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Microsoft, Intel, GE, Attract Dividend Seeking Retirees, But Are They Bad Bets For 2014?

Jan 3 2014, 9:16am CST | by

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Microsoft, Intel, GE, Attract Dividend Seeking Retirees, But Are They Bad Bets For 2014?
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Microsoft, Intel, GE, Attract Dividend Seeking Retirees, But Are They Bad Bets For 2014?

Retired investors think they need income, which often leads them to favor large-cap value stocks paying fat dividends. Except, as Investment Strategies columnist William Baldwin has repeatedly pointed out , it’s not “income” you need in retirement, but cash,  and you can get cash by selling appreciated stocks. Moreover, when you’re investing through a taxable account (i.e. not an IRA or 401k), taking capital gains is more tax efficient than receiving dividends, since you can offset capital gains with capital losses and can control when you realize income.  In this guest column, Kenneth G. Winans , a veteran investment manager based in Novato, Calif . offers another good reason that older stock investors should not fixate on dividends: with their shorter time horizons, they need to start paying more attention to momentum.

Now Billed As “Cheap,” Microsoft , Intel, GE Attract Older Investors, But Are They Bad Bets?

By Kenneth G. Winans

Are you a retiree who’s still willing to put some portion of your investments into stocks? The good news is that there are plenty of attractively priced large-capitalization stocks around.

The S&P 500 just had its best year since 1997, but the stocks in the index are trading at just 19 times trailing earnings per share and on average 16.6 times 2014 estimates—higher than the stock market has averaged for the past century or so, but well below levels set in the frothy late 1990s.

But which stocks will or won’t score price gains in 2014 and beyond? And how should an older investor screen for potential winners and dismiss likely losers?

I screened large-cap stocks recently for picks and pans. The names I came up with may surprise you.

The cheap large-cap stocks that I’d sell now include these five names that are very widely held, and popular among older risk-averse investors due in no small part to their relatively high dividends. They are Cisco Systems, General Electric, Intel, Microsoft. and Pfizer. The five I’m buying on behalf of many of my retired clients have been top performers: Apple, Nike, Precision Castparts, Starbucks and Whole Foods. They’re not quite as cheap.

Surprised? Why pan cheap stocks, you’re wondering? Especially the first five, which are shares of well-managed companies with stable or growing earnings and are trading near historically low p/e ratios. Meanwhile, where do I get off calling my 2014 picks “cheap”? Four of the five trade at p/e ratios of 20 or higher—way above the market’s average.

My simplest answer is this: stock price momentum. That’s the notion that a stock’s price is more likely to keep going in the same direction than to head in the opposite direction.

Don’t bother looking for Ben Graham’s treatise on price momentum. It doesn’t exist. He and his many value-minded adherents trumpet with absolute conviction that if a company’s sales and earnings grow but the fundamental multiples of its shares—their price-to-earnings ratio, price-to-sales ratio and the like—compress, the stock becomes “undervalued.” The undervalued stocks eventually become screaming buys, drawing in hordes of investors. The undervalued shares then vault well past high-flying stocks.

Yet we don’t live in a world where stocks always behave in the elegant way that Graham describes. What the last 15 years of historic bull and bear markets has taught us is that to ignore past stock price trends can be hazardous to your financial health. When I hunt for new stock investments for my clients–especially older investors who may not have a decade or two for Graham’s scenario to play out—I try not to get drawn into buying stocks that, despite being fundamentally cheap, have been relentlessly lousy price performers.  Price increases are important because that’s the main way stocks keep up with or exceed inflation, which will eat away at a retiree’s portfolio.

My focus on momentum may put me at uncomfortable odds with value-investing purists. “The whole point of investing is about portfolio performance,” my partner, Marc Edwards, likes to say supporting my view that momentum almost always trumps value when it comes to stock picking. “Making money for your clients is more important than being right on valuation.” (While admittedly not as celebrated as Ben Graham, Marc’s been in the investment business since 1971.)

