Portfolio Review

7/12/2010


While our buy lists have outperformed this year, we are always looking to improve our performance. Recent modifications to our Quadrix® stock-rating system are part of that effort, as is our relentless focus on limiting our buy lists to stocks we truly like. Based on Quadrix scores, news developments, and share-price performance, we took a fresh look at several names on our buy lists.

LIST RETURNS
Focus
List
(%)
Buy
List
(%)
LT Buy
List
(%)
S&P 500
Index
(%)
2010 †
1.0
(3.5)
(6.3)
(7.8)
2009
40.0
37.6
30.6
23.5
2008
(48.8)
(46.3)
(36.5)
(38.5)
2007
22.8
19.2
10.8
3.5
2006
12.9
16.9
9.7
13.6
2005
8.1
13.2
4.1
3.0
2004
17.5
22.4
9.0
9.0
2003
20.2
29.2
24.6
26.4
Since 2003 † 
53.3
77.9
33.7
16.8
† Through July 6. Notes: Returns are fully invested and exclude dividends and transaction costs.

Two stocks are being downgraded this week. Our recommended cash position, lifted last week based on the bear-market confirmation signaled by the Dow Theory, is being increased again. Our Long-Term Buy List now has 31% in Vanguard Short-Term Investment-Grade ($10.73; VFSTX), while our Buy List and Focus List have 28% in this relatively low-risk bond fund.

General Mills ($36; GIS) was dropped from the Buy List last week based on the company’s disappointing profit guidance. While we had planned to keep the stock on our Long-Term Buy List, the May-quarter results and year-ahead guidance resulted in sharp declines in the Quadrix scores for Momentum and Earnings Estimates. As a result, the Overall score has dropped to 41. Rather than maintain a position in a stock with a below-average Overall score, we’re dropping General Mills from the Long-Term Buy List. On our Monitored List, General Mills is being dropped to a B (average).


Raytheon ($47; RTN) is being sold from the Buy List and Long-Term Buy List. Raytheon’s valuation remains attractive, and it seems less exposed to budget cuts than other large defense contractors. In fact, this month Raytheon was awarded a missile contract worth up to $368 million with the U.S. Navy. But uncertainty related to budget cuts is pressuring nearly all defense stocks, and earnings-estimate trends for Raytheon have turned negative. Moreover, Raytheon’s operating momentum is slowing, with per-share earnings expected to be down for the June and September quarters. The stock’s Overall Quadrix score has dropped to 78, reflecting below-average scores for Momentum, Earnings Estimates, and Performance. Raytheon is being downgraded to a B (average) on our Monitored List.

Stock reviews

In each of the last four quarters, Hospira ($58; HSP) has posted double-digit profit gains on sales growth of at least 6%. But the stock’s Overall Quadrix score has dipped to 75, partly because of a below-average score for Value. At 17 times trailing earnings, the stock is not particularly cheap versus its history. The stock rebounded to a new high this month, helped by a report that French drugmaker Sanofi-Aventis ($29; SNY) is looking to make at least one major U.S. acquisition. Hospira’s relatively small market capitalization of $9.6 billion could make it an appealing target.

Hospira recently completed a tender offer to buy Javelin Pharmaceuticals, a niche maker of pain-management drugs, for $145 million. With the deal, Hospira will take ownership of drug candidate Dyloject, a post-surgery painkiller that awaits approval from U.S. regulators. The deal bodes well for long-term growth, but Hospira’s year-ahead prospects hinge mainly on continued growth in generic injectable drugs. June-quarter results are expected July 28, with consensus estimates project per-share earnings growth of 8% on a 5% sales gain. Hospira is no longer a bargain, but the stock remains a Focus List Buy and a Long-Term Buy based on its growth prospects and unique market niche.


Microsoft ($24; MSFT) said it will discontinue the Kin, a smartphone aimed at young consumers, just 48 days after its launch. In recent years, few of Microsoft’s ventures outside of its core software business have been successful. While gamers flocked to its Xbox 360 video-game system, its digital-music player was greeted with indifference and plans for a tablet computer have been shelved.

Nevertheless, Microsoft remains the leading maker of business software, and sales of its Windows 7 operating system have been brisk. For the June quarter, Wall Street projects profits of $0.46 per share, up 28%, on 16% sales growth. Results will be released on July 22. At 12 times trailing earnings, shares trade 32% below the stock’s five-year average and 24% below other systems-software companies in the S&P 1500 Index. While Microsoft has been a frustrating stock, it remains a Long-Term Buy based on its discount valuation and growth prospects.


With more than 8.5 million customers, Rogers Communications ($33; RCI) is the No. 1 wireless carrier in Canada. The company is also a leading cable-television provider, while a growing media division includes radio and television stations. A majority of revenue and cash flow is generated from wireless and broadband services. June-quarter earnings per share, expected July 27, are expected to climb 6% to $0.69. That figure could prove conservative given recent operating momentum and the company’s history of exceeding expectations.

Rogers shares have retreated 12% from a June 21 high, reflecting the market pullback and worries regarding increased competition. Canada has relaxed restrictions on foreign ownership of telecom operators, a development many expect to result in new entrants in the wireless market. While price competition is likely to worsen, continued volume gains should help sustain earnings growth. Also, Rogers’ extensive distribution network provides a competitive edge. Consensus estimates project per-share earnings growth of 10% for 2010 and 9% for 2011. Rogers, reasonably valued at 12 times the 2010 estimate, is a Focus List Buy and a Long-Term Buy.


Varian Medical Systems ($52; VAR) has slumped about 7% since late April, when the company issued somewhat disappointing profit guidance. Varian seems reasonably valued at 19 times trailing earnings, 23% below its five-year average P/E.

Varian is on the front edge of a new product cycle, with several new products capturing a lot of interest. Increased use of radiation therapy in emerging markets also bodes well for Varian, which in June equipped the first of a series of cancer-treatment centers in India. The fact that international markets have generated most of Varian’s growth in recent quarters has some investors worried, as the company generates about a third of its revenue from customers in growth-challenged Europe.

Still, Varian’s near- and long-term prospects appear solid. While June-quarter earnings are expected to be down slightly, consensus estimates project per-share profits will be up 9% this year and 12% in 2011. Looking further out, cancer diagnoses are becoming more common, which should boost demand for Varian’s products worldwide. The National Cancer Institute estimates 1.6 million cancer cases will be diagnosed in the U.S. this year, up from 1.3 million in 2000, and the number of new cases is likely to continue rising. Varian, due to post June-quarter results on July 28, is a Focus List Buy and a Long-Term Buy.

  RANK CHANGES

General Mills ($36; GIS) is being dropped from the Long-Term Buy List, while Raytheon ($47; RTN) is being dropped from the Buy and Long-Term Buy lists.


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