ourselves to recommending only our favorite 25 to 30 year-ahead picks on our Buy List — and only our favorite 12 to 16 on our Focus List.

Sometimes that means downgrading stocks we liked at higher levels, including some we still like quite a bit. And sometimes that means setting ourselves up to look foolish, like when we dropped CVS Health ($88; CVS) from the Focus List in September 2013 — right before it surged 39% in 13 months.

Still, we're not going to apologize for ranking CVS somewhere between No. 17 and No. 30 during that run-up, and we're not inclined to apologize for the fact that our Focus List has crushed the S&P 500 Index by a lesser margin than our Buy List.

PERFORMANCE OF OUR LISTS
Year
Focus
List
($)
Buy
List
(%)
LT Buy
List
(%)
S&P 500
Index
(%)
Since 2003 *
222.5
274.0
194.0
130.0
2014 *
20.3
19.6
18.1
9.5
2013
36.0
42.8
42.7
29.6
2012
14.2
16.0
15.8
13.4
2011
(4.8)
(9.1)
(4.2)
0.0
2010
19.5
12.7
10.3
12.8
2009
40.0
37.6
30.6
23.5
2008
(48.8)
(46.3)
(36.5)
(38.5)
2007
22.8
19.2
10.8
3.5
2006
12.9
16.9
9.7
13.6
2005
8.1
13.2
4.1
3.0
2004
17.5
22.4
9.0
9.0
2003
20.2
29.2
24.6
26.4
* As of Nov. 5.     Returns assume fully invested portfolios, excluding dividends and transaction costs.

Do we wish the returns of the Focus List and Buy List were reversed? Sure. We would look smarter.

Remember, though, that finding an investment adviser who thinks he or she is smart is not your goal. You want a record of success that is repeatable, and the superior performance of our broader Buy List points to the merits of our disciplined, quantitative-plus approach. Our success reflects a system, not a few huge winners.

This week, responding to third-quarter results and shifting scores in our Quadrix® rating system, we are making several rank changes.

Focus List additions

Jones Lang LaSalle ($141; JLL), a provider of real-estate-related services and investment management, is being added to the Focus List after posting impressive results for the September quarter. Both per-share profits and sales rose more than 20%, topping consensus estimates.

Jones Lang says it expects rental rates for prime office space to rise in most key markets. Since the report, profit estimates have risen for the December (projected to grow 15%) and March (41%) quarters. Jones Lang, with an Overall rank of 98, is a Focus List Buy and a Long-Term Buy.


Semiconductor-equipment maker, Lam Research ($80; LRCX) is being upgraded to the Focus List. Shares have advanced 11% since we added Lam to our Buy and Long-Term Buy lists in late August, outpacing the S&P 1500's gain of less than 2%. The company grew September-quarter sales 13% and per-share profits 19%, topping the consensus on both measures.

Management says spending on wafer-fabrication equipment could rise 5% to 10% in calendar year 2015 — and growth within Lam's specialty areas should comfortably exceed the overall industry. Lam is a Focus List Buy and a Long-Term Buy.

Other upgrades

F5 Networks ($125; FFIV), a maker of products for computer networks, is being added to the Buy and Long-Term Buy lists. The company has posted double-digit sales growth in four of the last five fiscal years. Operating income jumped 15% on an 18% sales gain in the September quarter, reflecting strong demand for network-security products in the wake of increased cyber attacks on large companies. Buybacks reduced the share count by more than 5% year-over-year, keying a 25% increase in per-share earnings excluding items.

While not cheap at 20 times expected year-ahead earnings, F5 trades in line with peers and at a sharp discount to its five-year norm. F5, with a Quadrix Overall score of 96, is a Buy and a Long-Term Buy.


Travelers ($101; TRV), a leading provider of property and casualty insurance, is being added to the Long-Term Buy List. A quiet hurricane season triggered better-than-expected results for the September quarter, with per-share operating earnings up 11%. Total revenue rose 7%, helped by the November 2013 acquisition of a Canadian insurer.

