Want Our Best? Buy The Focus List

6/21/2010


Our Focus List is designed to highlight our very top picks for year-ahead returns. It’s also meant to be a portfolio subscribers can actually follow, with reasonable trading costs and a tolerable risk level. Sometimes balancing these multiple objectives is not easy, but our experience since the Focus List’s December 1994 inception has resulted in some useful guidelines:

In general, we limit the Focus List to 12 to 18 stocks. While this is not enough names to be fully diversified, we’ve found an equal-weighted portfolio of 12 to 18 well-chosen stocks to be only moderately more volatile than a 30- or 40-stock portfolio. While some readers would prefer a more focused Focus List, we regularly present our top five or six picks among the Focus Buys — including the midyear capital-gains favorites reviewed in the paragraphs below.

When a stock no longer ranks among our top 12 to 18 picks, we drop it from the Focus List. In years past we were sometimes too slow to drop quality names that no longer ranked among our very favorites, but nowadays the Focus List is run on a “love it or leave it” basis — even if that means dropping a stock that still qualifies for our broader Buy List. Our approach seems to be working, with the fully invested Focus List gaining 63.8% since year-end 2003 versus 26.7% for the S&P 500 Index excluding dividends and trading costs. On average, the Focus List has dropped roughly nine stocks per year.

We use our recommended cash position to reduce the Focus List’s risk. The Buy List and Focus List always have the identical recommended cash position, with both currently holding 16.3% in Vanguard Short-Term Investment-Grade ($10.67; VFSTX) as a hedge. Adjusted for our recommended cash position, the Focus List has gained about 269.4% since its December 1994 inception, versus 247.8% for the fully invested Focus List and 142.5% for the S&P 500 Index.

OUR FOCUS LIST
12-
Company (Price; Ticker)
Date
Added to
Focus
List
% Chg.
on the
Focus List
Div.
Yield
(%)
Trailing
P/E Ratio
Sales
(%)
EPS
(%)
Aflac ($44; AFL)
11/27/09
1.7
2.5
9
8
16
AmerisourceBergen
($32; ABC)
9/17/09
50.5
1.0
16
9
27
BMC Software ($38; BMC)
4/2/09
9.1
0.0
14
2
33
Comcast ($19; CMCSa)
6/11/09
28.5
2.0
14
4
30
CVS Caremark ($32; CVS)
6/11/09
6.4
1.1
12
11
9
DirecTV ($39; DTV)
10/9/08
95.4
0.0
21
11
47
Hospira ($56; HSP)
7/2/09
50.0
0.0
16
12
29
IBM ($130; IBM)
5/15/08
1.0
2.0
13
(4)
13
Intel ($21; INTC)
——
2.9
16
9
57
Lubrizol ($90; LZ)
——
1.6
10
2
203
Newmont Mining
($56; NEM)
——
0.7
18
47
140
NII Holdings ($39; NIHD)
10/9/08
73.0
0.0
18
11
17
Rogers Communications
($37; RCI) e
5/6/10
6.9
3.2
14
33
95
Ross Stores ($58; ROST)
2/18/10
22.3
1.1
14
12
62
Travelers ($51; TRV)
3/4/10
(4.3)
2.8
8
5
53
Varian Medical
($52; VAR)
3/25/10
(7.2)
0.0
18
5
14
Note: % change through June 15.    e Yield estimated.

Since the independent Hulbert Financial Digest began following the Focus List at year-end 1995 through year-end 2009, the Focus List has outperformed the Wilshire 5000 Index of all U.S. stocks — despite having 7% lower volatility. On both an absolute and risk-adjusted basis, the Focus List outperformed the Wilshire 5000 Index since year-end 1995 and over the past five and 10 years.

In the following paragraphs, we review our top five Focus List picks for the second half of 2010, including two of our three new additions.

Upgrades

Maker of roughly 80% of the world’s microchips, Intel ($21; INTC) is a highly cyclical company. Today could be an opportune time to buy the shares, for at least two reasons. First, industry growth forecasts are rising, as are analyst projections for Intel. Even the most pessimistic analyst estimate predicts 129% profit growth this year.

