Last year was a year for stock market record books as index fund buyers added 30% to their nest eggs while many skilled hedge fund managers underperformed. Oddly, many of the smartest investment advisors believe that despite the run up, selected equities still look attractive.
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T. Rowe Price’s Head of U.S. Equities John Linehan is taking a cautiously bullish approach: “Moving forward, U.S. stocks are unlikely to match their recent strength…On the plus side, corporate health remains strong and valuations are neutral. There are still attractive areas, such as companies that are benefiting from the reindustrialization of America. Market tailwinds and headwinds are now more balanced, so we believe it’s time to be cautious.”
Linehan is essentially saying that 2014 will be a stock pickers market. His fund, for example, holds among its top holdings Irving,TX’s Flowserve Corp.(FLS) , a maker of pumps, valves and seals used in a host of industries. T.Rowe Price Value Fund also owns a significant amount of specialty chemical and materials company Celanese Corp (CE).
As has been Forbes’ tradition we have gathered a selection of “Best Ideas” for 2014 from some of our favorite money managers and investment advisors.
Editor, Forbes Low Priced Stock Report
Buy: Ballantyne Strong (BTN)
BTN has tons of cash thanks to sales of digital equipment to movie theaters that switched to the new standard. That’s now largely played out and it would have been easy for BTN to blow cash on a “diworsification” acquisition. But instead, BTN made a great accretive purchase: Convergent Corp. with a growth business (digital content for out-of-home advertising, etc.) and an operating profile adjacent to BTN’s network support center that serves digital theaters. This debt-free company still has lots of cash (40% of the stock price) and the stock still has a measly (0.59) price/sales ratio.
Buy: Rite Aid (RAD)
I first recommended Rite Aid in June 2011 at $1.05 and again in January at $1.45. The stock now trades above $5.00 and I still like it. My original investment case remains alive and well. One aspect of this is that the company’s remodeling efforts, emphasizing its new fresh-looking “wellness” format is working. The transition still has a lot of legs left: Only a little more than 1,000 stores have been renovated thus far, out of a total of 4,600. And with more efficient operating practices, cash flows remain very healthy (as was the case even before GAAP net income moved above zero), meaning the company can comfortably pay the interest on its still-considerable debt and refinance as necessary.
Note, too, my investment case had not and still does not assume RAD will surpass or catch up to its main rivals Walgreen’s (WAG) or CVS Caremark (CVS). Instead, I continue to believe that even after RAD’s 2013 rally, the stock’s valuation remains far enough below those of WAG or CVS to enable shareholders to benefit even as RAD’s operations continue to make baby steps toward the levels maintained by the industry leaders. Bear in mind that price/sales is very much influenced by margin, and there is plenty of room for RAD’s operating margin to make progress relative to peers as store-overhaul attracts more revenue and improves overhead-cost coverage.
Buy: Omega Protein (OME)
The stock market has shown itself to be interested in the LOHAS (lifestyle of health and sustainability) through high valuations on such large issues as Whole Foods (WFMI) and Lululemon (LULU), and we’ve done well so far with such recent selections as Gaiam (GAIA) and Primo Water (PRMW). Omega Protein, which catches menhaden, a wild herring-like fish found along the Atlantic and Gulf of Mexico coasts and harvests a variety of protein and oil products, could turn into an intriguing stealth LOHAS play
At present, more than 90% of the business comes from animal feed products produced from OME’s proteins and oils. That, in and of itself, is a nice business given that these ingredients are especially good for swine and fish, which are in high demand given increasing appetites for pork and seafood. But it’s not necessarily a straight-line trend given variations in annual fish catch, product yields derived from the catch, etc. (So far this fishing season, catch has been down but yields are up).
Going forward, however, product for human consumption seems like it’s shaping up as an attractive growth driver as supplement manufacturers increasingly come to appreciate the benefits of fish-based proteins and oils, which contain Omega-3 fatty acids not produced in the body and which therefore must be obtained from food or special supplements. The mundane valuation metrics for shares of this modestly-leveraged, profitable and strong cash-flow generator do not seem to account for this prospect.
Editor, Forbes/Lehmann Income Securities Investor
Buy: Energy master limited partnerships
Income investors should look to energy related master limited partnerships (MLPs) for income in 2014 and beyond. Such partnerships offer high current income, steady dividend growth, inflation protection and tax deferral to boot. Better yet, they offer long term price appreciation as the domestic energy boom in the U.S. will continue to displace imported oil and gas for years to come.
