Looking For A Few Good Stocks

6/20/2011


The Forecasts' investment philosophy revolves around creating reasonably diversified portfolios limited to our best ideas, and the smallest one we recommend is the Focus List, which currently contains 14 stocks.

But when we hear from readers looking for stock ideas, they never ask for our favorite 14 names. They just want a few of our best.

Even the Focus List is designed to be a part of a larger portfolio, and we would never advise readers to put all their money in fewer than 10 stocks. Still, we aim to please, and twice a year we present a few capital-gains favorites for the year ahead. We do this in June and again in December, in conjunction with our semiannual Outlook issue.

In recent years our capital-gains favorites have outperformed, on average. From December 2001 through December 2009, we presented 48 midyear picks and 60 year-end picks in our Outlook issues.

We assumed a purchase the day after the newsletter went to press and a holding period that ended a bit more than 12 months later, at the end of June or December of the next calendar year. If we sold a stock from our buy lists before the year was up, we calculated our returns as of the sale date. On average, our 108 capital-gains favorites gained 5.0% excluding dividends — not exactly breathtaking but respectable considering the stock-market travails of the past 10 years. In comparable periods, the S&P 500 Index returned an average of 3.0%.

Can we promise similar outperformance with our midyear 2011 picks? Of course not. But we can promise our best effort at selecting the five standouts reviewed below. All are components of our Focus List, presented in the the table below.

Apple ($332; AAPL) is pressing its lead in the tablet-computer field, where some rivals struggle for traction. The company has made no announcements, but some analysts expect a new iPad tablet in time for the holiday shopping season and a new iPhone launch in September, a version that incorporates fourth-generation wireless technology. Profit estimates for fiscal 2011 ending September have marched higher over the last month, now calling for 64% growth.

In the years ahead, Apple could expand the iPhone's market share by pushing into emerging markets with less-expensive models, though researcher Gartner ($37; IT) sees Apple preserving profit margins rather than chasing share by lowering prices.

Apple shares, down 9% from the February high, seem attractively valued. The stock trades at less than 16 times trailing earnings, one of its cheapest valuations in the past eight years and 42% below its five-year average. Apple's cash holdings of $31.23 billion account for more than 9% of its share price. Apple is a Focus List Buy and a Long-Term Buy.


Alliance Data Systems ($88; ADS) processes credit-card membership programs and manages loyalty programs and marketing databases for other industries. Both sales and cash provided by operations have grown in six consecutive quarters. The economic recovery, unbalanced though it seems at times, should bode well for credit-card issuance and loyalty-program participation.

The S&P 1500 Technology Sector Index has declined 1% this year, while Alliance Data shares have jumped 24%. Yet Alliance Data still earns a solid Quadrix Value score of 70. At less than 14 times trailing earnings, shares trade 29% below their three-year average and 20% below their industry average.

Analyst estimates project earnings per share of $1.65 in the June quarter, up 20% on 8% revenue growth. Alliance has proved it can manage expectations, beating the consensus in each of the last four quarters, including a surprise of nearly 21% in the March quarter. Wall Street's full-year earnings target of $7.10 per share implies 21% growth. Earning an Overall score of 96, Alliance is a Focus List Buy.


Neither recession nor uneven recovery has slowed DirecTV ($47; DTV). Quarterly sales haven't declined since the middle of 2003, while operating cash flow has risen at double-digit rates in six of the last eight quarters. The U.S. business provides steady growth, while Latin America supplies the kicker.

The Latin America unit signed up its 10 millionth subscriber in June, up from about 3 million in 2004. Management sees revenue rising 30% in Latin America this year, which would mark its strongest gain since 2008. The region boasts strong momentum. Net subscriber additions nearly doubled in the March quarter after rising 11% in 2009 and 76% in 2010.

Shares have rallied 39% since the end of last June. At 17 times trailing earnings, the stock trades 12% below its three-year average. If DirecTV merely holds at its current P/E and hits the 2011 consensus per-share-profit estimate of $3.23, the stock stands to gain another 18% by early next year. DirecTV is a Focus List Buy and a Long-Term Buy.


