Big Stocks At Big Discounts
Everybody has heard the adage, â€œThe bigger they are, the harder they fall.â€ There's a lot of truth to that, as evidenced by the fallout when a major company fails. The high-profile meltdowns of Enron and WorldCom â€” and more recently Citigroup ($5; C), Bank of America ($13; BAC), and General Motors ($35; GM) â€” not only made headlines but also cost thousands of real-life investors a lot of money. You still hear Enron jokes from time to time.
But there's another truism about size, something nobody talks about but everybody learns early in life on the playground: â€œThe bigger they are, the harder they hit.â€ The largest stocks exert an outsized force on capitalization-weighted indexes. For example, the 50 largest stocks in the S&P 1500 Index combine for a market capitalization of roughly $6 trillion, or about 44% of the entire index. And right now, those big stocks are flashing some serious investment appeal.
The biggest stocks currently earn both higher Quadrix Overall scores (reflecting superior fundamentals) and Value scores (reflecting lower valuation ratios). As of Dec. 28, the 50 largest components of the S&P 1500 Index averaged a trailing P/E ratio of 17.8, 14% below the average valuation for S&P 1500 stocks. Over the last 15 years, the largest stocks have averaged a premium of 9% versus the S&P 1500 average.
The largest stocks also top the index average for Quadrix Momentum, Quality, Financial Strength, and Earnings Estimates. That combination of value and broad-based fundamental strength can add up to good news for investors. Rarely have so many of the biggest, best-known companies been available at such discounts.
The largest companies have generated better-than-average sales and profit growth over the last 12 months. But despite that excellent operating momentum, big stocks have not matched the stock-market gains of their smaller cousins. Over the last 12 months, the median stock in the S&P 1500 Index returned 20.2%, versus 17.4% for the median among the 50 largest.
It is not unusual for smaller, riskier stocks to pace the market during the first stages of a bull market. But over time, quality wins out. In 2011, the market should recognize the strength of some of the most massive players. The table below lists stocks among the 50 largest in the S&P 1500 that also make a big splash in our Quadrix stock-rating system. Three of our favorites are reviewed below.
Abbott Laboratories' ($47; ABT) market capitalization of $74 billion ranks fourth among U.S. drug companies. Abbott also sells nutritional, diagnostic, and vascular products, which account for nearly half of the company's revenue and blunt the effects of drug-patent expirations.
A flurry of acquisitions in the past year, worth more than $10 billion, have expanded Abbott's position in generic drugs and emerging markets. Abbott's size also helps the company absorb adverse events. The company recalled nearly 360 million glucose testing strips that could give false readings, but the action had no effect on Abbott's 2010 profit estimate, considering the products account for less than $20 million of inventory. In other news, Abbott and AstraZeneca ($46; AZN) are dissolving a partnership that sought to design a cholesterol pill. Again, Abbott says profits for 2010 and 2011 shouldn't be affected.
Relative to its three-year averages, the stock trades at discounts of 25% for trailing earnings, 21% for sales, and 16% for cash flow. Shares also trade at a discount to other pharmaceutical companies versus 2011 estimated earnings. The consensus projects per-share-profit growth of 12% for both 2010 and 2011. Yielding 3.7%, Abbott Laboratories is a Buy and a Long-Term Buy.
Earlier this year, Microsoft ($28; MSFT) lost its spot as the biggest technology company by market capitalization to Apple ($325; AAPL). However, Microsoft still holds a slight edge in sales, producing $65.76 billion in revenue in the past year.
Sales of smart phones could exceed those of personal computers in the next couple years. In January, Microsoft will provide a glimpse of its newest operating system for mobile devices, though no launch date has been announced. The company's current system has gained some momentum. In the first six weeks after the Windows Phone 7 launch, 1.5 million phones using the operating system sold. Acer said it will begin selling three tablet computers in 2011, one using Microsoft's Windows operating system.
The stock earns strong Quadrix scores for Momentum (91), Value (88), and Overall (96). Free cash flow surged 36% to $19.52 billion in the 12 months ended September. Microsoft is a Buy and a Long-Term Buy.
Wal-Mart Stores ($54; WMT) has notched sales of $419 billion in the last four quarters, more than any other U.S. company. In the past year, Wal-Mart generated $9.05 billion in free cash flow, more than the sales of 56% of S&P 500 companies.
Wal-Mart is known for big stores with small prices. But U.S. same-store sales have declined in six straight quarters, and that weakness might push Wal-Mart to shrink its store size as well. The retailer is considering a smaller store format as it pushes into one of its last unchartered territories, the largest U.S. cities. Wal-Mart has already gained approval to build more stores in Chicago, and it is in talks with construction unions about moving into New York City.
But Wal-Mart still must rely on foreign markets for most of its growth. Over the next five years, the company plans to boost its work force by 36%, primarily outside of the U.S. It is pursuing majority ownership of a retailer in sub-Saharan Africa and eying deals in China and Brazil. Growth could also come from India, which is considering easing restrictions on direct investment by foreign retailers. Wal-Mart is a Long-Term Buy.