There are three ways to play this: by direct purchase of MLPs, by buying a closed-end fund specializing in them, and by buying an exchange-traded fund that holds a composite of the industry. For direct purchase, look at the pipeline companies Plains All American LP (PAA, 4.78% yield/10.19% dividend growth) and Kinder Morgan Energy Partners LP (KMP, 6.75%/8.45%). Pipelines offer the most reliable dividend because they don’t depend on the price of oil and gas.
To get a broader selection and specialized management look for a closed-end fund such as Kayne Anderson MLP Investment Co (KYN, 6.49%/9.44%) or Fiduciary/Claymore MLP Opportunity Fund (FMO, 6.66%/8.40%). To buy the broadest cross section of this market, the Alerian MLP ETF (AMLP, 6.32%/7.23%) offers a low fee indexed approach which has worked well. No matter which approach you use, an investment in this sector belongs in every portfolio.
Editor, Prudent Speculator and CIO, Al Frank Asset Management
Buy: Ensco PLC (ESV)
Ensco is the world’s second largest offshore driller. The firm operates across six continents with one of the newest jackup and deepwater fleets in the contract drilling industry. In its last few earnings releases, ESV has shown a relatively impressive ability to keep operating expenses in check and generate solid free cash flow. I believe that the outlook for deepwater drilling remains attractive and Ensco is well positioned to benefit as new builds come online and it realizes favorable contract rollovers.
ESV has a solid balance sheet and future cash use should provide another near-term catalyst, coming in the form of additional rig capacity, debt reduction, share buybacks and dividend increases. On that last point, the driller recently announced a 50% increase in its quarterly dividend (from $0.50 to $0.75). ESV trades for less than 10 times trailing 12-month earnings and for a little more than 8 times the current 2014 consensus earnings estimate, while the shares also boast a 5.3% dividend yield.
Buy: American Eagle Outfitters (AEO)
American Eagle Outfitters is a retailer of high-quality clothing focused on 15- to 25-year old shoppers. AEO operates more than 1,000 stores in North America and ships to 81 countries worldwide via its Web sites. AEO is down 25% since early August, tumbling after reporting very disappointing second quarter results due to poor product execution in women’s apparel and the need to offer a high level of promotions to drive foot traffic and in early December issuing weak guidance for the fourth quarter.
I believe the shares offer an attractive long-term opportunity, just as they did when I had a previously very lucrative stint with the company from 2000-2008, even as I respect that the teen retailing space is challenging. AEO has overall brand strength, especially in denim, and management is focused on improving product assortment, implementing inventory management enhancements and growing its international presence. Additionally, I am quite smitten with the balance sheet, which sports no debt and $1.75 per share of cash and short-term investments, and 3.3% dividend yield.
Jim Oberweis and Dave Covas
The Oberweis Report
Buy: Ligand Pharmaceuticals (LGND)
Ligand Pharmaceuticals, a biopharmaceutical company based in La Jolla, Calif., offers investors a unique biotech opportunity that is profitable today with sustainable profitability going forward. Its business model is focused on drug discovery and partnering with pharmaceutical companies at an early development stage, handing off the late-stage drug development, regulatory matters and commercialization and collecting royalties, milestones and license fees in return.
The company made a transformative acquisition of Captisol in 2011, a formulation technology that improves the function of molecules that may otherwise be sub-optimal. As partnered drugs that depend on Captisol technology get approved, Ligand stands to earn royalties from those drug sales. In October Pfizer announced the FDA approval for Duavee, a new treatment for hot flashes and prevention of post-menopausal osteoporosis. We expect significant near-term growth from two blockbuster drugs; Ligand is receiving growing royalty payments from sales of Promacta for low platelet count (co-discovered by Ligand and GlaxoSmithKline) and from sales of Kyprolis for multiple myeloma. It currently has five royalty-producing drugs in its portfolio and we think it can nearly double this to nine in 2014, providing additional revenue streams while diversifying its business even further. We believe Ligand can grow revenues 38% in 2014 to $65 million, with earnings more than doubling to $1.40 per share.
CEO, Gerber Kawasaki Wealth & Investment Management
Buy: Apple (AAPL)
Apple is a cheap stock in a tech sector that’s getting very expensive. Apple is dominating the holiday season with its tablets and phones. The refreshed product line is doing much better than expected. I expect Apple’s China Mobile deal to meaningfully add to earnings next year. The real kicker is if Apple comes out with any new product. A TV will bring this stock to new highs. It has an iconic worldwide brand and this company certainly deserves at the minimum the market multiple. I see nice upside this year with or without a television.