MasterCard ($274; MA) lines its coffers with the cash consumers are not using. Leveraged to the ongoing shift away from cash use, MasterCard, an electronic-payment processor, saw its free cash flow surge 95% to $1.81 billion in the past year. MasterCard should also benefit from the budding mobile-payment market. To avoid sharing fees with credit-card companies, U.S. wireless carriers had originally sought to establish their own networks for offering mobile payments through smartphones. But now carriers have scaled back their plans and opened discussions with Visa ($76; V) and MasterCard to use consumers' existing credit cards.  

The U.S. Senate rejected a proposal to delay a new law limiting interchange fees on debit cards, so MasterCard could face downward pressure on the fees it charges banks. However, the effect on MasterCard appears manageable. U.S. debit cards account for about 17% of the company's transaction volume. In contrast, U.S. debit cards generate about 26% of Visa's volume.

Per-share profits are projected to grow 17% in 2011, a pace that seems sustainable over the next five years. MasterCard is a Focus List Buy and a Long-Term Buy.


Scoring above 80 in five of six Quadrix categories, Walter Energy ($115; WLT) earns a maximum Overall rank of 100. Walter, a coal miner, reported 69% higher revenue in the 12 months ended March, as fatter profit margins contributed to free-cash-flow growth of 116%.

Reflecting the April acquisition of Western Coal, both revenue and per-share earnings are projected to double in 2011. Walter said the Japan disaster has not meaningfully reduced coal shipments in the near term, easing concerns that the country's damaged infrastructure could disrupt shipments.

Shares trade at 14 times trailing earnings, a 28% discount to their three-year average and 30% below the average diversified metals and mining stock in the S&P 1500 Index. Considering its 2011 outlook, the stock looks even more attractive at less than eight times projected current-year profits, 53% below the peer-group average. Walter is a Focus List Buy.

FOCUS LIST
Percent Gain Or
Loss On List
P/E Ratio
Company (Price; Ticker)
Div.
Yield
(%)
Stock-
Market
Value
($Bil.)
Date
Added To
Focus List
Price
Added
To List
($)
Absolute
(%)
Versus
S&P
500
Index
(%)
Trailing
Vs.
5-Yr.
Avg.
Vs.
Industry
Avg.
Quadrix
Overall
Score
Sector
Aflac ($46; AFL)
2.6
21.9
11/27/09
43.65
7
(11)
8
0.55
0.77
80
Financials
Agilent Technologies
($49; A)
0.0
17.4
1/6/11
41.48
18
17
19
0.77
0.97
96
Health Care
Alliance Data Systems
($88; ADS)
0.0
4.9
5/26/11
92.01
(4)
(2)
13
0.64
0.70
96
Technology
Altera ($44; ALTR)
0.5
14.4
11/4/10
33.04
33
27
16
0.81
0.78
95
Technology
Apple ($332; AAPL)
0.0
311.1
9/9/10
263.07
26
10
16
0.60
0.77
99
Technology
CSX ($74; CSX)
1.9
27.7
9/9/10
53.97
38
21
17
1.08
0.80
93
Industrials
DirecTV ($47; DTV)
0.0
37.6
10/9/08
20.09
135
93
17
0.83
0.85
98
Cons. Discretionary
Exxon Mobil
($80; XOM)
2.3
399.6
1/27/11
79.88
1
2
11
0.96
0.76
98
Energy
Hess ($73; HES)
0.5
24.9
4/7/11
84.53
(13)
(10)
13
1.10
0.89
93
Energy
IBM ($164; IBM)
1.8
203.5
5/15/08
128.46
28
37
14
0.98
0.66
93
Technology
J.P. Morgan Chase
($42; JPM)
2.4
167.0
1/27/11
45.10
(8)
(7)
9
0.57
0.50
82
Financials
MasterCard
($274; MA)
0.2
35.9
4/7/11
265.17
3
7
18
0.79
0.96
95
Technology
Oracle ($23; ORCL)
0.7
165.2
4/7/11
33.72
(5)
(1)
15
0.76
0.51
95
Technology
Walter Energy
($115; WLT)
0.4
6.1
5/5/11
126.58
(9)
(6)
14
0.76
0.66
100
Materials
Focus List Average
1.0
102.7
18
13
15
0.80
0.76
94
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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