A Tighter Focus

6/19/2017


Sometimes a name says it all. Like Focus List.

Our Focus List is a portfolio of stocks, a focused basket of 16 names from the among the 33 on the Buy List. That focus on just a few names makes the Focus List less diversified than the Buy List, and probably best suited as a portion of a broader equity portfolio rather than as the entire portfolio.

The Focus List serves several purposes:

1) Identifying our very top picks. Subscribers often ask us which stocks we like best. The Focus List answers this question.

2) Providing a tighter list. The Buy and Long-Term Buy lists tend to offer superior diversification by sector and market capitalization. However, many investors would rather own fewer stocks for ease of analysis and tracking news, sacrificing some diversification benefit for the sake of a more compact portfolio.

3) Focusing our minds. The act of carving out a Focus List from the Buy List forces us to clarify our thinking about each recommended stock relative to the other stocks we like. Such an exercise requires us to revisit the stocks frequently — a good thing — and constantly weigh the merits of each stock — also a good thing.

This exercise in analysis and discipline has paid off in the form of superior returns. Since we started the Focus List in late 1994, it has returned 253% (9.1% annualized) excluding dividends and transaction costs, versus 177% (7.3% annualized) for the S&P 500 Index. The Focus List outperformed the S&P 500 in five of the last eight calendar years and has gained 13.2% so far this year, topping the index by four percentage points.


Sector weightings have shifted

The Focus List contains our top 12 to 18 stocks for year-ahead returns. We pick stocks, not sectors. But a strong sector naturally offers a larger pool of attractive candidates for inclusion on our Focus List.

Over the past 12 months, we have sharply curtailed the Focus List's exposure to industrial stocks. The sector delivered above-average returns in the past year but generated sluggish operating growth and no longer looks especially cheap. It currently represents 13% of Focus List stocks, versus 42% at this time last year.

In place of industrial stocks, we now have a greater concentration in the technology (robust operating momentum and projected growth), consumer-discretionary (low valuation), and financials (strong projected growth, low valuation) sectors.

Below, we review a top pick from each of the five sectors represented on the Focus List.

Carnival ($65 CCL) scores above 75 for all six Quadrix categories, contributing to an Overall rank of 98. Carnival's capacity has expanded 47% over the past decade, outpacing the global cruise industry's 30% growth. Carnival expects capacity to climb at an annualized rate of 5% through 2020, below industrywide projected growth of 6%. Despite steady growth, the cruise industry appears underpenetrated, considering the global supply of cruise cabins is just 5% of the number of U.S. hotel rooms.

The U.S. eased travel restrictions to Cuba last year, opening up a new market for the U.S. travel industry. However, President Trump has threatened to revive the ban, which could cost U.S. cruise operators $200 million in annual revenue, estimates lobbying group Engage Cuba. Additionally, Carnival was forced to reroute some of its cruises after China restricted travel to South Korea in March due to a dispute over the installation of a missile-defense system. Yet the company's overall bookings remain strong, and analyst estimates are rising for both fiscal 2017 ending November (projected growth of 8% for per-share profits, 4% for revenue) and fiscal 2018 (15%, 5%). Carnival is a Focus List Buy and a Long-Term Buy.


Citizens Financial Group ($37; CFG) enjoys strong operating growth, as the improving U.S. economy drives loan growth and higher interest rates boost profitability. Per-share profits jumped 31% in the 12 months ended March on 12% higher revenue. For the June quarter, the regional bank is expected to earn $0.59 per share, up 28%, on sales growth of 9%. For the year, analysts target 24% growth for per-share profits and 8% growth for revenue. Estimates are rising for both periods.

The stock earns an Overall score of 96, supported by category ranks above 70 for five of six Quadrix categories. The lone exception is a disappointing Performance rank of 45. But Citizens has performed better than most other S&P 1500 regional banks, generating a 3% total return in 2017, while its industry averaged a slight loss. Citizens Financial, yielding 1.5%, is a Focus List Buy and a Long-Term Buy.


Centene ($78; CNC) has been one of the few insurers to turn a profit from the health-care exchanges operated under the Affordable Care Act. And it continues to press its advantage. While many of its peers plot their retreat from the exchanges, Centene announced in June plans to enter ACA marketplaces in Kansas, Missouri, and Nevada next year. It also expects to expand operations in six states where it already has a presence. The company insures about 1.2 million people through the exchanges, roughly 10% of its total membership.

Uncertainty over the fate of ACA presents some risk to Centene, especially if lawmakers curtail funding of Medicaid expansion, which generates roughly 20% of the company's profits. But the stock's valuation reflects such concerns. At 17 times trailing earnings, the stock trades 27% below the average S&P 1500 health insurer and 36% below the average health-care stock. The shares have rallied 12% since we added Centene to the Focus List in February, ahead of the 4% gain for the S&P 1500 Index. Centene is a Focus List Buy and a Long-Term Buy.


ON Semiconductor's ($16; ON) components power computing products, smartphones, industrial robotics, and even promising new ventures such as car automation. Management says demand remains solid and inventory levels within distribution channels consistent with historical norms. Additionally, ON is taking a larger share of the smartphone market, with its content projected to increase 20% to 30% in some devices in the second half of 2017.

Per-share profits are projected to jump 42% this year, and analyst estimates are rising. Although the stock has surged 23% in 2017, the rally doesn't seem to fully reflect that strong growth. Shares trade at just 12 times estimated 2017 profits, which ranks among the cheapest 20% of stocks in our research universe and offers a steep 50% discount to the average S&P 1500 semiconductor stock. ON, earning an Overall rank of 98, is a Focus List Buy and a Long-Term Buy.