Buy: Tesla Motors (TSLA)
Tesla is not a cheap stock but with the pullback recently over car fires it presents a great opportunity. This is not a car stock but a company that is transforming the car industry. The model S is a great and safe car and the NTSB will confirm this in a few months giving the stock the boost it needs to rebuild its momentum in 2014. The problem is inexperienced drivers crashing the car, not the car. Sales will continue to be strong for the model S and the new model X coming out late 2014 will be an amazing SUV. This will be an incredibly sought-after car. It will also be a further catalyst for the company in 2014; the demand will outstrip supply for many years to come. Co-founder, CEO and Product Architect Elon Musk delivers and I think he will continue to in 2014.
Editor, Validea Hot List
Buy: HCI Group (HCI)
Property and casualty insurers from Florida sound like a risky proposition. But HCI has an advantage. Florida’s state-run insurer—which was created as a lender of last resort but became the lone option for many after several big insurers left the state—is being forced to divest a substantial portion of its policies because it grew too large. The forced sale has let firms like HCI pick and choose from some very profitable policies.
That’s led to stellar growth for HCI, which has grown earnings at a 32% pace and sales at a 51% clip over the long term. The state policy divestiture is continuing, and HCI has a lot of cash left. Its net cash/price ratio (net cash is cash and marketable securities minus long term debt) is more than 35%, helping earn it a 100% score from my Peter Lynch-based Guru Strategy. The Lynch model also likes that HCI trades for just 8.8 times earnings, making for a bargain-priced 0.28 P/E-to-growth ratio. HCI also gets a perfect 100% score from my Motley Fool-inspired model, thanks in part to its $9.84 in free cash per share and 92 relative strength, and a 92% score from my Martin Zweig-based model.
Editor, Forbes Dividend Investor
Buy: Brookline Bancorp (BRKL)
If you’re not a Forbes Dividend Investor subscriber, you are not yet aware of my apparent predilection for regional banks. Of our 196 currently recommended stocks, 25 of them are regional or savings banks—by far the biggest industry group represented among past picks.
In truth, I don’t have any prejudicial fondness for the financial sector. It’s just that these banks flash the kind of value and comfortable dividend coverage that I seek out. Plus they have all done very well since they were recommended. The SPDR Regional Banking ETF (KRE) that tracks the overall group was up 28% from May 1 through the first of December. Our bank stocks gained an average of 35%, with some like TrustCo Bancorp (TRST) and First of Long Island (FLIC) surging more than 40% since May. Current yields on our regional bank recommendations average 3%, double the 1.5% yield on the KRE.
With fundamentals still looking attractive and valuations still modest, this smaller bank out of Massachusetts currently sports the highest overall score for any savings banks on the model I used to select it. Brookline Bancorp is the holding company for Brookline Bank and First Ipswich Bank in Massachusetts, and Bank Rhode Island. It maintains lending and deposit relationships with small- to mid-sized businesses and individuals.
In 2013, Brookline benefitted from higher loan and deposit amounts as well as better performing loans. For the full year, analysts expect $0.54 in earnings per share. The dividend has been steady since April 2009 at $0.085 per quarter, good for an annual payout of $0.34 and a 3.6% yield. Brookline trades more cheaply than it has in recent years. At 16 times earnings, the stock is well below its 25 average price-earnings ratio since 2008. Getting back to that average P/E produces a $13.50 stock. The average price-to-sales ratio over the past five years has been 5.7. Based on sales over the past year, that P/S multiple would produce a $16 stock price. Split the difference and you’re still looking at 66% potential upside if the stock trades at historical valuations and maintains current sales and profits.
Buy: Transocean (RIG)
It’s usually a sign of underlying buying interest in a stock when it gains in price on a day when the overall market is negative. That’s what happened on December 2 with Switzerland-based Transocean, the world’s largest offshore contract driller for oil and gas wells. Its shares ticked higher by 0.38%, albeit on light volume, while the S&P 500 dipped 0.13%, and even industry-specific Market Vectors Oil Services ETF (OIH) was down 0.43%.
There’s a lot to like about Transocean these days. In November it struck a deal with Carl Icahn, who owns nearly 6% of the company, and was agitating for a number of changes. He got another one of his people on the board of directors, and Transocean also cut the number of board seats from 14 to 11, giving existing members greater weight. Icahn also extracted a pledge that Transocean will boost profits by $800 million through cost cutting and increased efficiency.
Most significant for dividend investors is that Icahn succeeded in getting the company to agree to pay a $3 per share dividend next year, up 33.4% from the current $2.24 annual rate. RIG has a current yield of 4.6%. Transocean will also explore spinning off some of its assets into a master limited partnership structure.
