Portfolio Review


Rank changes

Reflecting December-quarter results and changing Quadrix scores, we are making some changes to our recommended lists this week.

J.P. Morgan ($47; JPM), already a Long-Term Buy, is being added to the Buy List. The financial-services giant blew past the profit consensus for the December quarter, topping expectations by 20% and marking the third consecutive quarterly profit surprise of at least 12%. Since then, expectations for both 2013 and 2014 have risen by 1%. J.P. Morgan's annual return on equity topped 11% in 2012, its highest level since 2007.

With a Quadrix Overall score of 98 and scores of 88 or higher in Momentum, Value, Financial Strength, and Earnings Estimates, J.P. Morgan looks good from a lot of angles. The stock's chart is impressive, showing price gains of 9% over the last month and 28% over the last six months. Despite the strong price action, J.P. Morgan trades at nine times trailing earnings, a 42% discount to the median diversified financial stock in the S&P 1500 Index and 42% below its own five-year average.

Canadian auto-parts maker Magna International ($53; MGA), initiated as a Buy on Jan. 14 and added to the Long-Term Buy List last week, is now going onto the Focus List. The consensus projects U.S. sales of cars and light trucks will rise at least 3.5% this year and next year, and those targets could prove conservative if the economy heats up.

Magna's operating profit margin rose to 7.3% in the 12 months ended September from 6.7% in the same period a year earlier, and the consensus projects further margin expansion. Excluding noncash amortization costs connected with an acquisition, Magna's per-share profits should rise at least 13% this year on 5% revenue growth. But investors need not pay up for that growth, as the shares trade at just 10 times expected 2013 earnings, 38% below the peer-group median.

American Express ($59; AXP) is being removed from the Focus List, but it remains a Buy and a Long-Term Buy. Its Quadrix Overall score has dipped to 84, though the company still earns above-average scores in every category except Performance. Amex's trailing price/earnings ratio of less than 14 is 25% below its three-year average and 11% below the median diversified financial stock.

Amex's profits rose 8% in the December quarter, in line with the consensus. The consensus projects profit growth of 8% this year and 12% next year, manageable targets. The modest decline in Overall score and concerns about how Amex would respond to economic weakness have knocked the stock from among our very favorites, but the shares still represent a solid pick for total returns over the next year and beyond.

December-quarter earnings

Qualcomm ($63; QCOM) said December-quarter earnings per share rose 30% to $1.26 excluding special items, $0.13 above the consensus. Revenue also exceeded the consensus, climbing 29% to $6.02 billion, while operating cash flow advanced 11%. Qualcomm targets per-share profits of $1.10 to $1.18 in the March quarter, equating to 9% to 17% growth versus the 9% consensus. Qualcomm is a Buy and a Long-Term Buy.

Celgene ($99; CELG) grew earnings per share 26% to $1.32 in the December quarter, easing past the consensus by a penny. Revenue advanced 13% to $1.45 billion, marking the company's 40th consecutive quarter of at last 10% growth. Sales for Revlimid, a treatment for blood cancer, rose 17% to more than $1 billion. Up 25% since we first recommended the stock in early December, Celgene is a Buy and a Long-Term Buy.

In the December quarter, EMC ($24; EMC) earned $0.54 per share excluding special items, up 10% and $0.02 above the consensus. Revenue grew 8% to $6.03 billion, also slightly above the consensus. But the shares slumped on disappointing outlooks, both from EMC itself and from 80%-owned VMware ($77; VMW), which sees soft demand from the government and big companies in the first half of 2013. VMware makes virtualization software that lets computers run multiple operating systems and applications on a single server. EMC calls for 2013 per-share earnings of $1.85, implying 9% growth, on sales of $23.5 billion, up 8%. The consensus had projected earnings per share of $1.90 and sales of $23.57 billion. EMC is a Buy and a Long-Term Buy.

Mergers and deals

Thermo Fisher Scientific ($62; TMO) is reportedly one of multiple companies weighing a bid to buy Life Technologies ($70; LIFE), a maker of biomedical laboratory equipment. With a market value of $11.02 billion, Life Technologies would be Thermo Fisher's biggest acquisition since its own creation via a $12.8 billion merger in 2006. Thermo Fisher is a Focus List Buy and a Long-Term Buy.

Continuing its shift away from lower-margin ventures,  Cisco Systems ($21; CSCO) agreed to sell Linksys, its home-networking business, to Belkin International. Cisco originally bought Linksys for about $500 million in 2003. Terms of the deal, expected to close in March, were not released. Cisco is a Buy and a Long-Term Buy.

Apple's not rotten, despite market slide

Apple's ($458; AAPL) December-quarter earnings report stoked fears about the company's growth outlook. With the rapid unraveling of Research In Motion ($16; RIMM) still fresh in investors' minds, some wonder if Apple can keep churning out widely popular devices. Even Apple called the number of product releases in 2012 "unprecedented." Although CEO Tim Cook claims the "pipeline is chock-full," he offered few hints about whether Apple can duplicate its 2012 success in the year ahead. Since the report, Apple did announce a new iPad with twice the memory of current models, set to go on sale Feb. 5.

Most investor concerns center around the iPhone, which accounted for 56% of the company's December-quarter sales. Surveys found the iPhone has lost share in Hong Kong and Singapore — two key regions that can presage trends in Western countries.

In our view, the consensus profit-growth estimate for the fiscal year ending September 2012 (less than 2%) is conservative, and the valuation (10 times the 2013 estimate) is compelling. See Value Focus for more on Apple. Apple. Apple is rated Focus List Buy and Long-Term Buy. RIM is rated C (below average).

Dipping below Microsoft's Surface

Microsoft's ($28; MSFT) per-share profits slipped 3% to $0.76, ahead of the consensus estimate of $0.75. Sales crept 3% higher to $21.46 billion. The business division, which includes the Microsoft Office business-software suite, saw sales slip 10% in advance of a Jan. 29 update. Including upgrades and presales, the unit's revenue rose 3%. Fresh off the October debut of Windows 8, Microsoft's Windows unit grew revenue 24%. The Windows division also includes the Surface RT tablet.

Suppliers reportedly say shipments of all Windows-based tablets have totaled just 2 million units, well short of initial targets of at least 4 million units by the end of December. Only about half of the shipped tablets have sold, hindered by a high price tag and a small number of applications. Microsoft hopes to turn the tide with its Surface Pro tablet, a more robust version of the Surface RT set to go on sale on Feb. 9. But Apple also wants to claim a stake of the enterprise market with a new iPad, equipped with the same amount of memory as the Surface Pro and priced about $200 less.

Microsoft doesn't make Office software for the iPad, which raises the stakes; if Windows-based tablets fail, Microsoft now could end up shut out of the tablet market. Motorola Solutions ($59; MSI) said it plans to design a rugged Windows-based tablet for police officers and factory workers. Microsoft, a Long-Term Buy, pays a 3.3% yield to compensate investors willing to wait for the company to jump-start its profit growth. Motorola Solutions is rated B (average).

Rank Changes

J.P. Morgan Chase ($47; JPM) is being added to the Buy List. Magna International ($53; MGA) is being added to the Focus List. American Express ($59; AXP) is being removed from the Focus List but remains a Buy and a Long-Term Buy. The Vanguard Short-Term Investment-Grade ($10.82; VFSTX) fund now accounts for 3.2% of the Buy List and 8.8% of the Long-Term Buy List.

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