Portfolio Review

10/11/2010


Comcast ($18; CMCSa) is being dropped from the Focus List and Buy List, as the stock no longer ranks among our top picks for 12-month gains. Because Comcast still represents a solid choice for three-year returns, the stock remains a Long-Term Buy. The cable-television giant generates strong free cash flow, but cash provided by operations is essentially flat over the past year. The Quadrix® Overall rank is 78 after starting the year at 97. A weak Earnings Estimates score of 19 reflects unfavorable analyst revisions in the past few months.

The stock has been hampered by concerns that Comcast will be forced to make concessions to win regulatory approval for the NBC Universal deal. In early October, U.S. regulators went back to Comcast and General Electric ($17; GE) to ask for more details on the proposed deal. Should the deal get cleared, as Comcast expects, the extensive review could weaken Comcast’s bargaining power with other cable operators over retransmission fees. Also crimping the stock are concerns about consumers dropping cable in favor of Internet television. While cable-cutting consumers are unlikely to impact near-term results materially, such big-picture concerns could weigh on investor sentiment for some time.


Stryker ($51; SYK) is being dropped from the Buy List, though the stock is being kept as a Long-Term Buy. Stryker’s Overall score has fallen to a mediocre 78, partly because of poor earnings-estimate trends. The stock has bounced from $43 in August, and though it remains cheap relative to its history (shares trade at 16 times trailing earnings, 17% below the three-year average P/E) it no longer represents an especially attractive value relative to peers in the health-equipment group.

September-quarter results are slated for release Oct. 19. Shares slumped after the June-quarter report because of soft sales for orthopedic implants. Another near-term disappointment would not be surprising, especially considering signs of pricing pressure on medical devices. But the company maintains a robust balance sheet, and results should benefit as Stryker moves further away from a cloud of regulatory violations. Analysts see per-share profits rising 11% in 2010.


McKesson ($61; MCK), a distributor of pharmaceuticals and surgical supplies, is being removed from the Long-Term Buy List. The stock was dropped from the Buy List in September. Since then, McKesson’s Overall Quadrix score has slipped to 68. At 13 times trailing earnings, 22% below the five-year average P/E, the stock is cheap. However, we are worried about a further slowdown in profit growth. Wall Street expects 6% growth in fiscal 2011 ending March, and that target could be at risk. Ahead of the September-quarter announcement, we believe it is wise to step to the sidelines. The stock should be sold. McKesson is now rated B (average).

BUY LISTS OUTPERFORM
————————— Price Change —————————
Focus
List
(%)
Buy List
(%)
LT Buy
List
(%)
S&P 500
Index
(%)
2003
20.2
29.2
24.6
26.4
2004
17.5
22.4
9.0
9.0
2005
8.1
13.2
4.1
3.0
2006
12.9
16.9
9.7
13.6
2007
22.8
19.2
10.8
3.5
2008
(48.8)
(46.3)
(36.5)
(38.5)
2009
40.0
37.6
30.6
23.5
2010 *
12.5
4.9
2.1
4.1
Since 2003 *
70.7
93.2
45.5
31.9
* As of Oct. 5.
Since 2003, our Focus List, Buy List, and Long-Term Buy List have outperformed the S&P 500 Index by a wide margin. Returns assume portfolios are fully invested and exclude dividends and transaction costs.

Stock reviews

Sigma-Aldrich’s ($62; SIAL) Overall score has dropped to 66, with a 47 for Momentum and 35 for Value. Free cash flow surged 65% in the past year, while revenue climbed 7%. Sigma-Aldrich, a provider of ingredients for specialty chemicals, is a high-quality company. But the stock, up 24% since June, seems somewhat expensive at 20 times expected 2010 earnings.

For now, Sigma-Aldrich remains a Long-Term Buy based on its track record and operating momentum. But the stock could be downgraded if the company does not deliver strong third-quarter results, due Oct. 21. Consensus estimates project earnings of $0.73 per share, up 4%, on revenue of $541 million, up 1%. The company seems capable of exceeding expectations if momentum in overseas operations continues. For 2010 and 2011, Wall Street projects per-share profits of $3.14 and $3.42, implying growth of 12% and 9%. Sigma-Aldrich is a Long-Term Buy.