After taking a hit after the April 2010 explosion and spill on its Deepwater Horizon rig at BP’s Macondo Well in the Gulf of Mexico, earnings are back on the rise. Analysts expect Transocean to earn $4.18 per share in 2013, up 5.5% from 2012. Revenue should be higher by 3.5% to $9.52 billion. For 2014, earnings are forecast to grow 35% with sales up 6.7%.
Current valuations make a good case for jumping into Transocean. Its average price-sales ratio over the past five years is 2.03, 6.4% higher than today’s P/S multiple of 1.91. With $26.40 per share in expected sales for 2013 that average P/S implies a $53.60 stock price. It trades at a 75% discount to its five-year average P/E ratio, but at 43.8 times trailing earnings it’s rather plump and reflects the effects of the spill costs. Nonetheless, at 8.9 times 2014 earnings, which are growing at better than a 30% clip is pretty cheap.
Buy: M.D.C Holdings (MDC)
There was a significant bottom for housing stocks on October 3, 2011, from which the iShares Dow Jones U.S. Home Construction (ITB) ETF rose 206% through May 13 of 2013. PulteGroup (PHM) soared 560% and KB Home shot higher by 375%. Since mid-May it’s been a different story. The ITB is down 15%, and many builders have seen their shares trade lower by 25% or more.
After the pullback, there are some good pockets of value in housing and one place to find it is in shares of M.D.C. Holdings. The Denver-based homebuilder is down 27% in the past six months after shooting 150% higher from October 2011 through May 2013. Founded in 1972, MDC builds and sells first-time and move-up single-family homes under the Richmond American Homes brand name in Arizona, California, Colorado, Florida, Maryland, Nevada, New Jersey, Pennsylvania, Utah and Virginia.
2013 was a banner year for MDC. Revenue is expected to grow 36% to $1.64 billion, and earnings are forecast to jump to $6.06 per share from $1.28 in 2012. For 2014, sales growth should moderate to 6.1%, while the consensus earnings forecast is $1.91 per share.
Dividends are a big part of the MDC story, having been paid without fail since 1987. The company maintained the payout through the financial crisis and the amount has remained steady at $1.00 per year since November 2005, giving it a current yield of 3.4%. The payout is well covered by earnings. In December 2012, MDC prepaid the entire year of dividends for 2013.
MDC looks cheap at current multiples. Over the past three years, the stock has traded at an average price-sales ratio of 1.51, compared to its present P/S multiple of 0.87. With $33.55 in expected revenue per share in 2013, MDC would be a $50 at its three-year average multiple.
Editor, Forbes Investor
Buy: LMI Aerospace (LMIA)
LMI Aerospace is a leading supplier of structural assemblies, kits and components and a provider of design engineering services to the commercial, corporate, regional and military aircraft markets. Hurt by lower-than-expected operating results—especially in the back half of the year—LMIA’s stock got clobbered in 2013.
However, the company’s operations should rebound strongly is 2014—boosted by better performance from its engineering services business and recovery in profit margins stemming from additional synergies associated with its acquisition of Valent Aerostructures, improved plant efficiencies, and the absence of cumulative cash adjustments, which negatively impacted margins in 2013.
Buy: Rovi Corp. (ROVI)
Rovi is a global leader in technology solutions that power the discovery, delivery, display and monetization of digital entertainment. The company serves cable, satellite, telecommunications, mobile and Internet service providers, consumer electronics manufacturers, and entertainment and online distribution companies including Apple, Comcast, eBay, Google, Panasonic, Samsung, Sony, Toshiba and Verizon.
A strategic decision to not sacrifice profits for volume forced the company to take a more conservative view on the expected level of contract closings for the second half of 2013. This led to two downward revisions of full-year revenue and earnings guidance over the past three months, resulting in a sharp sell-off. But I would not write off ROVI so quickly.
The company’s desire to obtain appropriate value on potential licensing contracts is the right decision from a long-term growth perspective in my view. And while it may be taking longer to secure these deals than initially expected, I remain confident that they will be obtained. Given its attractive valuation, I expect the stock to rebound sharply once this happens.
Buy: CVS Caremark (CVS)
CVS Caremark, together with its subsidiaries, provides integrated pharmacy health care services in the United States. Its recent third quarter 2013 earnings report was strong and the stock gained 7.5%. Net revenues rose 5.8% year-over-year to $31.97 billion—aided by claims growth in its specialty pharmacy business. Pharmacy same-store sales were up 5.7%, while front-end same-store sales fell 1.0%. CVS also raised its full year earnings per share guidance slightly to $3.94-3.97.
