Portfolio Review


Three new stocks and an upgrade

Profit projections for managed-care provider Aetna ($44; AET) are modest, with the consensus projecting a 1% decline in per-share profits in 2012 after a 40% gain in 2011. But we see at least three reasons to believe Aetna can top expectations:

1) Estimates are rising. The 2012 profit projection has risen over the last three months, including a 2% increase in the last 30 days. Aetna's medical loss ratio is likely to increase in 2012 in the wake of abnormally weak cost inflation in 2011, but the consensus still seems conservative.

2) Analysts don't yet have a handle on what Aetna can do, as evidenced by profit surprises of at least 21% in each of the last three quarters.

3) Profit estimates don't reflect Aetna's operating momentum. Per-share operating profits have risen at least 24% in each of the last seven quarters. While we don't expect a continuation of the torrid growth, the consensus seems unduly conservative.

Aetna earns a 99 Overall in Quadrix, with maximum ranks of 100 for both sector-specific scores. Aetna was initiated Dec. 23 as a Buy and a Long-Term Buy.

Qualcomm's ($55; QCOM) sales rose 33% in the year ended September, with per-share profits up 35% and operating cash flow up 20%. Nearly two-thirds of Qualcomm's sales come from wireless microchips and software, and the company is profiting from the explosive growth of smartphones, particularly in emerging markets. Qualcomm generates most of its remaining revenue from licenses and royalty fees, again benefiting from the worldwide growth market for high-speed wireless. Qualcomm holds key patents for the core technology in third-generation wireless networks, which is also a crucial component in nascent higher-speed networks.

Qualcomm shares aren't cheap relative to the rest of the market at 17 times trailing earnings, but they trade at a discount of at least 22% to the one-, three-, and five-year average price/earnings ratios. The Federal Communications Commission cleared AT&T ($30; T) to purchase wireless spectrum from Qualcomm for $1.93 billion, just days after the telecom's bid to acquire T-Mobile USA fell apart. In other news, Qualcomm founder Irwin Jacobs will retire from the board in March. Qualcomm was initiated Dec. 23 as a Buy and a Long-Term Buy. AT&T is rated C (below average).

Advance Auto Parts ($71; AAP) has seen its Quadrix Overall score rise to 97 from 86 at the end of October, lifted by improvements in Momentum (recent operating results) and Earnings Estimates (profit-target revisions) scores. Per-share-profit growth accelerated in the first three quarters of 2011, and over the last 90 days, profit projections for 2012 increased 7%. Wall Street now expects profit growth of 12% in 2012 and 14% annually over the next five years.

The year-ahead picture for Advance Auto looks bright. As customers adapt to higher gasoline prices, the recent decline in miles driven in the U.S. should reverse. In recent years, many drivers have held off on maintenance expenditure. And as the economy improves, pent-up demand should translate to higher sales of maintenance products.

We expect the commercial business to continue pacing growth at Advance Auto, and sales to garages could account for more than 35% of revenue next year, versus 31% in 2010. Advance believes the commercial business will eventually generate 50% of its sales, and given the company's U.S. market share of less than 5%, the targets seems reachable. On Dec. 23, Advance was added to the Buy List.

Visa ($102; V) has been remarkably consistent. Over the last eight quarters, sales growth has never dipped below 12%, and per-share operating profits have risen at least 24%. With more than $10 per share in cash and no debt, Visa's pristine balance sheet contributes to a Financial Strength score of 94. Like rival MasterCard ($375; MA), Visa is not cheap relative to the market. But at 20 times trailing earnings, Visa trades at a 12% discount to its five-year average P/E ratio.

So far, we have yet to see the effect of the federally mandated cap on credit-card fees. But in an effort to forestall problems, Visa has stepped up its spending on incentives to keep merchants using its network. Meanwhile, Visa's payment volumes rose 17% in the September quarter, with 28% growth outside the U.S.

Long-term trends favor Visa, as more Americans opt for noncash payments and use of credit and debit cards becomes more prevalent overseas. Wall Street expects profit growth of 16% in fiscal 2012 ending September and 19% annually over the next five years. Visa was initiated as a Long-Term Buy on Dec. 23. MasterCard is a Focus List Buy and a Long-Term Buy.

Corporate roundup

On the mobile-device battlefield, Apple ($407; AAPL) lost ground in a German court, as well as with consumers in Europe. A German judge rejected Apple's claim that Samsung's redesigned tablet computer still looks too much like an iPad. The decision is preliminary, but it hurts Apple's chances of winning an outright ban of Samsung mobile devices, which use Google's ($640; GOOG) Android operating system. In the November quarter, the iPhone gained market share in the U.S. (36% from 25% a year earlier) and Britain (31% from 21%), while struggling in continental Europe, according to industry researcher Kantar Worldpanel ComTech. Kantar blamed iPhone's weakness in Europe on economic instability and cheaper prices for Android-based smartphones. Apple and Google are rated Focus List Buy and Long-Term Buy.

The U.S. Justice Department approved Exelon's ($44; EXC) $7.9 billion bid to acquire Constellation Energy Group ($40; CEG) on the condition that the companies sell three electric plants in Maryland to preserve competition. Exelon expects to complete the deal in early 2012, though it still needs approval from public-service commissions in New York and Maryland, the Federal Energy Regulatory Commission, and the Nuclear Regulatory Commission. Exelon is rated A (above average) and is a member of our Top 15 Utilities portfolio.

Brazil continued its aggressive response to a November oil spill by announcing that federal police will seek indictments of up to 17 Chevron ($108; CVX) and Transocean ($39; RIG) employees linked to the leak. Both companies publicly backed their workers and vowed to defend them against any charges, and it is uncertain whether prosecutors will pursue the threatened indictments, which would set a dangerous precedent and potentially discourage foreign investment. Regardless of the Brazilian developments, Chevron shares rose, as did those of Exxon Mobil ($85; XOM), on a report that U.S. crude oil supplies had declined. Chevron and Exxon Mobil are rated Focus List Buy and Long-Term Buy.

Rank Changes

On Dec. 23, Aetna ($44; AET) and Qualcomm ($55; QCOM) were initiated as Buys and Long-Term Buy, and Visa ($102; V) was initiated as a Long-Term Buy. Advance Auto Parts ($71; AAP), already a Long-Term Buy, was added to the Buy List. After the changes, the Vanguard Short-Term Investment-Grade ($10.62; VFSTX) fund makes up 12.9% of the Buy List and 14.6% of the Long-Term Buy List.

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