Shares of Varian Medical Systems ($62; VAR) have jumped 32% this year, including a 16% gain since August. Varian still trades at a substantial discount to its own five- and 10-year norms for price/earnings and price/cash flow. But the stock’s strong performance has dragged its Quadrix Value score down to 33, contributing to the Overall score’s slide to 76. The rally has heightened the risk in the stock, and another 10% to 15% gain in the near term could be enough to prompt a downgrade.

Varian, a maker of medical software and radiation-therapy equipment, has favorable new-product momentum. Profit estimates are trending higher, and Wall Street expects per-share-profit growth of 8% on 4% higher revenue in the September quarter. Results are scheduled for release Oct. 28. Varian Medical is a Focus List Buy and a Long-Term Buy.

Mobile-phone update

On Oct. 11, Microsoft ($24; MSFT) will introduce a series of smart phones powered by its new operating system, Windows Phone 7, according to The Wall Street Journal. The phones will go on sale in early November. Microsoft is trying once again to muscle its way into the crowded mobile-phone market, a task that has proved difficult in the past. In the six months ended Aug. 10, Google’s ($538; GOOG) Android-based device accounted for 32% of smart phones sold in the U.S., followed by 26% for Research In Motion’s ($50; RIMM) BlackBerry and 25% for Apple’s ($289; AAPL) iPhone, with both Android and the BlackBerry gaining share in August.

Reportedly, Apple plans to bolster the iPhone’s market position by making the device available for Verizon Communications ($34; VZ) to sell in early 2011, ending an exclusive U.S. agreement with AT&T ($29; T). In other news, Microsoft also said its version of a tablet PC will be “seen” by Christmas, leaving its actual launch date in doubt. Microsoft and RIM are rated Buy and Long-Term Buy. Apple is a Focus List Buy and a Long-Term Buy. AT&T, Google, and Verizon are rated B (average).

Tech report

Hewlett-Packard ($41; HPQ) named Leo Apotheker as its CEO. Apotheker worked at SAP ($51; SAP) for more than 20 years but lasted less than one year as the software company’s sole CEO before resigning abruptly in February. Apparently, the market was unimpressed by H-P’s choice, and shares slid on the announcement. Hewlett-Packard is a Buy and Long-Term Buy . . . Intel ($19; INTC) plans to invest $2.75 billion to upgrade a semiconductor plant in Israel, partially funded by a $200 million Israeli government grant. Intel is a Buy and a Long-Term Buy.

Corporate roundup

Wal-Mart Stores ($54; WMT) said Charles Holley will replace Tom Schoewe as chief financial officer, effective Nov. 30. The discounter also said it would boost its work force by 36% in the next five years, primarily outside of the U.S. Finally, Wal-Mart will partner with Humana ($51; HUM) next year to offer a U.S. Medicare prescription-drug plan with a discounted premium. Wal-Mart Stores is a Long-Term Buy . . . J.P. Morgan Chase ($40; JPM) and Bank of America ($14; BAC) delayed home-foreclosure proceedings to check for documents that might contain errors. Officials in at least seven states are probing lenders including both J.P. Morgan and Bank of America for possible fraud; the U.S. Justice Department is also probing J.P. Morgan. J.P. Morgan is a Buy and a Long-Term Buy. Bank of America is rated C (below average) . . . Lubrizol ($110; LZ) said it expects earnings of $13.50 per share in 2013, up 80% from 2009 results, lifted by geographic expansion, improved product mix, and share repurchases. Shares rallied on the projection, which equates to annualized growth of more than 15%. Lubrizol is a Focus List Buy.

  RANK CHANGES

Comcast ($18; CMCSa) and Stryker ($51; SYK) are being dropped from the Buy List but remain Long-Term Buys. McKesson ($61; MCK) is being dropped from the Long-Term Buy List. Vanguard Short-Term Investment-Grade ($10.88; VFSTX) now represents 28.0% of the Buy List and 28.7% of the Long-Term Buy List.


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