Focus On Your Best Ideas

5/9/2011


Our Focus List has a straightforward strategy: Limit the portfolio to our top 12 to 15 picks for year-ahead returns, and drop any stock that no longer ranks among our very favorites.

The second part of that strategy is the hard part; selling a winner requires an open-mindedness that can be hard to find when things are going well, while selling a loser means conceding a mistake. And because selling just before a stock rallies is so aggravating, fear of potential remorse (and subscriber anger) can make selling even more difficult for newsletter editors.

Our Buy List also takes a love-it-or-leave-it approach, but the tight limit on the number of Focus List stocks makes it especially sensitive to changes in our stock-market view. Based mostly on March-quarter reports and Quadrix scores, two stocks are being dropped from the Focus List. Walter Energy’s ($131; WLT) addition to the list is discussed in Portfolio Review.

Among more general themes seen in our Focus List, a few seem especially noteworthy:

The technology sector remains attractive, but our exposure to the most cyclical tech areas was too high heading into earnings season. No sector has more stocks (or a greater percentage of stocks) with Overall Quadrix scores above 90. But semiconductors, semiconductor equipment, technology distributors, and other cyclical tech groups have seen average Momentum and Earnings Estimates scores drop since earnings season began around April 6, suggesting expectations for the groups had become too optimistic.

Our health-care exposure may be too low. Health care ranks No. 1 among the 10 sectors based on average Overall score — and No. 2 based on the percentage of stocks with scores above 90. Agilent ($51; A), with considerable tech exposure, is the only health stock on the Focus List, so a pullback in Bard ($108; BCR) or another health name may prompt an upgrade.

Among big banks, J.P. Morgan Chase ($46; JPM), with an Overall score of 94, stands head and shoulders above the crowd. Among the big banks in the S&P 500 Index, only J.P. Morgan earns an Overall score above 75. More impressive, J.P. Morgan is the only big bank to avoid a big drop in its Momentum score since earnings season began.

Energy is looking better. Much-improved earnings and earnings estimates, along with modest share-price underperformance, have brought more energy stocks into buying range. The energy sector now ranks No. 3 based on average Overall score, reflecting improved scores for Momentum, Value, and Earnings Estimates.

As a partial hedge, a 5% to 10% cash position seems appropriate. Vanguard Short-Term Investment-Grade (VFSTX; $10.78), a relatively low-risk bond fund we use instead of a money-market fund, has returned 1.4% so far in 2011. The fund, yielding 1.8%, seems unlikely to do much better over the balance of 2011. But the fund has modest downside risk — and tends to perform best when expectations for the economy and stock prices are deteriorating. Over the long haul, our willingness to hold some money on the sidelines has helped returns somewhat — while considerably reducing risk. In fact, according to the independent Hulbert Financial Digest, the Focus List outperformed the U.S. stock market for the five, 10, and 15 years ended Dec. 31 — yet had monthly volatility 10% lower than the market for the 15-year period.

Downgrades

Lam Research ($47; LRCX) is being dropped from the Focus List, Buy List, and our Monitored List. Profit estimates have been under pressure since the company issued disappointing guidance, with consensus estimates now projecting year-to-year declines for the June and September quarters. We had been hopeful that Lam’s discount valuation (eight times expected current-year earnings) would provide some support. But discouraging guidance from several rival semiconductor-equipment players has undermined our confidence.


Texas Instruments ($35; TXN) is being dropped from the Focus List and Buy List. The semiconductor giant remains a Long-Term Buy, largely because it seems cheap and its long-term growth prospects seem intact. But near-term profit estimates have continued to deteriorate in recent weeks, and the company is now expected to post year-to-year profit declines in the June and September quarters. The stock’s Quadrix Overall score has dropped to 74.


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