Profit estimates for 2014 and 2015 have moved higher over the past 30 days, and Travelers earns a score of 97 for Earnings Estimates. The stock, with a Value score of 96, appears cheap versus industry peers and versus its own five- and 10-year norms. Travelers, yielding 2.2%, is a Long-Term Buy.

Downgrades

We are dropping Google ($556; GOOGL) from the Focus List due to its weak Quadrix scores and a somewhat sloppy September quarter. The stock's Overall score has fallen to 59. The latest quarter also revealed continued operating momentum, giving us confidence to keep the stock on the Buy and Long-Term Buy lists. Although Google is no longer among our very best ideas for 12-month returns, the stock still ranks among our favorite 20 to 30 picks. Google is a Buy and a Long-Term Buy.


SanDisk ($94; SNDK) is being removed from the Focus List but retains its Buy and Long-Term Buy ratings. SanDisk, a maker of flash-storage products used in consumer electronics, posted 9% lower per-share profits for the September quarter and gave disappointing guidance for the current quarter. The Overall score has slipped to 72 from 97 at the end of June. SanDisk shares trade at 14 times estimated 2015 earnings, a 15% discount to the median for S&P 1500 technology stocks. SanDisk is a Buy and a Long-Term Buy.


Qualcomm ($77; QCOM) is being removed from the Long-Term Buy list after the semiconductor company reported weak September-quarter results and a soft outlook. Qualcomm earned $1.26 per share excluding special items, missing the consensus by $0.05. Sales increased 3% to $6.69 billion, well short of the consensus of $7.02 billion. Management's guidance was similarly disappointing. Qualcomm continues to struggle to collect licensing royalties in China, where it also faces an antitrust probe. Management expects device makers to report to Qualcomm just 80% to 87% of actual shipments in calendar year 2014. Given the uncertain timing for when these problems will get resolved, the stock is now rated B (average) and should be sold.

Earnings check-up

CVS Health ($88; CVS) earned $1.15 per share in the September quarter excluding special items, up 10% and $0.02 above the consensus. Revenue advanced 10% to $35.02 billion, ahead of the consensus, on 16% growth from the pharmacy-services unit and 3% growth from the retail business. The company's decision to end tobacco sales weighed on retail revenue. CVS, a Buy and a Long-Term Buy, rose on the earnings news.


Cognizant Technology Solutions ($52; CTSH) grew September-quarter earnings per share 12% to $0.66 excluding special items, topping the consensus. Sales increased 12% to $2.58 billion. For the December quarter, Cognizant expects sales growth of 11% to 12%, ahead of the consensus. Shares surged on the report. Cognizant is a Buy and a Long-Term Buy.


Magna International ($103; MGA) said per-share profits soared 58% to $2.19 in the September quarter, exceeding the consensus by $0.22. Revenue advanced 6% to $8.82 billion, also ahead of the consensus, as vehicle-production volumes rose 8% in North America and 4% in Europe. Magna also raised its 2014 guidance for vehicle production in North America and Europe and turned more bullish on operating profit margins. Magna, a Focus List Buy and a Long-Term Buy, jumped on the news.


Rank Changes

Jones Lang LaSalle ($141; JLL) and Lam Research ($80; LRCX) are being added to the Focus List, replacing Google ($556; GOOGL) and SanDisk ($94; SNDK), which are being dropped from the Focus List but remain Buys and Long-Term Buys. F5 Networks ($125; FFIV) is being initiated as a Buy and a Long-Term Buy. Travelers ($101; TRV) is being added to the Long-Term Buy List, replacing Qualcomm ($77; QCOM), which is being dropped from the list. The Vanguard Short-Term Corporate Bond ETF ($80; VCSH) now accounts for 6.5% of the Buy List and 6.6% of the Long-Term Buy List.


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