Confidence Could Be Everything
The battle between two powerful economic forces has raged into 2011, and its ultimate resolution will go a long way in shaping the path of the U.S. stock market.
• Consumers are not very confident, with the Conference Board index of consumer confidence still less than half its 2007 level. Unemployment exceeds 9%; wage growth is sluggish; and a housing recovery seems like a distant hope.
• Yet investor confidence has rebounded. The S&P 500 Index jumped 6.5% in December, its best performance for that month since 1991. Among newsletters, bulls outnumber bears by near-record margins. Brokerages catering to U.S. retail investors saw a surge of inflows at the end of last year, and the second week of January brought the biggest weekly inflow into U.S. stock funds since May 2009.
Who is right? Are consumers unduly gloomy, or are investors irrationally optimistic? While investor sentiment seems a bit exuberant and vulnerable to a near-term retrenchment, we tend to side with the optimists for the year ahead. The Jan. 28 report on December-quarter U.S. gross domestic product was expected to mark the sixth consecutive period of growth â€” and a return to the level of real output seen before the recession began in late 2007. Consensus forecasts project GDP growth of more than 3% in 2011.
BOUNCE BACK: TOTAL S&P 500 SALES AND NET INCOME
Above are rolling 12-month totals through the September quarter, which show revenue and earnings for S&P 500 members trending sharply higher in recent periods.
With the unemployment rate likely to stay above 8.5% in 2011, consumer confidence may remain under pressure. But the prospects of U.S. companies and U.S. consumers have increasingly diverged in recent years. In fact, 58% of the nonfinancial, nonutility companies in the S&P 500 Index saw trailing 12-month net income, revenue, or cash provided by operations (CPO) reach three-year highs in the most recent quarter. About 12% posted three-year highs for all three statistics.
Net income. In the 12 months ended September, companies in the S&P 500 Index generated net income 12% above that from the same period in 2008. Net income as a percentage of sales, up for five consecutive quarters, has reached its highest level since the December quarter of 2007.
Revenue. Two-thirds of S&P 500 companies have already posted revenue above prerecession levels. In the 12 months ended September, total revenue for the index came within 4% of 2008 levels.
Cash provided by operations (CPO). In the most recent 12-month period, 20% of the nonfinancial, nonutility stocks in the S&P 500 posted their highest CPO in at least three years. Partly as a result, U.S. nonfinancial firms have more than 7% of total assets in cash, the largest proportion since 1959.
While aggregate statistics are encouraging, you can put the odds further in your favor by looking for attractively valued shares of bona fide growers. Listed in the table below are 10 such companies, all of which recently posted record highs for net income, revenue, and CPO.
Aflac's ($58; AFL) 12-month totals for revenue, net income, and CPO reached all-time highs in the September quarter. Growth accelerated for all three metrics in the first nine months of 2010, with sales rising 11% (versus 10-year annualized growth of 8%), net income surging 55% (versus 12%), and CPO advancing 11% (versus 8%).
Gross and operating profit margins have grown steadily in the past year. Most of the insurer's revenue growth has been generated by its Japan business (75% of revenue), while the U.S. unit (25% of revenue) slowly recovers from the downturn. Aflac, yielding 2.1%, is a Focus List Buy and a Long-Term Buy.
Altera ($38; ALTR) has rebounded from the downturn with four consecutive quarters of higher CPO, net income, and sales â€” with growth for the latter two accelerating in each of those periods.
Altera said December-quarter earnings rose 112% to $0.72 per share, a penny above the consensus. Revenue, increasing 52% to $555 million, also topped analyst targets. Sales of new products nearly tripled in the December quarter, and new products accounted for 53% of sales in the quarter, up from 29% in the same period a year earlier. Altera's projected range for March-quarter revenue exceeded Wall Street expectations. Altera expects sales to rose 31% to 37% in the March quarter, versus the consensus of 30%. Altera is a Focus List Buy and a Long-Term Buy.
Apple's ($341; AAPL) growth is tied to its knack for dreaming up and delivering devices that people never knew they wanted. In fiscal 2001 ended September â€” less than a month before the debut of its iPod â€” Apple's operations revolved around its Macintosh computer (82% of revenue) and software and services (18%). Today, those businesses (combining for 23% of December-quarter sales) flank Apple's newer gadgets, such as the iPhone (39%), iPad (17%), and iPod (13%).
Apple posted sales of $76 billion in the 12 months ended December â€” more than 14 times the total right before the iPod was released. Apple's 12-month operating cash flow has more than doubled since the end of 2008, while net income has tripled. Apple is a Focus List Buy and a Long-Term Buy.
DirecTV ($43; DTV) is generating all-time highs for revenue, net income, and cash flow. Return on equity has also reached record levels, more than double the rate of a year ago. CPO rose 20% in the first nine months of 2010, exceeding the three-year annualized rate of 12%. DirecTV has funneled much of that cash into stock buybacks, shrinking the share count by 8% in the nine months ended September.
Opportunities in Latin America support DirecTV's growth prospects, but investors seem skeptical. Consensus estimates project 30% annualized profit growth over the next five years, yet the stock trades at 14 times expected 2011 earnings. The PEG ratio (P/E to expected growth) is just 0.6, versus an average of 1.3 for cable and satellite companies in the S&P 1500 Index. DirecTV is a Focus List Buy and a Long-Term Buy.
St. Jude Medical ($43; STJ) boasts a consistent track record over the past decade, with annualized growth of 15% for revenue, 42% for net income, and 13% for operating cash flow. In that span, St. Jude has produced growth for sales in all 10 years, net income for eight years, and operating cash flow for seven years.
In the December quarter, St. Jude's per-share profits rose 17% to $0.75 excluding special items, exceeding the consensus by $0.01. Revenue climbed 12%, helped by growth of 9% for cardiac rhythm management (56% of sales for the quarter) and 20% for cardiovascular products (21%). St. Jude Medical is a Long-Term Buy.