Portfolio Review

1/11/2010


Dealing with our troublemakers

In an ideal world, shares of companies added to our Buy List or Long-Term Buy List would never issue disappointing news, deliver subpar returns, or suffer a meaningful drop in Quadrix scores.

In the real world, stock-market disappointments are inevitable — and the handling of such setbacks goes a long way in separating good and bad portfolio managers.

LIST RETURNS
Focus
List
(%)
Buy
List
(%)
LT Buy
List
(%)
S&P 500
Index
(%)
2010 †
3.1
2.6
1.9
1.9
2009
40.3
35.7
28.5
23.5
2008
(48.8)
(44.7)
(36.4)
(38.5)
2007
22.8
18.1
10.4
3.5
2006
12.9
14.8
9.3
13.6
2005
8.1
10.3
3.5
3.0
2004
17.5
18.8
8.7
9.0
2003
20.2
25.0
24.0
26.4
Since 2003 † 
56.4
71.0
40.1
29.2
† Through Jan. 5.
Notes: Returns are fully invested and exclude dividends and transaction costs. 

We will typically sell a stock on truly worse-than-expected earnings news or a big drop in Quadrix scores, as our strategy centers on limiting our portfolios to our best ideas. But dumping fundamentally strong stocks on minor setbacks is a recipe for subpar returns, so we examine such cases on a stock-by-stock basis. For one reason or another, the recommendations below have not worked out exactly as planned.

Despite mostly good news in the past couple months, AstraZeneca ($46; AZN) shares have been sluggish. Schizophrenia drug Seroquel XR gained wider use in the U.S., and the same could happen for cholesterol pill Crestor if regulators follow the December recommendation of an advisory panel. The company filed in November for U.S. approval of Brilinta, an experimental treatment for blood clots. In trials, the company says Brilinta outperformed a rival treatment that generates about $9 billion in annual sales.

AstraZeneca needs new drugs to offset major patents set to expire in the next five years, and legal troubles are also weighing on the stock. AstraZeneca has reached a preliminary agreement to pay $520 million to settle a federal investigation into the marketing of Seroquel. But it could still face thousands of lawsuits from former patients claiming Seroquel caused diabetes and other problems.

AstraZeneca makes two dividend payments each year, with the larger distribution typically issued in March. While AstraZeneca is based in the United Kingdom, it sets the dividend in U.S. dollars, so there is no need for currency translation. The dividend yield is 4.5%, and the trailing P/E ratio is a modest 7.6, about 42% below the three-year average. AstraZeneca is being maintained as a Buy and a Long-Term Buy, but we are anxious to hear any Seroquel or product-development news when December-quarter results are posted on Jan. 28.


Chevron’s ($80; CVX) Overall Quadrix score has dropped to 58, lower than any that of any other recommended stock. But, in our view, Chevron is the best of the major integrated oil stocks.

The company’s operations are more heavily leveraged to oil than its peers, a potential short-term advantage. Oil prices rebounded more strongly than natural gas in 2009 — and oil probably enjoys a more stable outlook for the year ahead. For the long term, Chevron’s outlook will be colored by the development of a major liquefied natural gas project in Australia.

Chevron combated lower refining margins and weak price realizations in the September quarter. The company topped the consensus profit estimate handily, but per-share earnings excluding asset sales and tax items fell 55% to $1.72. Revenue tumbled 41%.

Profit and sales comparisons are expected to turn favorable in the March quarter, so the stock’s abysmal Quadrix Momentum score of 9 seems likely to improve. For full-year 2010, per-share earnings are expected to jump 53% to $7.75, a number likely to climb if oil prices keep rising. Chevron, yielding 3.4%, is a Long-Term Buy.


Comcast ($17; CMCSa) shares jumped after details of the NBC Universal deal were unveiled in early December. Comcast parted with $6.5 billion in cash and $7.25 billion in assets to obtain a 51% stake in a venture valued at $28 billion, dispelling fears of a worst-case scenario that would have depleted its cash reserves and loaded it with debt.

However, the stock has failed to build on that surge. The Quadrix Performance score remains below 50, partly because of worries regarding programming costs. Historically, broadcasters have given pay-TV operators free access to retransmit their programs in exchange for the distribution of new cable channels or higher rates for existing channels. One exception has been CBS ($14; CBS), which receives about $0.50 a month per subscriber in certain markets.

Following the lead of CBS, News Corp ($16; NWSa) negotiated a deal that will charge Time Warner Cable ($42; TWC) to transmit its Fox network. Details were not disclosed, though News Corp. had originally targeted $1 a month per subscriber. Time Warner has already announced a rate hike, and this could become common practice as new fees spread to other pay-TV companies. Comcast’s contract with CBS expires in 2011, at which time other broadcasters might band together to establish programming fees. Comcast, a Focus List Buy and a Long-Term Buy, seems capable of a rally above $21 over the next year.


National Oilwell Varco ($47; NOV), which builds and outfits drilling rigs, has cautioned that tight credit markets could delay a recovery in the energy sector. Lately, good news has come in small doses. Crude oil has moved above $82 a barrel, near the 14-month high but well off 2008 record highs. The U.S. rig count for natural gas has recovered after bottoming out in June but remains 40% below year-earlier levels.

Shares have rebounded with oil prices in recent weeks. However, the stock’s Quadrix scores for Momentum and Earnings Estimates are still pressured by the pessimistic September-quarter earnings release. National Oilwell beat the consensus estimate for per-share earnings, as it had in the previous three quarters. But both profits and revenue fell sharply from a year earlier, as did the backlog.

At $7.3 billion, the Sept. 30 backlog was down 16% from June 30 and down 38% from a year earlier. National Oilwell remains a Buy and a Long-Term Buy, though we may downgrade the stock if December-quarter order trends disappoint or the stock moves into the mid-$50s.


Qualcomm’s ($48; QCOM) Overall Quadrix score of 61 reflects below-average scores for Value, Earnings Estimates, and Performance — all languishing in the low 40s. But Wall Street profit estimates have stabilized recently, and the stock has rallied nearly 16% since Qualcomm posted solid September-quarter results.

The company’s outlook will be tied to the performance of smartbooks — new, hybrid gadgets that combine features of smartphones and netbooks. Smartbooks have larger screens and keyboards than traditional mobile phones. Their batteries last longer than those of netbooks, and they receive continuous online access through 3G phone networks. Several versions employ Qualcomm’s Snapdragon processor, which is important for Qualcomm considering it has thus far failed to take a significant share of the netbook market.

Wall Street expects Qualcomm’s earnings growth to get back on track, with per-share profits projected to climb 81% in the December quarter and 13% in the year ending September. The consensus projects profits will grow at an annualized rate of 17% over the next five years. Qualcomm will report December-quarter results on Jan. 27. For now, Qualcomm remains a Long-Term Buy.


Travelers ($48; TRV), a leading provider of property-casualty insurance for automobiles, homes, and businesses, earns poor Quadrix scores for Performance and Earnings Estimates. Shares rose 10% in 2009 but stalled in the final five months of the year. Travelers is considered a safer insurance play, so it has not benefited from the shift toward riskier stocks.

The shares are cheap at less than nine times the 2010 consensus profit estimate of $5.62 per share, a forecast that seems conservative. Last year’s mild hurricane season could make comparisons difficult in the year ahead. It might also challenge Travelers’ efforts to raise premiums on property coverage. However, Travelers has gained market share during the recession, and retention rates remain near historic highs. With an Overall score of 90, Travelers is a Buy and a Long-Term Buy.

  RANK CHANGES
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