In Pursuit Of Perfection
Everybody wants the one, perfect stock. In reality, perfection is impossible to attain and pinning all your hopes on just one company is unwise.
But just because perfection is out of reach should not keep you from pursuing it. For our money, the perfect stock offers strong profit-growth prospects at a discounted price. More specifically, we look for the following attributes from a stock:
• An attractive valuation relative to peers, historical norms, long-term growth prospects, and the market as a whole.
• Favorable sales, earnings, and cash-flow trends.
• A good track record, including high returns on equity and investment.
• A strong balance sheet.
• Superior share-price momentum.
Finding a stock that exemplifies all of these traits is difficult, and sometimes it makes sense to compromise for the sake of portfolio diversification. But you can improve your odds of investment success by aiming high, and Quadrix helps us consider dozens of metrics to find stocks with the best overall fundamentals.
The track record of our Focus List, representing our top picks for 12-month returns, suggests our process works. Through April 13, the Focus List is up 9.6% for the year on a fully invested basis excluding dividends and transaction costs, versus 7.4% for the S&P 500 Index. Since 2003, the Focus List has risen 66.2%, nearly twice the 36.1% return of the S&P 500 Index.
In the world of Quadrix, Aflac ($55; AFL) is a well-rounded stock. It earns an Overall Score of 98, and all six of its category scores rank in the top 33% of stocks in our research universe.
The competitive landscape in Japan, the world’s third-biggest life-insurance market, altered in March when MetLife ($45; MET) agreed to acquire Alico, American International Group’s ($40; AIG) international life-insurance business, for $15.5 billion. However, Aflac’s CFO said the company’s Japan unit has a history of outperforming Alico, and any changes MetLife implements will take some time to take effect.
In anticipation of a recovery, Aflac’s recruitment of U.S. agents rose 11% in 2009. For 2010, the consensus sees Aflac generating 11% sales growth to drive per-share earnings 10% higher. Reflecting an annualized profit-growth forecast of 13% over the next five years and a current-year P/E of 10, Aflac’s PEG ratio is just 0.80. Aflac, up 20% this year, is a Focus List Buy and a Long-Term Buy.
On its own, Raytheon’s ($58; RTN) 4% annualized sales growth over the last five years sounds unimpressive. However, the company’s efforts to shed noncore businesses and improve efficiency have weighed on sales growth. Returns on assets and equity have more than quadrupled over the last five years.
Leverage to intelligence and surveillance programs — key areas for supporting American forces in Afghanistan — positions Raytheon to benefit even if U.S. defense spending flattens. In April, Raytheon won an $88 million order to install passenger-screening equipment at U.S. airports.
A $36.87 billion order backlog represents about 150% of 2009 sales and should support the top line in the year ahead. Raytheon’s global footprint provides additional insulation from budget cuts. Raytheon collected 30% of last year’s orders from foreign countries.
Raytheon generated $1.97 billion in free cash flow last year, up 58%, and has a history of sharing its excess cash with shareholders. Over the last three years, Raytheon has raised its dividend at an annualized rate of 9% and repurchased enough stock to shrink the share count at a 5% rate. The stock, up 29% from October lows, trades near its 52-week high. Yet at 12 times trailing earnings, shares trade 32% below the five-year average. Raytheon is a Focus List Buy and a Long-Term Buy.
Shares of Ross Stores ($57; ROST) jumped when the off-price retailer reported same-store sales rose 14% in March, well ahead of the consensus estimate of 6.4%. Total revenue surged 19% for the month. Ross boosted its per-share-profit guidance for the April quarter, with the target range of $1.14 to $1.16 implying 58% to 61% growth. Before the announcement, Wall Street had projected per-share profits of $0.97.
Ross’ stores are generating more sales while carrying less inventory, leading to fewer markdowns. The soft economy is driving some of these gains as more consumers hunt for bargains. Ross consistently produces reliable revenue and per-share-earnings growth — not since 2005 has either one declined in a quarter. Return on equity stands at 41.3%, up from 30.8% a year ago.
The stock trades at 16 times trailing earnings, 8% below its five-year average P/E ratio. It also looks cheap versus its peers, with apparel retailers in the S&P 1500 Index averaging a P/E of 23. Ross is a Focus List Buy and a Long-Term Buy.
Setting new 52-week highs in each of the last four months, Varian Medical Systems’ ($56; VAR) stock has rallied 19% this year. The company’s chief products include X-ray equipment and pricey oncology systems that kill cancerous tissue with radiation. After curbing capital spending last year, hospitals should begin replacing older equipment as their balance sheets improve.
Varian has grown free cash flow, profits, and revenue over the last year. Cost controls and a shift toward new products and software with richer profit margins have helped fuel the profit gains.
Orders from overseas markets are starting to pick up as radiosurgery gains acceptance as a cancer treatment in foreign countries. For fiscal 2010 ending September, Wall Street expects 7% higher per-share earnings. Over the next five years, the consensus predicts 15% annualized profit growth. Varian Medical is a Focus List Buy and a Long-Term Buy.