What You're Thinking

4/4/2016


We get a lot of questions from readers. Today we answer four that are either timely or timeless:

Q Hawaiian Holdings ($47; HA) earns a Quadrix Overall score of 99, but you don't recommend it on any of your buy lists. Why not?

A Not everyone asks about this tiny airline, but we hear similar questions about high-scoring stocks all the time.

We compute scores for roughly 5,000 companies, which means that about 500 score above 90. Most of those high scorers never make our recommended lists for at least one of these three reasons:

1) They're too small. We generally limit our recommended lists to stocks with market capitalizations of at least $4 billion. At $2.7 billion, Hawaiian Holdings doesn't qualify for the Forecasts.

2) We don't need the exposure. This issue also applies to Hawaiian Holdings. The 18 airline stocks in our research universe average Quadrix Overall scores of 86, the highest average for any group with at least four stocks. We already recommend two airlines, but 13 score above 90 Overall, which leaves us with a lot of high scorers that won't make our lists — including some that might earn Buy ratings if we did not like a rival more.

3) Individual company analysis reveals weakness Quadrix doesn't show. Quantitative systems such as Quadrix can only take into account factors already revealed in statistics. Before adding a stock to our recommended lists, we follow up with individual company analysis to consider issues ranging from changes in market share to regulatory troubles to product pipelines.

Plenty of stocks with high Overall scores have problems that keep them off our recommended lists.

Q It feels like a recession. What do you think?

A While we can't rule out a recession, we don't see one as likely.

For one thing, hiring growth remains solid. This trend suggests businesses are confident they can cover the cost of those salaries with higher revenue in the future, and also gives consumers more money to spend.

Those consumers, who account for more than two-thirds of gross domestic product, continue to spend that money. According to the Bureau of Economic Analysis, personal-consumption expenditures rose nearly 4% year-over-year in the first two months of 2016. While consumers remain somewhat cautious, as evidenced by recent declines in sentiment, they aren't panicking.

Most analysts expect the U.S. economy to keep growing. GDP growth slowed to an annualized rate of 1.4% in the fourth quarter, but the key word is still "growth." The Blue Chip Economic Indicators consensus calls for GDP to rise 2.1% this year and 2.4% in 2017, reasonable targets.

Q With interest rates likely to rise, why do you keep your cash in a short-term bond fund rather than, well, cash?

A We use a short-term bond fund because cash earns almost no return at the moment. Short-term bond funds do fluctuate in value somewhat, but as a rule they don't move very much, and they offer a meaningful yield. The ETF we recommend, Vanguard Short-Term Corporate Bond ($80; VCSH), yields 2.0%. It has spent the last 12 months between $78.85 and $80.44, a spread of just 2%.

Yes, we know that bond prices tend to decline when interest rates rise. However, longer-term bonds usually react more sharply to rate changes than do short-term bonds. Vanguard Short-Term Corporate focuses on investment-grade bonds with average maturities of three years. Such bonds shouldn't fluctuate as much as longer-term bonds, and in many cases the fund might simply hold them to maturity and sell at par value. While our chosen bond ETF may lose some value in a rising-rate environment, a large decline seems unlikely.

Q I own both Dow Chemical ($51; DOW) and DuPont ($64; DD) shares. Should I hold both companies through the merger (second half of 2016), sell one, or sell both? My cost basis is low, so if I sell, most of the proceeds will be taxable gains.

A We expect this merger to go through, and we're changing our rating on both stocks to B (average). Before, Dow was rated A (above average) and DuPont C (below average). While Dow looks like the superior investment option as currently constructed, we expect the combination to earn a B rating, which means we won't recommend it for purchase. With that in mind, subscribers should consider selling one or both stocks now, in advance of the combination.

If taxes are your biggest concern, you lose little by waiting for the merger, as the deal will incur no tax liability. That said, we'll close out this answer with a few words aimed at anyone who fears selling a stock with big gains:

If you hold onto an unattractive stock to avoid paying taxes on gains, you might see the price fall enough to shrink the tax bill, which wouldn't make you happy. Didn't you buy the stock to make money? Here's a better choice: Declare victory, because you accomplished your goal. Sell the shares, pay the taxes, and find a good use for the after-tax profits.


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