Portfolio Review


Stick with Google

Google ($554; GOOGL) earns a Quadrix Overall score of 67, among the lowest for our recommended stocks. The stock has tested our patience in the past year — and has surely frustrated many of our subscribers — but we think Google is worth keeping for several reasons:

• The company has never put much emphasis on hitting quarterly numbers; it last topped consensus profit estimates in the September 2013 quarter. But Google's March-quarter earnings per share came within 1% of the consensus — closer than any other quarter during that stretch.

• Cash from operations surged 51% to $6.62 billion in the March quarter, marking the eighth straight quarter of double-digit growth. Google has also become more disciplined with its capital expenditures.

• The stock trades at 21 times trailing earnings, though its P/E ratio drops to 18 after excluding net cash of $87 per share; the median S&P 1500 technology stock has a P/E ratio of 20.

• Analyst estimates also appear to be stabilizing, with the consensus projecting 11% higher earnings per share on 13% revenue growth this year.

We're also intrigued by Google's moves in mobile advertising. A new business venture could help boost the rates Google charges for mobile ads. Ads accessed on personal computers currently fetch a higher price.

Google is adding buy buttons to its online-results pages when users search for products using mobile devices. Clicking on the button will send users to a second Google page where they can complete the purchase. Macy's ($68; M) is reportedly talking with Google about participating in the launch. Some retailers fear Google's move could weaken their own relationships with customers.

Mobile ads have a lower conversion rate than those that appear on PCs, partly due to awkwardness in navigating retailers' mobile websites and the tedious process of entering credit-card information and shipping instructions on a small keypad. Google proposes to store shopper information across all retailers to simplify mobile purchases.

Mobile commerce is a potentially huge business opportunity. Google says online searches on mobile devices exceed those on PCs in the U.S., Japan, and eight other countries

Separately, Google cut prices by up to 30% on certain cloud-computing services, continuing its aggressive discounting strategy over the past two years. Microsoft ($48; MSFT) and Amazon Web Service, Amazon.com's ($431; AMZN) cloud unit, may be forced to follow suit. Google is a Buy and a Long-Term Buy. Macy's is a Long-Term Buy. Microsoft is rated B (average). Amazon.com is rated C (below average).

Charter moves in after Comcast bails

Charter Communications ($178; CHTR) is trying to do what Comcast ($59; CMCSa) couldn't — purchase Time Warner Cable ($184; TWC). Analysts give Charter's $56.7 billion cash-and-stock deal a better chance of closing than Comcast enjoyed, in large part because the resulting entity — New Charter — would be smaller than Comcast by itself. With more than 19 million internet subscribers and more than 17 million cable-TV customers, New Charter would become the third-largest pay-TV provider in the U.S., behind only Comcast and the pending merger of AT&T ($35; T) and DirecTV ($92; DTV).

The merger would boost Charter's influence and pricing power, but don't write off Comcast, which for now remains the biggest dog in the race and has proven capable of competing effectively against large, well-financed rivals. In addition, while a Charter-Time Warner Cable combo would control less than 30% of the broadband market, well below the 57% share that contributed to the death of Comcast's proposal, regulators are unlikely to roll over.

Federal Communications Chairman Tom Wheeler says the agency will "look to see how American consumers would benefit" before approving the Charter deal. "An absence of harm is not sufficient." Comcast is a Buy and a Long-Term Buy. AT&T and DirecTV are rated B (average).

Health-care review

CVS Health ($103; CVS), best known for its eponymous retail drugstore chain, is continuing its evolution into a vertically integrated health-care conglomerate. The company has agreed to pay $10.4 billion in cash and assume $2.3 billion in debt to acquire Omnicare ($96; OCR), adding an estimated $0.20 per share to 2016 earnings. The deal represents a 4% premium to Omnicare's price at the time of the announcement, but a 24% premium to its average price over the last 100 days. Omnicare operates two businesses, a specialty pharmacy that distributes pricey drugs and a far larger, if slower-growing, unit that provides drugs to nursing homes.

The purchase of Omnicare, the eighth-largest specialty-drug distributor in the U.S., will further boost the reach of CVS, already the country's leading specialty-drug provider. In the March quarter, spending on specialty drugs rose 46%; the specialty business is likely to continue padding CVS' growth in coming quarters. In addition, Omnicare's focus on elderly patients positions CVS to ride the long-term trend of an aging America and tap into segments of the health-care market where it has little exposure. CVS, which rose on the merger announcement, is a Buy and a Long-Term Buy.

A U.S. group has challenged patents for Sovaldi, Gilead Sciences' ($112; GILD) expensive hepatitis C drug, in five countries — China, Russia, Ukraine, Brazil, and Argentina. Gilead agreed last year to make the drug available at a lower price in 91 developing countries, but the activists wish to unleash generic competition in emerging economies not covered by the discount deal.

Concerns about backlash over Gilead's drug prices are the main reason the consensus projects per-share-profit growth of less than 2% next year, after 34% growth this year. Gilead trades at 11 times expected year-ahead earnings, a valuation that takes into account a lot of bad news. The shares are rated Buy and Long-Term Buy.

United Rentals expands

United Rentals ($105; URI) is broadening its footprint, adding 10 specialty-rental locations, including two in Canada. A leading provider of construction and industrial equipment, with nearly 900 locations, United Rentals operates in a fragmented and competitive market. However, tight supply and rising equipment costs have helped sustain rental prices, while an upturn in construction is boosting demand.

Shares have rallied 8% over the past month but still trade 13% below their September high. That weakness partly reflects worries about exposure to the energy sector, which accounts for roughly 6% of total sales. Prospects for earnings growth look bright, however, spurred by expanding profit margins and healthy trends for cash flow. Cash provided by operations increased 19% over the past 12 months, and free cash flow hit a record $330 million in the March quarter. United Rentals, earning a solid Quadrix Value score of 82, is a Focus List Buy and a Long-Term Buy.

Corporate digest

Apple's ($132; AAPL) brand rose in value 67% to $247 billion last year, according to Millward Brown's annual BrandZ rankings, taking the number one spot back from Google ($554; GOOGL). Apple's brand power was illustrated when the accidental posting of a photo of an unidentified iPhone — possibly a yet-to-be released 6C — in late May made national headlines. Apple is a Focus List Buy and a Long-Term Buy. Google is a Buy and a Long-Term Buy.

The Russian government should decide within three weeks whether to accept Schlumberger's ($91; SLB) $1.7 billion bid for a 46% stake in Eurasia Drilling. Schlumberger is a Long-Term Buy.

Rank Changes

No changes were made this week in Dow Theory Forecasts.

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