Focus List review

5/19/2008


Our Focus List serves two purposes:

1. Provide a model for investors who like a tightly focused portfolio, allowing subscribers to put our advice into action with a limited number of trades.

2. Highlight our top picks for 12-month returns, providing a shopping list for investors looking to put money into the market.

When these two goals seem at cross-purposes — and we must choose between highlighting our very best picks and modeling a usable, diversified portfolio — we try to reflect what we’d do with our own money. In general, this common-sense approach has worked nicely, especially since the introduction of our Quadrix stock-rating system in 2000.

Since its December 1994 inception, the fully invested and equal-weighted Focus List has gained 340.7% (11.7% annualized) excluding dividends and transaction costs, versus 205.1% (8.7% annualized) for the S&P 500 Index. Adjusting for our recommended cash position, the Focus List has gained about 348.0% (11.8% annualized), with lower volatility than the fully invested Focus List.

Still, looking back at the Focus List’s nearly 14-year history, we have probably erred most often on the side of inaction, sticking too long with stocks we liked but did not love enough to have on the Focus List.

No more. Today is the first day of the rest of our lives, and et cetera, so Manulife Financial ($38; NYSE: MFC), PepsiCo ($67; NYSE: PEP) and Hewlett-Packard ($44; NYSE: HPQ) are being dropped from the Focus List. IBM ($127; NYSE: IBM) and Qualcomm ($45; NSDAQ: QCOM), already rated Buy, are being upgraded.

Manulife Financial ($38; NYSE: MFC) reported disappointing March-quarter results, with per-share profits of C$0.57, down 10% and 19% below the consensus estimate. Solid growth at the company’s insurance businesses was not enough to offset sharp declines in money-management profits.

Consensus profit estimates are on the decline, and Wall Street now expects 2008 earnings of $2.87 per share in U.S. dollars, down from the $3.15 consensus at the end of January. Manulife seems reasonably valued, but with few catalysts apparent, the stock no longer seems as likely to outperform the market. Manulife is being downgraded to Neutral and dropped from the Focus List, Buy List and Long-Term Buy List.


PepsiCo ($67; NYSE: PEP) remains our favorite pick in consumer staples. But PepsiCo no longer ranks among our favorite 15 to 20 stocks, partly because its defensive qualities are less appealing in the more bullish environment we anticipate over the next year. PepsiCo is being dropped from the Focus List but remains on the Buy List and Long-Term Buy List.


Hewlett-Packard ($44; NYSE: HPQ) agreed to pay $13.9 billion in cash for Electronic Data Systems ($24; NYSE: EDS), a 33% premium over EDS’ closing price before the announcement. The acquisition, expected to close in the second half of 2008, should double the size of H-P’s services division. While H-P says the deal will enhance its competitive position relative to industry leader IBM ($127; NYSE: IBM), subscribers need not worry about IBM, which has been delivering solid services growth. The H-P deal makes operational sense, but the price is no bargain, and integration challenges make the stock a bit riskier. H-P is being dropped from the Focus List, but remains a Buy and a Long-Term Buy. New Focus List Buy IBM looks a little better.


IBM ($127; NYSE: IBM) surprised investors in the March quarter when it was able to squeeze out 6% revenue growth in the U.S. to augment double-digit growth overseas. Last year, sales from outside the U.S. accounted for 63% of revenue. Sales to emerging economies rose at a 20% rate in 2007 and provided 15% of total revenue.

IBM shares are up 17% this year, versus a 4% decline in the S&P 500 Index. Consensus estimates project 20% per-share-earnings growth in 2008 and another 12% in 2009, with estimates on the rise. With a Quadrix® Overall score of 94, IBM is being added to the Focus List.


Global shipments of third-generation (3G) wireless phones, which can handle video and other features that require high speeds and heavy data loads, are expected to surpass sales of handsets from previous generations for the first time this year. That’s good news for Qualcomm ($45; NASDAQ: QCOM), a market leader in 3G wireless technology.

Consensus estimates project per-share-profit growth of 5% in fiscal 2008 ending September and 13% in 2009, conservative targets for a company poised to collect a royalty from almost every 3G device sold. Qualcomm is being added to the Focus List.

Other rank changes
Adobe Systems ($41; NASDAQ: ADBE) shares have risen 27% since March 18, when February-quarter earnings came in well above consensus estimates and the company projected higher-than-expected profits for fis- cal 2008 ending November. Per-share profits and cash flows have grown at least 23% in each of the last five quarters. That operating momentum should continue, and Adobe seems capable of rising to $50 per share over the next six to 12 months. Consensus estimates project profit growth of 18% this year and 13% next year. Adobe, with a Quadrix Overall score of 94, is being upgraded to a Buy and a Long-Term Buy.


Coventry Health Care ($43; NYSE: CVH) is being dropped from the Buy List and Long-Term Buy List. While Coventry shares have bounced since the company reported decent March-quarter results and reiterated its guidance for 2008, cash-flow trends have deteriorated. Given the sluggish enrollment-growth prospects and uncertain pricing outlook for managed-care providers, the stock seems vulnerable to further bad news. Coventry is being downgraded to Neutral.

News report
Microsoft ($30; NASDAQ: MSFT) is appealing the European Commission’s $1.39 billion fine levied in February for failing to comply with antitrust regulations. A decade-long scuffle with the EU continued in January, when the commission opened two new antitrust investigations. In other news, published reports suggest the company’s attempted purchase of Yahoo ($27; NASDAQ: YHOO) may not be dead. Activist billionaire Carl Icahn reportedly increased his stake in Yahoo in an effort to bring Microsoft back to the negotiating table. Microsoft is a Buy and a Long-Term Buy. Yahoo is rated Neutral . . . FedEx ($90; NYSE: FDX) lowered its profit guidance for the May quarter, citing reduced demand and rising fuel costs. FedEx is a Long-Term Buy . . . Illinois Tool Works ($55; NYSE: ITW) offered $2.1 billion for U.K.-based Enodis, a maker of restaurant equipment, topping Manitowoc’s ($43; NYSE: MTW) $1.89 billion bid. Enodis accepted the Illinois Tool deal, while Manitowoc says it is reviewing its options. Shares of Manitowoc, a Focus List Buy and Long-Term Buy, have jumped 11% since news of the rival bid broke . . . Citigroup ($23; NYSE: C) said it would sell between $400 billion and $500 billion of its $2.2 trillion in assets over the next three years in an attempt to cope with problems in the housing and credit industries. Citigroup retains its Neutral rating.

Earnings review
Wal-Mart Stores ($56; NYSE: WMT) said April-quarter earnings rose 12% to $0.76 per share. Sales rose 10% to $94.12 billion, with U.S. same-store sales up 2.9% excluding gasoline. The company said it expects July-quarter per-share earnings of $0.78 and $0.81 — the consensus calls for $0.81. Wal-Mart is a Long-Term Buy . . . American International Group ($39; NYSE: AIG) posted a March-quarter per-share loss of $1.41 excluding investment write-downs, versus a gain of $1.68 in the year-earlier period, as the weak housing and credit markets hurt performance. The company also increased its quarterly dividend by 10% to $0.22 per share, payable Sept. 19. AIG is rated Neutral . . . Sprint Nextel ($9; NYSE: S) reported adjusted March-quarter earnings of $0.04 per share, down 78%. Sales fell 8% to $9.33 billion as the subscriber count fell 1.5% to 52.8 million. Sprint is rated Underperform.


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