Portfolio Review

3/30/2015


Rank changes

Two new stocks

We are initiating coverage of ADT ($41; ADT) as a Buy and a Long-Term Buy. The Quadrix Overall rank of 96 is supported by strong scores for Momentum (82), Value (80), Earnings Estimates (91), and Performance (91). 

Spun off from Tyco International ($43; TYC) in September 2012, ADT provides electronic-security services to nearly 7 million residential and small-business customers. Investors have worried that ADT will struggle as telecommunications companies enter the security market. However, ADT has protected its turf so far, posting 19% higher per-share profits in the December quarter and 10% growth in operating cash flow. Moreover, ADT's noncompete agreement with Tyco expired in October, expanding the company's addressable market.

The stock does not look particularly cheap based on its trailing P/E ratio of 19. But it ranks in the cheapest 25% of our research universe for several key value metrics: price/operating cash flow, price/free cash flow, and enterprise value/EBITDA.


Affiliated Managers Group ($214; AMG) is joining the Long-Term Buy List. The company's business model revolves around taking ownership stakes in boutique investment-management firms. Assets under management though its affiliates rose 15% to $620 billion last year from a combination of net inflows, investment in new asset managers, and market appreciation. The stock earns above-average scores for all six Quadrix categories, contributing to an Overall rank of 96. Both sector-specific scores exceed 85.

Affiliated Managers has produced revenue growth of at least 8% in 10 straight quarters, while cash from operations has risen by double digits in each of the past nine quarters. Free cash flow soared 47% in 2014, supplying management with fresh funds for acquisitions. Per-share profits are projected to climb 20% in 2015 on 10% revenue growth. Shares trade at just 16 times estimated year-ahead earnings, a 13% discount to the average for asset-management stocks in the S&P 1500 Index.

Two downgrades

Cognizant Technology Solutions ($61; CTSH) is being removed from the Buy and Long-Term Buy lists. Cognizant shares have dashed to a 16% gain this year and are up 94% since we added them to the Long-Term Buy List in the July 1, 2013, issue, more than tripling the S&P 500's 28% gain.

It can be difficult to sell a winner, especially if it still earns a solid Overall score of 82. But Cognizant recently posted its weakest growth in more than 15 years for annual per-share profits (17%, versus five-year annualized growth of 21%), sales (16%, 26%), and operating cash flow (3%, 17%).

With a trailing P/E ratio of 23, the stock trades roughly in line with its five-year average, and at a 5% premium to the industry median. That valuation no longer seems justified, given Cognizant's slowing growth rate and declining returns on equity and assets. Cognizant is now rated B (average) and should be sold.


ManpowerGroup ($84; MAN) shares have surged 30% since the company posted December-quarter results at the end of January. In the wake of that run-up, the stock no longer seems cheap enough to rank among our favorites, given its operating momentum and outlook.

Operating cash flow has fallen sharply in each of the past two quarters, and trailing 12-month operating cash flow trails net income, which can signal low-quality earnings. Hurt by the rising U.S. dollar, Manpower's year-ahead per-share profits and revenue are projected to decline. Profit estimates remain under pressure. Assuming the P/E ratio reverts to its 10-year median of 17, even if Manpower meets the current 2015 profit estimate of $5.10 per share, the stock would sell for about $88 at the end of the year, up just 4% from current levels.

The stock has risen 5% since we added it to the Buy and Long-Term Buy lists in May, lagging the S&P 500's 9% gain. With an Overall rank of 68, Manpower is being dropped from the Buy and Long-Term Buy lists. It is also being removed from the Monitored List and should be sold.

Technology review

Apple's ($123; AAPL) manufacturers are having trouble assembling the Apple Watch, according to two separate reports. The problems could force Apple to lower its initial production target ahead of the device's April 24 launch. In other news, Apple will reportedly unveil a new set-top box in June, the same time it announces a streaming TV service. Apple is a Focus List Buy and a Long-Term Buy.


Google ($567; GOOGL) named Ruth Porat its new CFO. The 28-year veteran at Morgan Stanley ($35; MS) helped bring technology companies public in the 1990s. She spent the last five years as the bank's CFO, overseeing a major cost-cutting plan.

Separately, Google and Intel ($30; INTC) announced a partnership with Swiss watchmaker TAG Heuer. The companies plan to launch a smartwatch later this year that will compete with the Apple Watch. Google is a Buy and a Long-Term Buy. Intel and Morgan Stanley are rated A (above average).

Corporate roundup

Gilead Sciences ($100; GILD) said nine patients developed abnormally slow heartbeats while taking its hepatitis C drugs concurrently with amiodarone, a potent heart treatment. One of the patients died, while three others needed pacemakers. Gilead said the labeling for its hepatitis C drugs already warns against combining the drugs. Citing the low number of patients on amiodarone, one analyst said he expects the disclosure to have minimal effect on Gilead's sales. Gilead is a Long-Term Buy.


Union Pacific ($111; UNP) shares fell after rival Kansas City Southern ($103; KSU) cut its March-quarter and full-year guidance due to foreign-currency headwinds and weaker volumes, particularly for energy and coal. Union Pacific relied on coal alone for 17% of 2014 revenue; a portion of its industrial-products unit (18% of revenue) represents energy end markets. Union Pacific's per-share-profit estimates have slipped in the past 30 days, with consensus currently calling for growth of 20% for the March quarter and 14% for the year. Union Pacific remains a Buy and a Long-Term Buy.


H.J. Heinz, owned by Berkshire Hathaway ($144; BRKb) and 3G Capital Partners, is acquiring a 51% stake in Kraft Foods ($83; KRFT). The $45 billion deal will form the world's fifth-largest food company. Kraft shareholders will receive a special cash dividend of $16.50 per share, along with one share in the new company, Kraft Heinz. Berkshire is rated A (above average). Kraft is rated C (below average).


Rank Changes

ADT ($41; ADT) is being initiated as a Buy and a Long-Term Buy. Affiliated Managers Group ($214; AMG) is being initiated as a Long-Term Buy. CDW ($37; CDW) is being added to the Buy List. Cognizant Technology ($61; CTSH) and ManpowerGroup ($84; MAN) are being dropped from the Buy and Long-Term Buy lists. In the Top 15 Utilities portfolio, New Jersey Resources ($31; NJR) and Portland General ($36; POR) are replacing AmeriGas Partners ($47; APU) and UGI ($33; UGI).


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