Portfolio Review: March 14, 2016


Upgrades and downgrades

As Quadrix scores, valuations, and growth prospects shift, so does our enthusiasm for our recommended stocks. This week we're making several rank changes, though we're not adding any new stocks or dropping any from our buy lists entirely.

What we're doing

Amerco ($348; UHAL), Centene ($58; CNC), Lam Research ($74; LRCX), and Owens Corning ($45; OC) are being added to the Focus List, while CDW ($41; CDW) and Foot Locker ($63; FL) are being dropped from the Focus List.

On the Buy List, we're adding Biogen ($256; BIIB) and Owens Corning, while Wells Fargo ($49; WFC) is being dropped.

How we're doing it

To accommodate these changes without increasing our net exposure to stocks, we're also changing our target weights. On the Buy List, stocks on the Focus List now get a 3.6% target weight, down from 3.8%. The other stocks on the Buy List get a 3.1% weight, down from 3.3%.

On the Long-Term Buy List, Focus List stocks now get a 3.0% target weight, down from 3.1%. The other Long-Term Buys still get a 2.6% weight.

You don't need to mimic our target weights exactly. Use common sense, selling down your most overweight positions and adding to those most underweight. The lower your trading commissions as a percentage of your portfolio value, the more trades you can make without meaningfully reducing returns. But, in reality, a weighting difference of 0.2% probably won't make a notable difference in your portfolio's performance. 

Why we're doing it

We're making these changes mostly for company-specific reasons, but some big-picture considerations also played a role.

First, by expanding the number of Focus List stocks to 14 from 12, we should reduce volatility without diminishing expected return. We aim to limit the Focus List to our very best ideas. But the difference between our 12th and 14th favorite stocks is minor, whereas the broader list should notably dampen volatility.

Second, we see opportunities in some domestic cyclicals, like Amerco and Owens Corning. With U.S. employment showing steady growth, wage hikes likely to accelerate, and energy prices low, we expect continued improvement in the housing market as household formation accelerates.

Third, we're finding some attractively valued growers. The median company on our Buy List is expected to deliver current-year growth of 11.4% in per-share earnings and 5.6% in sales, versus respective medians of 5.6% and 2.2% for all S&P 500 companies. Yet our Buy List stocks trade at 12.5 times expected current-year earnings, on average, versus 17.2 times for S&P 500 stocks.


We reviewed Biogen, Lam Research, and Owens Corning in the March 7 issue. Centene, a managed-care concern focused on Medicaid, is a classic growth-at-a-good-price pick. The stock trades at 14 times the current-year profit consensus. Per-share profits are likely to climb 35% to 45% in 2016 and 10% to 20% in 2017. Amerco, a provider of moving trucks and storage spaces, represents an attractive play on an improving U.S. economy.


CDW and Foot Locker still rank among our favorite 24 year-ahead picks, but we're dropping them from the Focus List to make room for stocks with higher Quadrix scores and superior year-ahead prospects. Wells Fargo remains a solid choice for 24- to 48-month returns. But, after a 9% rally off its February low, the stock could face near-term headwinds if long-term interest rates and net interest margins remain at present levels.

Borderline stocks

If not for concerns regarding industry overlap, Skyworks Solutions ($71; SWKS) and Southwest Airlines ($42; LUV) would make the Focus List.

Disney ($98; DIS) almost made it on to the Buy List.

On the downside, Nvidia ($32; NVDA) looks somewhat expensive and could be downgraded if it rallies more in the near term. Shire ($159; SHPG) has seen its Quadrix scores deteriorate. While the stock seems cheap, uncertainty regarding its new-drug pipeline and pending merger with Baxalta put Shire near the bottom.

Stocks in the news

Kroger ($38; KR) grew January-quarter earnings per share 10% to $0.57, topping the consensus estimate by $0.03. Total revenue advanced 4% to $26.17 billion, narrowly missing analyst expectations. Same-store sales excluding fuel rose 3.9%.

Shares tumbled on the report, likely due to management's middling outlook for fiscal 2017 ending January. Kroger expects full-year earnings per share of $2.19 to $2.28, roughly bracketing the consensus of $2.23 and implying growth of 6% to 11%. Same-store sales are projected to rise 2.5% to 3.5% in the coming year, short of analyst expectations. Although volumes remain strong, management says slowing food inflation is hurting sales growth, especially for meat and milk products. Kroger also expects capital spending to rise sharply this year, constraining free cash flow.

Kroger is known for being conservative when issuing its initial full-year guidance. Moreover, the grocer's profit margins tend to improve in a deflationary environment. At 17 times estimated year-ahead earnings, Kroger shares trade at a 23% discount to the median consumer-staples stock in the S&P 1500 Index. Kroger remains a Buy and a Long-Term Buy.

New York's state attorney general launched a probe into claims that health insurers improperly restricted coverage of effective but expensive hepatitis C drugs to patients. Aetna ($109; AET) confirmed that it was part of the investigation that includes 16 insurers. Until now, scrutiny on hepatitis C drugs had focused on the prices charged by Gilead Sciences ($88; GILD) and other drugmakers.

In other news, a judge ruled last month that Gilead's hepatitis C drugs Sovaldi and Harvoni infringed on patents held by Merck ($52; MRK). A jury will now decide whether Gilead must pay royalties to Merck, which seeks $3 billion. Pharmasset, acquired by Gilead in 2011, began to work on a hepatitis C treatment around 2001. Merck claims it published a patent in 2002 that Pharmasset used  to develop the compound that ultimately became Sovaldi and Harvoni. Gilead is a Focus List Buy and a Long-Term Buy. Aetna and Merck are rated B (average).

Southwest Airlines ($42; LUV) said traffic jumped 13.5% in February on capacity growth of 14.7%. Separately, at least eight U.S. airlines, including Southwest and Alaska Air Group ($77; ALK), filed applications to offer flights between the U.S. and Cuba. The airlines applied for more routes than are available, and a final decision is expected this summer. Alaska Air is a Focus List Buy and a Long-Term Buy. Southwest Airlines is a Buy and a Long-Term Buy.

Rank Changes

Amerco ($348; UHAL), Centene ($58; CNC), Lam Research ($74; LRCX), and Owens Corning ($45; OC) are being added to the Focus List, while CDW ($41; CDW) and Foot Locker ($63; FL) are being dropped from the Focus List. On the Buy List, we're adding Biogen ($256; BIIB) and Owens Corning, while Wells Fargo ($49; WFC) is being dropped. We're also changing some of the target weightings on our recommended lists. Click below for the updated weightings. Vanguard Short-Term Corporate Bond ($79; VCSH) exchange-traded fund now accounts for 18.6% of the Buy List and 19.0% of the Long-Term Buy List.

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