Portfolio Review


List review

Because of third-quarter results, valuations, and Quadrix® scores, we’re making changes to our Focus List, Buy List, and Long-Term Buy List. We’re also making several changes to the A (above-average), B (average), and C (below-average) ratings we provide in our Monitored List supplement.

Because the Dow Industrials and Dow Transports have reached significant highs, we’re boosting the stock-market exposures of our buy lists. On the Buy List and Long-Term Buy List, the target weight for each of the 12 Focus List stocks is being increased by 0.7%.

While this approach will boost risk slightly relative to buying all the stocks in the portfolios, it will limit commission costs — and get more money into our very best ideas.

The Buy List’s position in Vanguard Short-Term Investment Grade ($10.90; VFSTX) is being cut to 16.6%, versus 18% for the Long-Term Buy List. The Focus List always has the same bond-fund exposure as the Buy List. Depending on the market’s action and the opportunities available, our plan is to lower our bond-fund exposure further in coming months by adding more stocks or shifting some money into an equity fund.

Focus List

Altera ($32; ALTR) is being added to the Focus List. The company appears to be snatching market share from rivals during a turbulent stretch for semiconductors. Yet the stock remains modestly valued at 13 times projected earnings for the next fiscal year, reflecting skepticism surrounding the sustainability of sales growth and profit margins.

Following explosive growth in 2010, when Altera’s per-share profits are expected to rise 194% to $2.47, Wall Street sees earnings slipping 4% in 2011 despite higher projected sales. That leaves plenty of potential upside for Altera. The stock earns a Quadrix Overall score of 100, and both of its sector-specific scores are at least 99.

Rogers Communications ($36; RCI) is being removed from the Focus List but remains a Buy and a Long-Term Buy. Shares slumped after Rogers reported a middling September quarter. Revenue missed Wall Street targets, and the addition of smart-phone customers triggered subsidies that crimped profit margins.

Although it no longer ranks among one of our very best ideas, Rogers’ fundamental story remains intact. Leveraged to growth in smart phones, it generates strong free cash flow. Yet the stock, yielding 3.5%, is reasonably valued at 13 times trailing earnings, 49% below the five-year average P/E.

Buy List

Semiconductor maker Texas Instruments ($30; TXN) is being added to the Buy List. Its Overall score of 99 is supported by scores of at least 70 in all six Quadrix categories. The stock also earns strong sector scores, with a Reranked Overall score of 98 and a 12-Factor Sector score of 89.

Shares have surged 29% since the end of August, turning higher again in October after TI reported strong results for the September quarter. Estimates for 2011 have ticked higher since the earnings report, but expectations for 2% growth in per-share profits seems unduly conservative.

GameStop ($20; GME) is being removed from the Buy List and Monitored List. The stock’s Overall Quadrix score has dropped to 78, hurt by subpar ranks for Momentum (28), Financial Strength (42), Earnings Estimates (41), and Performance (15).

Shares remain quite cheap at eight times trailing earnings, 62% below their five-year average, and could attract takeover interest. But industrywide, video-game sales fell 10% in August and 8% in September. The industry’s traditional business model seems to be splintering as consumers purchase more games through social networks, smart phones, and online distributors. GameStop has done fairly well in protecting its used-game business from rivals, but the barrage could keep pressure on the stock. While GameStop’s valuation reflects such concerns, the stock no longer qualifies as a Buy. 

Long-Term Buy List

St. Jude Medical ($38; STJ) is being added to the Long-Term Buy List. St. Jude sells medical devices, with a focus on cardiac-rhythm management, cardiac surgery, and atrial-fibrillation therapy. The stock earns an Overall score of 98 and a Value score of 86.

St. Jude generates consistent sales and profit growth. Operating profit margins have expanded in each of the last seven quarters. Earnings estimates have turned higher in the past month, with Wall Street now anticipating December-quarter profits of $0.74 per share, up 16% on 7% higher revenue. At 13 times trailing earnings, the stock trades at a 37% discount to its five-year average P/E and 25% below the average health-care-equipment stock in the S&P 1500 Index.