Consider Microsoft. The Seattle area-based, $80 billion-in-annual-revenue tech icon’s shares are trading at about 13 times the $2.90 a share it will probably earn in 2014. The company has generated excitement over plans to restructure. The company will organize itself into three big, sensible divisions, dump its terrible old system of “stack ranking” employees and even change the chief executive. Microsoft pays a relatively juicy 3% dividend, which has won it a lot of new fans among dividend-loving retirees. They’re in the company of many value investors, institutional and individual alike, who have had MSFT as a cornerstone of their stock portfolio for many years.

And yet here’s the inconvenient truth about Microsoft: It’s been a lousy investment since 1999. Despite posting solid earnings growth and paying out hefty dividends, its stock price is near the same level it was in 2000. In my view the high dividend has been more lure than luxury.

Microsoft should be a head-scratcher to value investors, especially retirees. Its P/E ratio seems to fall a little further every year, even while the company’s earnings go up smartly. Microsoft’s trailing P/E has plummeted to 14 recently. You can’t really curse the stock for not finding its way back to the 60-times-trailing-earnings level it set during the tech-stock bubble of the late 1990s. But it hasn’t even managed to maintain the 20-to-30-times-earnings P/E it occupied in the years after the bubble burst. Simply put: Yes, it’s been cheap—and getting cheaper just about every year./>/>

True, Microsoft’s shares have a gained ground recently, rising 40% in the past year. I think it’s trading at the top of a well-established trading range where Microsoft’s investors refuse to reward its reasonably good earnings growth by driving its shares higher. I’m not ready to believe they’ve really changed. Remember, it’s where a stock goes in the future that is of the most importance for the investor. So, even though Microsoft does look reasonably cheap, if I owned its shares, I would sell it in favor of a better growth stock.

Like Nike. The giant Beaverton, Ore., sports shoe, clothing and equipment maker’s shares trade at about 27 times trailing earnings and 22 times the $3.54 a share it’s expected to earn in 2014. That’s not expensive, at least not for Nike. Its trailing P/E ratio often jumped to more than 30 between 1996 and 2004. Though Nike’s 1.2% dividend yield is lower than the 2% yield offered by the average S&P 500 stock, the shoe company’s dividend has been growing dependably for years.

Doctrinaire value investors would overlook Nike. They wouldn’t care that the stock has been a long-term stellar performer. Including dividends, its shares have soundly beaten the total return of the S&P 500 over the last five years (producing a total return of 242% versus the index’s 131%), 10 years (437% versus the index’s 105%) and 15 years (866% versus the index’s 98%).

Nike’s shares will perform far better than stocks like Microsoft in 2014 and beyond. It’s not just that Nike’s earnings are projected to grow 16% and Microsoft’s just 9%. It’s also that Nike’s investors have been more willing to reward steady earnings growth than Microsoft’s have been. Put another way, Nike’s shares have strong momentum with higher highs and higher low points—that’s known as an uptrend. It’s one that favors retired investors, who tend to have shorter investment horizons than, say, Warren Buffett , who hung out his investment shingle in the 1950s.

In the table below, you’ll find more stocks that I think will have a good 2014. You’ll also see data on Microsoft and the other four stocks that I would sell in favor of my picks. All 10 are trading at P/E ratios lower than we’ve seen them trade for in the past. But five have generally underperformed the market over the past 10 years and 15 years. The five that you should favor for 2014 have momentum behind them.

Lastly, value investors like to point out that stocks with lower multiples significantly outperform high-flying stocks during bear markets. I think this misses the mark. While it is true that in the dreadful year of 2008 my picks did underperform, my choices made up all the ground lost within 22 months and since then have posted new highs with frequency. Ignoring stock price momentum is a time-tested mistake, and many value investors have paid a steep price for this oversight. I’m advising my older clients not to repeat it in 2014.

Big Mo, way to go!

Kenneth G. Winans is a veteran investment manager based in Novato, Calif .

Source: Forbes

 

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