Sharp Focus, High Returns

4/18/2011


Our Focus List outperformed the U.S. stock market for the three, five, 10, and 15 years ended Jan. 31, according to Hulbert Financial Digest, a newsletter that ranks investment newsletters.

By our numbers, the Focus List has risen 90.1% on a fully invested basis since 2003, versus 49.3% for the S&P 500 Index. The fully invested Focus List has topped the S&P 500 Index in five of the last seven years and leads the market so far in 2011.

The Focus List contains 12 to 15 stocks that represent our top picks for year-ahead gains. It serves investors best as a subset of a broader portfolio, rather than a fully diversified portfolio in its own right, as discussed below.


FOCUS LIST PERFORMANCE

Year
Focus
List
(%)
Focus List
Including
Cash
Holdings
(%)
S&P 500
Index
(%)
From 12/23/94
0.7
0.7
(0.1)
1995
30.4
30.4
34.1
1996
23.9
23.9
20.3
1997
26.6
26.6
31.0
1998
23.2
20.6
26.7
1999
22.9
19.3
19.5
2000
14.0
12.9
(10.1)
2001
(16.0)
(11.2)
(13.0)
2002
(28.9)
(24.3)
(23.4)
2003
20.2
19.1
26.4
2004
17.5
16.1
9.0
2005
8.1
7.6
3.0
2006
12.9
12.5
13.6
2007
22.8
21.5
3.5
2008
(48.8)
(38.6)
(38.5)
2009
40.0
31.8
23.5
2010
19.5
16.1
12.8
2011*
4.8
4.2
4.5
1994-Present*
303.5
346.3
185.7
2003-Present*
90.1
98.5
49.3

Since its inception on Dec. 23, 1994, our Focus List has risen 303.5% on a fully invested basis excluding dividends and transactions costs, well above the S&P 500 Index's 185.7% gain. Adjust for our cash or short-term bond holdings, and the Focus List gained 346.3%.


Today, nearly half of Focus List stocks come from the technology sector. That concentration makes sense, as technology stocks average higher Quadrix Overall and Momentum scores than any other sector and rank No. 2 in Quality. More than a third of tech stocks earn Overall scores above 80, while one-fifth score above 90.
Of course, that doesn't mean we like the entire sector or that we like every stock for the same reasons.

Focus List stocks tend to share some traits, such as attractive valuations and strong operating momentum. But there are exceptions.

Of the 15 stocks on the Focus List, 14 earn Overall scores in the 90s. We favor banking leader J.P. Morgan Chase ($47; JPM) and its still-solid rank of 86 for its attractive valuation and solid operating momentum.

As the table below illustrates, most Focus List stocks have grown cash flow provided by operations at double-digit rates in the past year — with the exception of IBM ($163; IBM) and Advance Auto Parts ($66; AAP), both of which have delivered strong profit growth and seem capable of strong March quarters.

We generally prefer to purchase growth at a good price, and few of our stocks are deep values. Still, every stock on the Focus List scores above 50 in Value. Nearly all 15 stocks are cheap based on P/E ratio relative to historical norms or relative to industry rivals — or both. The following paragraphs review top Focus List picks from four different sectors.

Consumer discretionary

A strong 2010 leaves Advance Auto Parts ($66; AAP) with tough growth comparisons in the year ahead. But management seems confident about growing 2011 same-store sales at a rate in the low to mid single-digits. A longtime player in the do-it-yourself (DIY) business, Advance Auto is rebalancing its operations to compete in the highly fragmented commercial market. The two units complement each other. Most of Advance Auto's stores are equipped to shuttle merchandise to garages, service stations, and dealerships. The retailer is testing a pilot program for home delivery and minor installation of DIY parts.

Advance Auto has topped consensus profit estimates by more than 5% in each of the last four quarters. For the March quarter, the consensus targets per-share profits of $1.38, up 16%, on sales growth of 5%. Advance Auto Parts is a Focus List Buy and a Long-Term Buy.

Financials

J.P. Morgan Chase ($47; JPM) is generating strong momentum despite substantial economic and regulatory headwinds. In 2010, operating profit margins expanded to their widest level in more than a decade, while return on equity rose to 10.3% from 6.3% in 2009. In March, with U.S. regulators' blessings, J.P. Morgan announced the restoration of its dividend, and the stock currently yields 2.1%.

At 12 times trailing earnings, shares trade 41% below their three-year average P/E and 34% below the peer-group average. Wall Street sees 2011 earnings rising 20% to $4.77 per share. Assuming even modest expansion of the P/E ratio, J.P. Morgan could gain 30% over the next 12 months. J.P. Morgan has proven itself capable of managing expectations, beating consensus profit estimates by at least 10% in each of the last five quarters. J.P. Morgan Chase is a Focus List Buy and a Long-Term Buy. The company's March-quarter earnings are reviewed in Portfolio Review.

Health care

Agilent Technologies ($45; A) is not purely a health-care company. Electronic measurement, a unit that makes instruments for testing semiconductors and smartphones, accounted for 51% of sales in the 12 months ended December. Life sciences accounts for 27% of revenue, as Agilent supplies equipment for clinical trials administered by drugmakers and academic researchers. Chemical-analysis instruments (23% of revenue) test the safety of food, drugs, and environmental conditions.