In November, CVS announced it will acquire Coram LLC, a leading provider of infusion therapies and nutrition services, from Apria Healthcare Group for $2.1 billion. While the transaction is not expected to be immediately accretive to earnings, it expands the CVS’ presence in the specialty pharmacy services market and should contribute to growth in future periods. Over the near term, I expect additional opportunities stemming from the Affordable Care Act to help fuel further growth ahead.
President, Envision Capital Management
Buy: International Game Technology Bonds 5.50%
It is the season for 2014 recommendations. What investments will work and which will fail?
It seems the choruses of professional and retail investors singing the bond markets demise are a bit off-key. The reason is that aging baby boomers know from past equity market declines putting everything into stocks now at all-time highs just may not be so prudent. Nothing is cheap: stocks, bonds or currencies.
So investors whose stock market wounds are healed but whose memories are still fresh, know that a bond allocation is imperative. It’s just how and what type that makes all the difference.
No matter what the bond market mutual fund managers tell you: There’s enormous risk of other people panicking and selling their bond funds than ever before. We have interest rate risk, credit risk and other investors panic selling risk; that’s the trifecta. Remember the May-June municipal bond fund sell off? Investors panicked and the selling was wicked and painful. Don’t put yourself in that position; buy individual bonds that have short final maturities or will be called. Rates rise; you can wait it out. Investors stampede in or out; you can wait it out…assuming maturities are 6 years or shorter.
My best ideas for 2014 include International Game Technology Bonds 5.50% due June 15, 2020, non-callable (Cusip: 459902AS1). This slot machine and gaming systems manufacturer is no one trick pony. IGT produces gaming software used on Internet sites, which is a growing business. Earnings for 2014 should roughly be $1.28-$1.38 according to JPMorgan Chase. If you believe as I do that the economy and consumers are all getting stronger, than the gaming industries will be a beneficiary. If you pay 106 for bonds that’s a 4.43 % yield to maturity. These BBB rated, investment grade bonds, should serve you well.
Buy: Hanesbrands Inc. 6.375%
When you think about the necessities of life put “underwear” in that category. Our tighty whities are usually not thought about—but they should be. And synonymous with this is Hanesbrand, the maker of bras, T-shirts, socks, underwear, hosiery, active wear and casual wear. Its pristine brands include: Hanes, L’eggs, Playtex, Wonderbra and Maidenform to name a few.
Hanesbrands’ gross margins are expanding and its recent acquisition of Maidenform certainly gives the company a lift (pun intended). With cotton prices way off their 2011 highs, Hanesbrands’ sales, gross margins and cash flow continue to improve. In fact, the 2013 Maidenform acquisition should generate $500 million in additional sales within a couple of years. With $ 450-$500 million in free cash flow, operating margins are expected to be up 12%-14%. This BB credit has nowhere to go but up in credit quality. Buy Hanesbrands Inc. 6.375% due December 15, 2020 callable beginning December 15, 2015 (Cusip: 410345AG7). Pay 110 and you’ll yield 2.77% to the 2015 call or 4.68 % to maturity. Bonds are callable after December 2015 with 30 days’ notice.
Financial Advisor, Conservative Wealth Management
Buy: AQR Style Premia Alternative I (QSPIX)
With central banks using a crowbar to force everyone into risky assets, it is prudent to have a portion of one’s portfolio that will not be fed into the wood chipper by rising interest rates the way stocks and bonds usually are. I have no idea whether rates will rise in 2014; I’m simply saying that it would be prudent to guard against the risk. This fund goes long and short a diversified pool of strategies and should have little correlation to a vanilla 60/40 portfolio.
Charles Rotblut, CFA
Editor, AAII Journal
Best Investment Ideas
If there is any consensus about 2014, it is that the year is going to have unexpected twists and turns. Right now, we know some of the potential risks: changes to monetary policy, Washington politics, Iran, North Korea and elevated stock valuations. We also know what could potentially help investors’ portfolios: corporate earnings, sustained economic growth and accommodative monetary policy (even if it is less accommodative than it has been this year).
What we don’t know are the actual rates of change in earnings growth and economic expansion or the exact factors that will influence both. You and I could make forecasts, but they would simply be forecasts and nothing else. So how should you position your position your portfolio if the outlook for 2014 is uncertain?
Determine the correct mixture of stocks, bonds and cash that makes sense given your investing time horizon (which can be in excess of 20 years even if you are retired). Then determine your emotional tolerance for risk. These two decisions will help you identify where on the scale of conservative to aggressive your portfolio allocation should be.