Southwest Airlines' ($60; LUV) stock has rallied 41% since we added it to the Focus List in May 2016, roughly double the S&P 500 Index's gain. Southwest's strong share-price action reflects the company's limited exposure to several developments hampering U.S. airlines this year.

Higher fuel and wage expenses will likely curb airlines' profit growth in 2017, though Southwest sees cost pressures easing in the second half of the year. Additionally, the U.S. travel ban has hurt demand for international flights to the U.S. Unlike many major U.S. airlines, Southwest has little direct exposure to foreign markets, with just 2% of operating revenue coming from outside the U.S.

Analysts expect Southwest's per-share profits to creep 2% higher this year, while the airline industry's profits are projected to be flat. At 16 times estimated 2017 profits, the stock looks expensive compared to other S&P 1500 airlines (average is 12) but remains cheap versus the broad industrial sector (24). Southwest Airlines is a Focus List Buy and a Long-Term Buy.

FOCUS LIST
If a Focus List stock fares better than the average for its sector in any of the statistics below, we present the number in bold. Most of the stocks look good from multiple angles.
Since Added
To Focus LIst
12-Month
--- Change ---
Est. EPS
Chg., Curr.
Yr. (%)
--- P/E Ratio ---
---- Quadrix Scores ----
Company (Price; Ticker)
Date
Added
To List
Initial
Price
($)
Price
Chg.
(%)
S&P
500
Chg.
(%)
EPS
(%)
Revenue
(%)
Trailing
Curr.
Year
Momen-
tum
Value
Overall
Sector
Alphabet
($968; GOOGL)
8/11/16
808.20
20
12
24
22
(1)
26.3
28.7
64
33
65
Technology
Carnival ($65; CCL)
4/20/17
59.21
9
4
68
4
7
18.5
17.3
88
76
98
Cons.
discret.
CBS ($61; CBS)
12/22/16
64.50
(6)
8
9
(8)
7
14.9
14.0
29
76
72
Cons.
discret.
CDW ($62; CDW)
8/11/16
45.52
35
12
25
6
11
17.5
16.2
66
60
81
Technology
Celgene ($121; CELG)
4/20/17
123.27
(2)
4
80
21
23
19.0
16.4
79
57
83
Health
care
Centene ($78; CNC)
2/16/17
70.07
12
4
31
84
8
16.6
16.4
97
94
99
Health care
Citizens Financial
($37; CFG)
12/22/16
36.00
2
8
31
12
26
17.2
15.2
92
85
97
Financials
Comcast
($41; CMCSa)
5/4/17
38.29
7
2
13
9
14
22.3
20.7
81
56
92
Cons.
discret.
Lam Research
($153; LRCX)
8/11/16
88.89
72
12
55
24
55
17.9
15.7
99
55
98
Technology
Lear ($147; LEA)
8/1/13
69.40
112
43
25
3
15
9.9
9.2
79
93
99
Cons.
discret.
Lowe's ($81; LOW)
4/27/17
85.27
(6)
2
12
11
16
19.2
17.3
61
76
80
Cons.
discret.
Mohawk Indust.
($244; MHK)
6/23/16
197.85
23
15
17
8
6
18.7
18.1
71
63
92
Cons.
discret.
ON Semiconductor
($16; ON)
5/25/17
15.50
1
1
14
31
42
16.8
12.4
94
75
98
Technology
Owens Corning
($65; OC)
3/10/16
45.80
43
23
29
10
10
16.5
16.3
48
84
92
Industrials
Southwest Airlines
($60; LUV)
5/19/16
42.17
41
20
(6)
2
2
17.0
15.4
56
76
95
Industrials
VMware ($88; VMW)
2/2/17
88.00
0
7
18
8
12
17.8
18.0
73
56
91
Technology
Focus List average
23
11
28
15
16
17.9
16.7
74
70
90

 

SECTOR SPOTLIGHT
Among the 11 sectors in the S&P 1500 Index, utilities and technology have generated the strongest operating growth over the last year. Conversely, the financials sector is projected to deliver the strongest profit growth this year and also looks quite cheap. Sectors represented on the Focus List are in bold. All numbers are averages.
12-Month Change
Est. EPS
Curr. Yr.
(%)
------- P/E Ratio -------
---- Total Return ----
----------- Quadrix Scores -----------
S&P 1500 Sector
EPS
(%)
Revenue
(%)
Trailing
Current
Year
Year-
To-Date
(%)
Last 12
Months
(%)
Momen-
tum
Value
Overall
Consumer discretionary
4
5
4
19.9
19.3
3
19
47
70
67
Consumer staples
5
4
6
23.5
22.1
5
9
42
51
52
Energy
(35)
(10)
(7)
30.0
27.0
(23)
(6)
53
50
31
Financials
7
9
10
19.2
17.6
4
35
58
68
70
Health care
5
11
5
25.2
24.3
16
24
51
49
57
Industrials
3
2
6
23.0
21.6
6
28
48
56
59
Technology
8
11
7
23.7
23.9
13
37
59
49
61
Materials
4
2
6
23.1
21.1
7
28
49
60
56
Real estate
3
8
2
36.1
36.5
4
10
49
38
45
Telecom services
(21)
2
(8)
25.2
26.3
4
12
33
59
40
Utilities
12
4
2
21.0
20.7
11
12
54
53
52
S&P 1500 Index
4
6
5
23.2
22.3
6
23
51
56
59
Notes: Averages exclude P/E ratios above 75 or below zero, and growth rates above 75% or below -75%. Quadrix scores are percentile ranks, with 100 the best.

 

 


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