Revenue streams from dissimilar end markets have contributed to drive robust growth. Agilent has reported double-digit sales growth in four straight quarters, a streak likely to extend for at least three more quarters. Wall Street targets 26% higher revenue for the April quarter and a 51% jump in earnings to $0.65 per share. Agilent is a Focus List Buy and a Long-Term Buy.

Industrials

To some, a train still makes a lonely sound. But to us, the whistle echoing from CSX's ($75; CSX) locomotives represents the soundtrack for a U.S. recovery. And rising gasoline prices could make railroads even more attractive relative to trucking. There's no shortage of investors jumping aboard. CSX shares have chugged 51% higher since the end of August, including a 17% gain so far this year.

Japan's nuclear scare has sparked renewed U.S. interest in coal (31% of CSX's 2010 revenue). CSX sees rising international demand for coal, hauled from the Appalachian Mountains not only to domestic utilities but also to coastal ports that ship the fuel to Europe and Asia. CSX expects the volume of its coal exports to surge 17% to 33% in 2010. In the U.S., coal demand should continue to rise as industrial activity picks up. CSX, not cheap but reasonably valued at 15 times expected 2011 earnings, is a Focus List Buy and Long-Term Buy.


Focus List: The name says it all

The Focus List is designed to deliver market-beating returns with a reasonable amount of risk. But with 12 to 15 stocks, the list is not designed to provide a fully diversified portfolio. At this time, our Focus List contains 15 stocks, versus 27 for our Buy List and 34 for our Long-Term Buy List.

How many stocks do you need to diversify without sacrificing too much excess return potential? Academic studies have pegged the number at about 40. Portfolios containing stocks with high Quadrix Overall scores tend to be less volatile, so the Buy List and Long-Term Buy List should provide enough diversification among U.S. equities for most investors. As a stand-alone portfolio, we are not willing to say the same about the Focus List.

As its name implies, the Focus List focuses on our top picks from the Buy List. We originally developed the Focus List to account for just a portion of a larger stock portfolio. Of course, the Forecasts understands that many investors would rather accept the excess volatility and use the Focus List as their primary portfolio than own all 27 stocks on the Buy List.

As shown in the chart above, since its inception in late 1994, the fully invested Focus List has gained 303.5%, versus 185.7% for the S&P 500. Considering that the Focus List contains our very favorite stocks, we continue to have high expectations for it.

Still, it is worth noting that a portfolio of just 12 to 15 stocks can be quite volatile, and investors who choose to mimic the Focus List should understand that fact.

FOCUS LIST
---- 12-Month Growth ----
---------- P/E Ratio ----------
Quadrix
----- Scores * -----
Company (Price; Ticker)
Sales
(%)
EPS
(%)
Oper.
Cash
Flow
(%)
Trailing
Vs. 3-
Yr. Avg.
Vs.
Industry
Average
Value
Overall
Sector
Industry
Advance Auto Parts
($66; AAP)
9
40
(5)
16.6
1.08
0.85
73
91
Cons.
Discret.
Specialty Stores
Aflac ($53; AFL)
14
59
13
9.6
0.70
0.88
98
94
Financials
Life & Health
Insurance
Agilent Technologies
($45; A)
28
205
92
20.2
0.89
0.98
56
92
Health
Care
Electronic
Equipment
Altera ($42; ALTR)
63
177
130
16.7
0.88
0.79
53
98
Technology
Semiconductors
Apple ($332; AAPL)
63
74
88
18.6
0.85
1.08
70
99
Technology
Computer
Hardware
CSX ($75; CSX)
18
48
58
18.5
1.24
0.87
57
95
Industrials
Railroads
DirecTV ($46; DTV)
12
65
17
18.7
0.95
0.92
80
94
Cons.
Discret.
Broadcast./
Cable TV
Exxon Mobil
($83; XOM)
24
56
70
13.4
1.12
0.82
79
97
Energy
Integrated
Oil & Gas
Hess ($80; HES)
14
246
49
15.6
1.14
0.96
83
96
Energy
Integrated
Oil & Gas
IBM ($163; IBM)
4
14
(6)
14.1
1.10
0.82
70
90
Technology
Computer
Hardware
J.P. Morgan Chase
($47; JPM)
0
71
NA
11.8
0.59
0.66
90
86
Financials
Financial Svcs.
Lam Research
($52; LRCX)
151
NM
NM
9.7
NM
0.61
88
99
Technology
Semiconductor
Equipment
MasterCard ($263; MA)
9
26
23
18.7
0.94
0.94
60
96
Technology
Data
Processing
Oracle ($33; ORCL)
42
34
22
16.1
0.86
0.56
59
96
Technology
Systems
Software
Texas Instruments
($34; TXN)
34
104
45
13.7
0.89
0.65
78
96
Technology
Semiconductors
Focus List Median
18
62
45
16.1
0.91
0.85
73
96
* Percentile ranks, with 100 the best.     NA Not Available.     NM Not Meaningful.

 


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