Though this may sound overly simplistic, the reality is that many forecasts are wrong. If forecasts are often wrong and investing success is significantly influenced by not making big mistakes, then taking a long-term view with your portfolio allocation may be the best investment idea for 2014 and beyond.
Editor, Jack Adamo’s Insiders Plus
Buy: U.S. Bancorp Series-A Preferred (USB-A)
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffett
If you don’t trust this market you’ll like U.S. Bancorp Series-A Floating Rate Non-Cumulative Perpetual Preferred Stock. The dividend rate is the greater of 3.50% or three-month LIBOR plus 1.02%. At the current price of $770 the yield is 4.55%. Your rate won’t go lower than that and you have better inflation protection than with TIPS. If the $1,000 par-value shares are redeemed, your capital gain is 30% at the current price. Should we face deflation, 4.55% will be noticeably better than what’s out there.
In the last 25 years three-month LIBOR, shown in turquoise, has been higher than 9% and as low as 0.24%. At my buy limit of $800, the base yield and yield at LIBOR 5% would be 3.75% and 7.75%. Buy the stock only with a limit order, never a market order. With patience, you can probably get the shares below $775. U.S. Bancorp Series A Preferred is a buy up to $800. Preferred stock symbols are not uniform across brokers. Make sure you get the right one.
Buy: Seaspan Series-C Preffered Shares (SSW-C)
Problem: You want to park some cash for a couple of years until the market outlook is clearer, but you’d like a decent return while you wait. Uncle Sam says no. I say yes.
Seaspan Corp. Series-C 9.50% Cumulative Preferred is redeemable at $25 on 1/30/2016, and if not redeemed by 1/30/2017, the rate goes up to 11.875%. Redemption is likely in 2016 because the company’s current cost of capital is significantly lower. The shares trade for $26.50 today, yielding 5.73% to redemption. At my buy limit of $27, the yield to redemption is 4.64%. With some patience, you should get the shares closer to today’s price.
Seaspan leases container ships on long-term charter. It is a very safe, steady business model, unaffected by spot-rates. 70% of its leases are with shipping companies owned by China and 20% are with major Japanese shippers. During the 2008 financial crisis, Seaspan did not cut rates and did not miss a single payment from its lessees.
Reported earnings fluctuate noticeably, due to hedge accounting rules, but cash flow easily covers preferred and common dividends. Buy Seaspan Series C 9.50% Cumulative Preferred up to $27.
Buy: Fidelity Select Construction & Housing (FSHOX)
Jim Lowell: “Buy what consumers are buying.”
Manager Holger Boerner invests in companies involved in the design and construction of residential, commercial, industrial and public works buildings, as well as companies that provide construction products or services or those involved in real estate. Towards the end of 2013, forward looking building permits and construction spending rose significantly more than expected (mainly on apartment permits), and housing prices followed their trend of rising a bit more slowly month-to-month. The risk is a rising rate environment that could make mortgages too expensive to pursue—I’d buy on the first big dip because, whether a secular or cyclical trend, I think this fund paves the way for pent up demand from consumers who are clamoring for more.
Buy: Fidelity Select Automotive (FSAVX)
Manager Annie Rosen owns companies that produce and/or sell cars and other vehicles, as well as parts and services related to the industry. In 2014, I don’t think U.S. consumers will take their foot of the car buying pedal. I do think that lenders will grease even more car buying wheels—not just here. Western Europe, collectively the #3 car sales market, saw year-end car sales rise for two consecutive months for the first time since 2011 … Spain saw its cash-for-clunkers program work like ours. Overall, Europe feels like a classic six-month lagging recovery relative to our own—car sales and auto-related stocks should correlate to the ongoing recovery there.
Meantime, China’s car sales were up 25% from the same period last year; its economy may be slowing, but it is growing car buyers at high speed. I don’t see that abating. Moreover, while emerging markets saw car sales fall year-over year, as their biggest trading partners recover more, 2014 emerging markets car sales could shift overall sales into high gear.
Buy: Fidelity MSCI Consumer Discretionary Index (FDIS)
I think Fidelity MSCI Consumer Discretionary Index complements the actively managed sector selections well. It’s the lowest cost, commission free consumer discretionary exchange-traded fund out there. This exchange-traded fund is made up of companies involved in the production of automobiles, durable goods, textiles, apparel and leisure equipment, as well as service companies such as hotels, restaurants, leisure facilities, media services and consumer retailing. Top 10 holdings: Amazon.com, Walt Disney, Home Depot, Comcast, McDonald’s, Time Warner, Ford Motor, Starbucks, Priceline.com and Nike. Foreign investments make up 3.6% of the holdings.