Second, the shares trade at only 16 times trailing earnings, 16% below the three-year average of 19. Using the lowest 2010 profit estimate and a P/E ratio of 19, the stock has an implied price of $33. Such a surge might be unrealistic, but the stock could reach $27 over the next year.

Intel re-established sales growth in the last two quarters while sharply increasing profit margins. Stronger operating momentum has led to a surge in free cash flow, and a robust balance sheet features sufficient cash to cover long-term debt nearly eight times over. Intel, yielding 2.9%, is a Focus List Buy and a Long-Term Buy.


Roughly 83% of Newmont Mining’s ($56; NEM) 2009 revenue came from gold, and its shares are highly sensitive to gold prices. Lately, that’s been a good thing. Hitting a record high in June, the price of gold has surged 14% this year. In comparison, shares of Newmont are up 19%. Despite these gains, the stock remains below its all-time high set in 2006 and trades at 18 times trailing earnings, 36% below the three-year average P/E ratio.

Operating results have improved over the last four quarters. Sales jumped 47% and earnings per share more than doubled as operating margins rose sharply. By dropping its hedges, Newmont became a full participant in gold’s rally. Of course, the opposite also applies: If gold prices fall, so will Newmont’s profits.

Newmont controls high-quality assets across the globe. Roughly 36% of its reserves are located in the Asia-Pacific region, followed by 33% in North America, 18% in Africa, and 13% in South America. Newmont scores at least 75 in all six primary Quadrix® category scores. With an Overall Quadrix score of 98, Newmont is a Focus List Buy and a Long-Term Buy.

Three more favorites

Over the last year, DirecTV’s ($39; DTV) sales growth has accelerated, while per-share earnings rose 42% and free cash flow nearly doubled. Aggressive buybacks have lowered the share count year-over-year in 17 consecutive quarters. The count fell 9% in the 12 months ended March 31.

DirecTV’s biggest long-term growth opportunity lies in Latin America, where pay-TV penetration is far below the 90% rate in U.S. households. Revenue from the region jumped 30% in the March quarter and now represents 14% of total sales.

The shares have bounced 29% since the end of January, while the S&P 500 Index is up 4%. But DirecTV’s stock price still hasn’t caught up with the rising expectations of analysts. Shares trade at just 13 times the consensus 2011 earnings estimate. DirecTV is a Focus List Buy and a Long-Term Buy.


IBM ($130; IBM) offers investors an attractive growth story at a reasonable price. The company expects to boost earnings to “at least $20” per share by 2015. That implies annual growth of 14%, which seems reasonable given IBM’s annualized growth of 13% over the last five years.

IBM plans to push further into the higher-profit services and software industries, while also targeting emerging markets such as China. To supplement organic growth, IBM plans to spend $20 billion on acquisitions in the next five years. In 2009, the company spent $1.5 billion on takeovers.

At 11 times estimated year-ahead earnings, IBM’s growth comes cheap. The stock trades 10% below its five-year average forward P/E ratio. Earning a Quadrix Value score of 80 and Overall score of 93, IBM is a Focus List Buy and a Long-Term Buy.


A dominating presence in Canada’s wireless and cable-TV markets, Rogers Communications ($37; RCI) has grown revenue at an 18% annual clip over the last 10 years. In the last 12 months, sales growth accelerated to 33%. Rogers has grown operating cash flow and free cash flow aggressively, though it retains little excess cash on the balance sheet. Instead, Rogers churns that cash into dividends and share buybacks. The dividend has risen at an annualized rate of 68% over the last five years. Stock buybacks have lowered the share count by 7% over the past four quarters.

Despite its robust track record, Rogers trades at 14 times trailing earnings, 37% below the three-year average. Shares also trade well below three-year averages for trailing price/sales and price/cash flow. Wall Street projects 11% earnings growth in 2010 and 8% in 2011. Rogers, a Focus List Buy and a Long-Term Buy with a dividend yield of 3.2%, could reach $46 to $48 over the next 12 months.


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