Our Strategy Pays Off

12/20/2010


The Forecasts likes stocks with the following characteristics:

• High Quadrix® Overall scores, which suggest broad-based fundamental strength.

• Attractive valuations. We don’t go for deep value stocks, which tend to be cheap for a reason, but instead seek growth at a good price.

• The potential to outperform. The market tends to reward stocks that exceed expectations for revenue or profits, and we look for companies with growth catalysts not fully reflected in the share price.

Among stocks with those characteristics, only the best make it onto our Focus List, a portfolio containing our top 10 to 20 selections for year-ahead returns.

Our strategy has served us pretty well in recent years. On a fully invested basis since the start of 2004, the Focus List has gained 51.4% excluding dividends and transaction costs, versus 11.6% for the S&P 500 Index. The Focus List topped the index’s gain in five of those seven years, including so far in 2010.

Since its inception in December 1994, the Focus List has gained 286.2%, or 8.8% annualized, well above the S&P 500’s 170.0% increase (6.4% annualized). Since 1998, we have held part of the portfolio in cash or a short-term bond fund. Including that cash position, the Focus List has managed a 328.8% return since 1994, with less volatile annual returns.

Based on the Focus List’s 15 full calendar years (1995 through 2009), the standard deviation of annual returns was 24.1% without the cash position, versus 21.4% for the S&P 500. Factoring in the cash position, the standard deviation was 20.4%. Standard deviation is a measure of volatility, reflecting how widely returns diverge from the average.

The table below lists all 13 of the Focus List stocks. Our six top picks for capital gains in 2011 are discussed below.

Earning an Overall score of 99, Aflac ($55; AFL) benefits from solid operating momentum and a modest valuation. The insurer’s sales rose 13% in the first nine months of this year, while free cash flow rose 12%. At 10 times trailing earnings, shares trade 32% below the three-year average P/E ratio.

Aflac continues to grow in Japan (about 75% of sales), but growth in the U.S. (roughly 25%) has been tougher to find. Management remains cautious about its U.S. outlook, but it should benefit as small companies, which make up a large portion of the domestic business, begin to hire again. Wall Street expects earnings to advance 14% in the December quarter on 21% higher revenue. Aflac, yielding 2.2%, is a Focus List Buy and a Long-Term Buy.


Altera ($37; ALTR) makes programmable logic devices (PLDs), semiconductors that can be programmed on-site, allowing customers to alter designs quickly and cheaply. So far this year, shares have surged 65% on strong operating momentum. Sales jumped 68% in the first nine months of 2010, while free cash flow quadrupled.

Altera’s quick adoption of new technology should help it gain market share in the coming year. The consensus projects 4% lower per-share profits in 2011, a target that seems unduly conservative. Altera has topped consensus profit estimates by at least 6% in each of the last four quarters. At 18 times trailing earnings, the stock trades 20% below its five-year average P/E. Altera is a Focus List Buy and a Long-Term Buy.


Apple ($320; AAPL) shares reached an all-time high of $325 earlier this month. And while the stock is not exactly a bargain at 21 times trailing earnings, the P/E remains 29% below the five-year average. Apple earns a Quadrix Value score of 56, placing it in the top half of stocks in our research universe.

The iPad tablet is striking a chord with individuals and businesses alike. Research firm Gartner ($33; IT) sees the iPad accounting for at least 80% of an estimated 19.5 million tablets sold this year, and estimates the tablet market could exceed 100 million units by 2012. Verizon Communications ($35; VZ) already offers the iPad and is widely expected to add the iPhone to its network in early 2011. Apple is a Focus List Buy and a Long-Term Buy.


Evidence of the U.S recovery rattles along CSX ($64; CSX) tracks, winding through states east of the Mississippi river. The railroad’s revenue chugged 16% higher in the first nine months of 2010. Pricing and volumes have remained strong in the December quarter, and CSX anticipates higher volumes in nine of its 10 end markets.

Management says it expects slow and steady economic growth next year. Wall Street sees profits jumping 18% in 2011. Shares trade at 13.5 times the 2011 estimate, versus the average of 14.2 for railroad stocks in the S&P 1500 Index. Scoring better than at least 60% of stocks in our research universe across all six quadrix categories, CSX earns an Overall rank of 94. CSX is a Focus List Buy and a Long-Term Buy.