Editor, The Turnaround Letter
Buy: FelCor Lodging Trust (FCH)
My best idea for 2014 is FelCor Lodging Trust, a real estate investment trust that owns 61 upper-scale hotels around the U.S. Going into the recession in 2008, FelCor had too many hotels in weaker markets and too much debt. Over the last few years, FelCor has refocused is portfolio on premier properties in the stronger hotel markets. Since 2010 FCH has sold 24 hotels and currently has three more under contract to sell. It has used the proceeds from these sales to upgrade many of the hotels in its portfolio, as well as reducing debt. In addition, it has been able to add a few marquee properties. FelCor has also refinanced much of its debt to reduce interest costs. All of these actions now have FCH’s financial results heading in a positive direction.
Furthermore, macro industry conditions remain very favorable. Demand for hotel rooms has been growing steadily for the last few years, as both business and leisure travel rebounds. However, the supply of hotel rooms has been relatively flat with very few new hotels being built. Both the broad industry trends and the company’s strategic moves bode well for FelCor stock. Moreover, the company has just reinstated a small dividend, and I expect the payout to grow as FelCor’s results continue to improve.
Disclosure Note: Accounts managed by an affiliate of the publisher of The Turnaround Letter own FelCor Lodging stock.
Editor, Investment Quality Trends
Buy: Philip Morris International (PM)
I believe 2014 will be a transitional year for the markets. With an apparent budget deal in Congress and no stomach for another fight on the debt ceiling, the primary policy issues have been dealt with. With more clarity from Congress the Fed will be able to focus solely on the data, which should allow for the tapering process to begin. Without the Fed backstop, I believe there will be a modest correction in the first half year and then a recovery to all-time highs. Fourth quarter 2014 could be rough as I believe a major correction will occur in 2015. My thought then is to play it safe with Philip Morris International. The tobacco giant sells its products in approximately 180 countries in the European Union, Eastern Europe, the Middle East, Africa, Asia, Latin America and Canada. The current cash dividend is $3.76 per share and the company has increased the dividend on average in excess of 10% per year the previous 12 years. The optimum buy price based on the current cash dividend is $82 or less.
Portfolio Manager, Barrack Yard Advisors
Buy: Cisco (CSCO)
One sector in the admittedly expensive U.S. stock market that remains attractive is “mega-cap” IT Companies. They are selling for low multiples of earnings/cash flow. They represent relatively high current shareholder rewards: the dividend plus buyback yields are more than 5% (and the payout ratios are low with room to grow). As a group, they represent high financial strength. Admittedly, they have disappointed investors over the past couple of years but I argue that has been baked into their current valuations: current forward P/E multiples of low teens versus about 20X prior to the Great Recession.
In other words, these firms used to be thought of as growth companies but not any longer. Given that I don’t believe there has been a paradigm shift that has destroyed their business models—particularly for the long product cycle businesses—I think the lackluster growth of the past couple of years is cyclical and not secular in nature. I believe it is timely to buy into this sector due to valuations and to my common sense conclusion: it is hard to imagine the economy growing without a meaningful pick-up in IT CAPEX spending.
My two favorite stocks in this theme are Cisco and IBM.
Cisco is a dominant player in its industry (global telecommunications infrastructure) that has grown by acquisitions and possesses industry leading financial strength. CSCO’s has net cash of some $30 billion, or $5.60 a share, a P/E of 11X and a dividend yield of 3.1%. The dividend plus buyback yield is about 5% and the payout ratio is 33%. CSCO is a highly profitable company and has grown its EPS by 12% over the past 10 years but that growth has slowed over the past few years to something like high single digits. Free cash flow yield is 10%.
Buy: IBM (IBM)
IBM also sells at a discount of 30% to the S&P 500. It has a free cash flow yield of 9% and a dividend plus share buyback yield of more than 7%. IBM’s product cycle is long and it benefits from a blue-chip balance sheet. Historically it has enjoyed net profit margins in the mid-teens and return on invested capital of 20%. IBM has significant economies of scale working in its favor and most of its commoditized businesses have been jettisoned: 86% of its revenues are derived from value-added services and software solutions.
The barriers to entry for potential competitors in its core business are high. I think the longer-term future for IBM could be better than the market expects. If not, a fact remains: IBM has an entrenched position in its marketplace and has grown earnings per share over the past decade by 12% a year, on average, through a combination of efficiencies, share buybacks and modest growth. Paying 12X earnings for that combination seems like a pretty good deal to me.