Energen ($45; EGN) is being dropped from the Long-Term Buy list, but it still constitutes one of our better utility holdings and will remain a member of the Top 15 Utilities portfolio listed on page 2. The stock’s Overall score of 74 reflects weak operating momentum and share-price action.

In the September quarter, Energen said profits from continuing operations rose 20% to $0.73 per share excluding a noncash write-off, missing the consensus by $0.08. Operating revenue rose 3%.

However, management guided 2011 per-share profits ($3.20 to $3.60) below the consensus estimate ($3.68) and the company’s 2010 target ($4.30 to $4.40). Shares seem reasonably valued but not particularly cheap at 10 times the midpoint of Energen’s 2011 guidance.

September-quarter earnings

AmerisourceBergen ($32; ABC) earned $0.50 per share in the September quarter, up 14% and $0.02 above the consensus. Revenue, climbing 5% to $19.72 billion, also beat Wall Street’s forecast. For fiscal 2011 ending September, Amerisource expects per-share profits of $2.31 to $2.41, implying 7% to 12% growth. Amerisource is a Buy and a Long-Term Buy . . . BMC Software ($46; BMC) grew September-quarter profits 24% to $0.82 per share excluding special items, exceeding the consensus estimate by $0.12. Revenue rose 9% to $502 million on a 20% jump in license revenue, also ahead of analyst expectations. Management lifted its profit guidance for fiscal 2011 ending March. BMC Software is a Buy and a Long-Term Buy . . . For the September quarter, Lubrizol ($105; LZ) said its profits were flat at $2.52 per share excluding a one-time tax benefit, missing the consensus by $0.10. Revenue increased 9% to $1.38 billion. While the company raised its guidance for 2010 per-share profits above the consensus at the time of the announcement, the consensus has since declined. Lubrizol is a Focus List Buy and a Long-Term Buy . . . Newmont Mining’s ($60; NEM) September-quarter profits jumped 37% to $1.08 per share excluding special items, ahead of the consensus estimate of $0.96. Advancing 27% to $2.60 billion, Newmont’s sales topped Wall Street expectations. However, shares declined after Newmont trimmed the top end of its gold-production outlook while also raising its cost forecast. Newmont is a Focus List Buy and a Long-Term Buy . . . Varian Medical Systems ($63; VAR) posted per-share earnings of $0.87 from continuing operations in the September quarter, up 12% and $0.03 above the consensus. Revenue rose 2%. Excluding a canceled order in the year-earlier period, net orders increased 12%. Varian raised its profit and sales guidance for fiscal 2011 ending September. Varian is a Focus List Buy and a Long-Term Buy.

Corporate roundup

Stryker ($50; SYK) agreed to purchase Boston Scientific’s ($6; BSX) neurovascular business for $1.5 billion in cash. Stryker sees the unit, which makes devices used to treat stroke, aneurysm, and other vascular conditions in the brain, generating up to $340 million in sales this year. Stryker is a Long-Term Buy . . . Oracle ($30; ORCL) plans to pay $1 billion for Art Technology Group ($6; ARTG), a maker of e-commerce software. Oracle’s bid represents a 46% premium to the stock’s closing price prior to the announcement. Oracle is a Long-Term Buy . . . In a departure from its traditional strategy, Intel ($20; INTC) agreed to manufacture microchips for Achronix Semiconductor, a closely held semiconductor start-up. The semiconductor giant has historically made only its own chips. Intel is a Buy and a Long-Term Buy . . . U.S. regulators are investigating whether J.P. Morgan Chase ($37; JPM) properly disclosed that a hedge fund helped select assets that went into a $1.1 billion collateralized debt obligation, then bet those assets would lose value. J.P. Morgan Chase is a Buy and a Long-Term Buy.

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