Wall Street sees DirecTV ($40; DTV) reporting 33% higher per-share profits in the December quarter. Profit growth should continue to outpace the industry in 2011. As the largest pay-TV company in Latin America, DirecTV anticipates 20% higher sales and profits there next year. By 2013, DirecTV expects total sales to reach $30 billion, up 25% from the 2010 consensus. Management sees earnings topping $5 per share in 2013, implying growth of at least 111% from the 2010 estimate.

That growth will be likely supported by internal investment, rather than acquisitions. DirecTV expects capital spending to rise 14% to $2.4 billion in 2010 and average $2.6 billion over the next three years. DirecTV is a Focus List Buy and a Long-Term Buy.


Newmont Mining’s ($62; NEM) stock has pulled back 6% from the all-time high set in September, offering value investors an opportunity to gain exposure to gold. In the nine months ended September, Newmont produced 4.86 million ounces of gold, up 3% from year-earlier numbers. New mines in Australia and Africa generated the growth. Copper production jumped 37% to 463 million pounds, mostly in Africa.

Analysts are ratcheting profit estimates higher for both the December quarter and 2011. Per-share profits are expected to rise 24% in 2011, on top of an expected 37% gain this year. Shares trade at 16 times trailing earnings, a 24% discount to the three-year average P/E. The stock exhibits broad strength in Quadrix, with scores of 80 or higher for five of the six major categories. With an Overall score of 97, Newmont is a Focus List Buy and a Long-Term Buy.

FOCUS LIST
Stock-
Market
Value
($Bil.)
Price
Added
To List
($)
12-Month
—— Growth ——
Est. EPS
—— Growth ——
—— P/E Ratio ——
Company (Price; Ticker)
Div.
Yield
(%)
Date
Added
To List
Sales
(%)
EPS
(%)
Curr.
Year
(%)
Next
Year
(%)
Fiscal
Yr. End
Trailing
3-Year
Median
Quadrix
Overall
Score *
Advance Auto Parts
($68; AAP)
5.8
0.4
9/9/10
56.04
6
37
31
16
Dec.
18.0
15.7
92
Aflac ($55; AFL)
26.2
2.2
11/27/09
43.65
12
47
15
11
Dec.
10.3
15.2
99
Altera ($37; ALTR)
11.8
0.6
11/4/10
33.04
54
157
195
(4)
Dec.
17.7
20.0
98
Apple ($320; AAPL)
297.5
0.0
9/9/10
263.07
52
66
26
17
Sep.
21.1
21.2
98
CSX ($64; CSX)
24.3
1.6
9/9/10
53.97
8
25
39
18
Dec.
17.2
16.0
94
DirecTV ($40; DTV)
34.9
0.0
10/9/08
20.09
12
70
63
30
Dec.
18.1
20.1
85
IBM ($146; IBM)
185.6
1.8
5/15/08
128.46
3
12
14
10
Dec.
13.3
12.7
89
Lubrizol ($108; LZ)
7.4
1.3
6/17/10
90.90
18
99
32
9
Dec.
11.2
11.5
96
Newmont Mining
($62; NEM)
31.0
1.0
6/17/10
59.68
46
146
37
24
Dec.
16.2
21.4
97
Ross Stores
($63; ROST)
7.5
1.0
2/18/10
47.10
11
40
26
9
Jan.
14.3
14.8
94
Texas Instruments
($33; TXN)
39.2
1.6
12/9/10
33.74
36
151
117
2
Dec.
13.8
15.0
98
Travelers ($55; TRV)
26.1
2.6
3/4/10
53.55
5
35
(4)
(1)
Dec.
8.5
7.8
94
Varian Medical Sys.
($68; VAR)
8.3
0.0
3/25/10
55.81
6
12
14
12
Sep.
23.0
18.3
70
Focus List Average
54.3
1.1
21
69
47
12
15.6
16.1
93
* Quadrix scores are percentile ranks, with 100 the best.

 


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