Editor, The Berman Value Folio
Buy: Arcelor-Mittal (MT)
The market has branded the steel stocks, especially Arcelor-Mittal, with a scarlet “S” for slowdown. But at 40% of sales, MT is priced for the end-time. Seen through a contrarian lens, I think the value is there. Like any deeply cyclical stock, you should buy MT when the economy is slack, prospects bleak and the recovery dim. By the time the all-clear sounds, bargains will be gone.
At first blush (and based on GAAP earnings) MT looks like a hot molten mess, with more than $5 billion in losses over the past year. Yet, the bulk of these losses were non-cash goodwill write-offs of overpriced acquisitions. In reality, MT is a cash cow, with nearly a billion dollars in positive free cash flow over the same period. When talk of taper transitions to talk of everything else, as it inevitably will, MT will be on everyone’s buy list. That will be the time to sell.
Disclosure: I own Arcelor-Mittal in accounts for myself and clients; I’m a shareholder in Insight Guru Inc., the parent company of Trefis.
Editor, The Arora Report
Buy: Applied Materials (AMAT)
Applied Materials, the largest company in the semiconductor fabrication equipment sector, has engineered a transformative merger with the third largest company in the sector, Tokyo Electron (8035: JP). The combined company will be a behemoth worth about $30 billion. Synergies will result in cost savings of $250 million in the first year and $500 million in the third year, but more important is the combined company will gain significant market share.
The semiconductor fabrication equipment sector is likely to grow from $28 billion in 2013 to $37 billion in 2017. The combined company is projected to generate $18.2 billion in revenues and $4.6 billion in operating income in 2017. This translates to earnings per share of $2.40 per share. As a reference, earnings over the last four quarters totaled $0.59. It is reasonable for the market to accord a P/E north of 20 to AMAT in 2017; as a reference, ASML Holding (ASML), the second biggest company in the sector, trades at a forward P/E (FYE 12/31/14) of 20. Based on the foregoing scenario, the stock will be north of $48 in 2017 compared to the present price of about $16.
Buy: WisdomTree India Earnings (EPI) and iPath MSCI India (INP)
In 1970, the GDP of India was $63.5 billion. In 2012, the GDP of India stood at $1.87 trillion, an increase of 2945%. India is now the tenth largest economy in the world based on market exchange rates. However, based on purchasing power parity (PPP), India is the third largest economy in the world. PPP eliminates misleading comparisons of GDP based on converting India’s GDP into dollars.
India’s GDP grew at 9.3% in 2010-2011. Due to slowing reforms, corruption and high current account deficits, the growth in India dramatically slowed to 4.8% in third quarter 2013.
The trigger for this call is the election results just released in four key Indian states. In a landslide, the opposition party BJP humiliated the ruling Congress party. India is set for national elections in May 2014; BJP is likely to win. BJP is business friendly and its leader, NarendraModi, has the fortitude to carry out tough reforms.
With reforms, India can easily get back on the track of 7%-8% growth. Based on the historical quantitative data, such growth in GDP may triple the Indian stock market in five years. Two of my favorite exchange-traded funds are WisdomTree India and iPath India.
CEO, CIO and founder of Atalanta Sosnoff Capital, LLC.
Buy: Citigroup (C), Boeing (BA), Celgene (CELG), Gilead Sciences (GILD), General Motors (GM)
For the new year, carry over from 2013 what’s made you rich. For me, this list includes banks like Citigroup, Boeing, biotech properties like Celgene and Gilead Sciences, and my last year’s favorite, General Motors. The rationale is low interest rates persist, price-earnings ratios stay in the upper teens and inflation is not a policy issue. Biotech is a go-to group because growth properties remain scarce and they’re capable of compounding earnings 20% per annum.
Managing Partner, Next Door Partners
Buy: V.F. Corp. (VFC)
I like stocks that seem reasonably valued, are making money, low debt and which have uptrending chart patterns. Theoretically, it’s the best of both worlds—fundamental analysis and technical. It doesn’t always work, but your probabilities of success become skewed in the right direction.
V.F. Corp., in the apparel business since 1899, fits the mold for 2014 with steady 5-year earnings growth, under control debt and a P/E in line with the S&P’s . It’s helpful that it has been paying a dividend since forever.
The stock is trading above $60 after starting 2013 at $38. VFC has traded above its 40-week and 200-week moving averages for three straight years. Now that’s an uptrend.
The move from October to now is quite extended and probably requires a pullback. As long as the trending continues, though, I like it.