Portfolio Review


Mutual fund portfolio change

In the small-cap value category, Homestead Small Company Stock ($23; HSCSX) is taking the place of Heartland Value Plus ($28; HRVIX), which is now closed to some investors. Homestead Small Company will assume Heartland Value's 5% weighting in the Conservative Portfolio and 6% weighting in the Growth Portfolio. Homestead ranks among the top 10% of its peers for three- , five- , and 10-year performance.

So far in 2011, Homestead has dipped 0.4%, versus a decline of 4.1% for the Russell 2000 Index. The fund's expense ratio of 1.18% is well below the average of 1.50% for the category. At the end of September, industrial stocks represented roughly 25% of the portfolio, followed by consumer staples at 13%. Homestead, which earns the maximum score of 100 in our fund-rating system, requires an initial investment of $500.

Technology roundup

Within some pockets of the tech sector, the rapid pace of innovation means moats once viewed as impassable can finally be crossed.

Google ($617; GOOG), notorious for spreading into new Internet-related markets, was expected on Nov. 19 to launch a music-download store that will compete with Apple's ($388; AAPL) dominant iTunes service. Google has reportedly reached agreements with three of the four largest music companies — Universal Music Group, Sony Music Entertainment, and EMI Music. Negotiations with the fourth major player, Warner Music Group, are ongoing. Meanwhile Google lost the support of Logitech International ($8; LOGI), which had made hardware for the company's Google TV initiative. Google still hopes it can lure pay-TV subscribers to cut their cable cords.

Google remains successful in defending its turf in the U.S. search market. The company held 66% of the market in October, roughly flat with the same month last year, according to researcher comScore. Microsoft ($27; MSFT) and partner Yahoo ($16; YHOO) combined for a 30% slice. The results exclude queries made on mobile devices.

In the last couple years, few companies have dug a moat more impenetrable than that of Apple. Its iPad tablet has repelled product launches from Hewlett-Packard ($28; HPQ) and Research In Motion ($19; RIMM), while attacking tablets that run on Google's Android through a series of lawsuits. But Apple shares have slumped recently, and a handful of culprits could be responsible for the pullback. The iPad might finally face a worthy challenger in Amazon.com's ($218; AMZN) Kindle Fire.  Debuting this week, Amazon.com's new tablet is priced to take share away from the iPad and supported by a digital ecosystem that could rival iTunes.

Simultaneously, there are rumors of Apple scaling back on the production of its iPad and iPhone 4S.  The production cuts, if true, could stem from disappointing sales or preparations for a new iPad. But the most likely culprit is Thailand, where floods may have crimped the supply of circuit boards used in Apple's devices. According to one report, Apple has already secured another supplier for the components.

Only China makes more hard drives than Thailand, so the flooding could affect nearly every company exposed to the PC industry. Researcher IDC now expects PC shipments to fall 2% to 3% in the December quarter, well below its prior projection of 5% growth. And the ramifications will probably seep into 2012. Dell ($16; DELL) cautioned that the flooding will hamper January-quarter revenue. The supply constraints should also hurt Microsoft and H-P, the latter of which is slated to post October-quarter results Nov. 21.

Wall Street doesn't expect much from H-P, projected to report earnings per share of $1.13, down 15%, on a 4% decline in revenue. H-P might try to pass the surging components prices on to consumers, while reserving its limited supplies for more profitable products, such as servers and high-end laptop computers. Both Apple and Google are rated Focus List Buy and Long-Term Buy. Microsoft is a Buy and a Long-Term Buy. H-P is a Long-Term Buy. Dell is rated A (above average). RIM is rated B (average). Amazon.com is rated C (below average).

Corporate report

Agilent Technologies ($38; A) earned $0.84 per share in the October quarter excluding special items, up 29%, and $0.03 above the consensus. Revenue increased 10% to $1.73 billion. The company provided guidance for fiscal 2012 ending October, with the midpoints of both revenue and per-share-earnings ranges exceeding consensus estimates. Agilent is a Focus List Buy and a Long-Term Buy.

Trilipix, a cholesterol drug made by Abbott Laboratories ($55; ABT), might fail to reduce the risk of heart attacks and strokes in concert with other drugs, said the U.S. Food and Drug Administration. U.S. regulators reviewed a study that tested two groups — one that used fenofibrate (a drug similar to Abbott's Trilipix) with a cholesterol-lowering statin, versus a second group using the statin alone — and found no significant difference regarding efficiency or safety. Abbott is a Long-Term Buy.

Warren Buffett said Berkshire Hathaway ($76; BRKb) paid $10.7 billion to accumulate a 5% stake in IBM ($189; IBM) this year. Buffett has previously shunned technology stocks, but he says IBM possesses all of the traits he looks for in an investment: reasonable valuation, favorable outlook, and a protective moat that shields a company's business from competition. IBM is a Buy and a Long-Term Buy. Berkshire is rated B (average).

Wal-Mart looks like a good deal

Wal-Mart Stores ($57; WMT) has turned an operational corner, delivering three consecutive quarters of same-store sales growth after posting declines in six of the previous seven quarters. Despite the gains, Wal-Mart trades at 13 times trailing earnings, a 23% discount to the median general-merchandise store in the S&P 1500 and 12% below its five-year average.

Wal-Mart earned $0.97 per share in the October quarter, up 8% excluding a one-time tax gain in the year-earlier period. Sales rose 8%, with U.S. same-store sales up 1.9% excluding gasoline. While sales topped the consensus, Wal-Mart's per-share profits fell $0.01 short of Wall Street expectations, as operating margins shrunk. The retailer expects per-share profits of $1.42 to $1.48 in the December quarter, in line with the $1.45 consensus, which reflects 8% growth.

Margin pressures could continue to weigh on the company in the near term, as Wal-Mart has pledged to discount aggressively to lure holiday shoppers. But Wal-Mart's foreign expansion and far-reaching cost cuts planned through fiscal 2017 suggest the stock still has excellent two- to four-year potential. Wal-Mart retains its Long-Term Buy rating.

Rank Changes

We are adding Homestead Small Company Stock ($23; HSCSX) to our mutual fund portfolios and dropping Heartland Value Plus ($28; HRVIX).

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