CWS Market Review – December 20, 2013

Ladies and gentlemen, here’s the 2014 Crossing Wall Street Buy List.

AFLAC ($AFL)

Bed Bath & Beyond ($BBBY)

CA Technologies ($CA)

Cognizant Technology Solutions ($CTSH)

CR Bard ($BCR)

DirecTV ($DTV)

eBay ($EBAY)

Express Scripts ($ESRX)

Fiserv ($FISV)

Ford ($F)

IBM ($IBM)

McDonald’s ($MCD)

Medtronic ($MDT)

Microsoft ($MSFT)

Moog ($MOG-A)

Oracle ($ORCL)

Qualcomm ($QCOM)

Ross Stores ($ROST)

Stryker ($SYK)

Wells Fargo ($WFC)

The five new stocks are eBay ($EBAY), Express Scripts ($ESRX), IBM ($IBM), McDonald’s ($MCD) and Qualcomm ($QCOM).

The five deletions are FactSet Research Systems ($FDS), Harris ($HRS), JPMorgan Chase ($JPM), Nicholas Financial ($NICK) and WEX Inc. ($WEX). I’ll have more to say about the Buy List changes and the new stocks next week.

To recap, I assume the Buy List is equally weighted among the 20 stocks. The “buy price” for each stock will be the closing price as of December 31, 2013. The new Buy List goes into effect on January 2, 2014, the first day of trading of the new year.

The Buy List is now locked and sealed, and I won’t be able to make any changes for the entire year. I’ll have a complete recap of 2013 at the end of the year. I’ll also have more to say about our new buys, plus I’ll give you new Buy Below prices.

Our low-turnover, long-term strategy has beaten the market for seven years in a row. I’m very excited for 2014 and I am confident we’ll extend our streak. Now let’s look at what happened to our Buy List stocks this week.

Nicholas Financial to Be Bought Out for $16 per Share

The big news for our Buy List this week, and which figured into the finalization of the Buy List for 2014, was that Nicholas Financial ($NICK) agreed to be bought out by Prospect Capital ($PSEC) for $16 per share. I’m not at all happy with this deal.

We knew there were parties interested in buying NICK, but I find this deal baffling because it’s a very low price for a buyout. The day before the buyout news came out, NICK had closed at $15.28, so it’s a premium of less than 5%. That’s tiny. Moreover, NICK had traded as high as $17.20 just two months ago. The $16-per-share offer is about 10 times trailing earnings, and it gives the dividend a 3% yield. I see no benefit in selling out at $16 per share.

A number of law firms have already announced legal threats against the deal, but this happens quite often. This time, however, I truly believe it’s a terrible price. In my view, $18 per share would be low but acceptable. If it goes forward, the deal is expected to close in April, and NICK shareholders will get $16 worth of shares in PSEC. It’s a tax-free deal, so if you plan to hold on, you’ll simply become a PSEC shareholder.

I don’t know much about PSEC. It’s a closed-end fund that specializes in targeting cheap deals. (Well, they certainly got one in NICK!) PSEC currently pays a monthly dividend of 11 cents per share, which gives the stock a rich yield, but I can’t say how sustainable it is.

Ideally, the current deal will be reviewed as it gets more scrutiny. Or possibly, someone else will make a counteroffer. Either way, NICK will not be on next year’s Buy List. For long-term shareholders, there’s no reason to sell. In fact, there is one small benefit in holding on, in that your position in PSEC will be much more liquid than it was in NICK. I’m not happy with this deal, but it looks like we’re stuck with it. At least we can say we made a very good profit with NICK. I wish them the best.

The Fed Tapers!

This week’s big economic news came on Wednesday, when the Federal Reserve announced that it would start tapering its bond purchases. Frankly, this caught me off guard. I wasn’t expecting a tapering announcement until next year. But starting next month, the Fed will reduce its bond purchases from $85 billion per month to a measly $75 billion (that’s $40 billion in Treasuries and $35 billion in mortgages).

Bear in mind, of course, that the bond buying isn’t ending. Far from it. The Fed is merely cutting back on the amount of purchases. In fact, the Fed indicated that it intends to be more accommodative going forward.

Let me explain that: The Fed reiterated its view that it expects to keep interest rates near 0% as long as the unemployment rate is above 6.5%. (It’s currently at 7.0%.) But they added a new wrinkle in their post-meeting statement. The Fed said that “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.”

That “well past” bit is new, and it signals to investors that despite the taper of bond purchases, low rates will be around for a long time to come. That’s what most certainly caused the stock market to rally on Wednesday. The S&P 500 added nearly 30 points to close at a new all-time high. The Fed also raised its growth estimates a bit for 2014.

What does taper mean for us? Honestly, not much. The most important point is that the Fed is still on the side of investors. We all knew this day was coming, but no one was sure when. Like I said, I didn’t see this coming for at least a few more months. As I’ve discussed before, we’ve gotten some better economic news lately, so the Fed feels it doesn’t need to push the economy quite as hard as it did before. Now let’s look at some of our earnings reports.

FactSet Research Earns $1.22 per Share

I’ve decided to remove FactSet Research Systems ($FDS) from next year’s Buy List. This was a tough call, because FDS is a very good company. I’m afraid the current price is just too high (more than 22 times this year’s earnings estimate). I’m very firm about valuations, and I refuse to stick with a stock that’s just too darn expensive.

I know I’ve been singing the stock’s praises until recently, but as I prepared this year’s Buy List, the math on FDS simply didn’t work. Earlier this week, the company reported fiscal Q1 earnings of $1.22 per share. That was two cents below the Street’s forecast, and the stock got dinged for a 6.4% loss.

For Q2, FactSet sees revenue ranging between $225 million and $228 million, and they see earnings coming in between $1.20 and $1.23. FactSet added that the ending of a tax credit for R&D should take a three-cent bite out of earnings. Wall Street’s consensus was for $1.25 per share.

I’m going to put FactSet back on my Watch List. I hope to add it again in years to come, but it will have to be at a better valuation.

Oracle Earns 69 Cents per Share

After the bell on Wednesday, Oracle ($ORCL) reported fiscal Q2 earnings of 69 cents per share which was two cents better than expectations. The stock jumped 5.8% on Thursday and touched a 13-year high.

Without a doubt, Oracle faces some problems. Plus, spending on IT around the world has been tepid. Still, I like Oracle a lot. The big concern isn’t hard to spot: weak sales growth. For the last three quarters, Oracle has missed Wall Street’s sales forecasts. Fortunately, that streak just came to an end. For Q2, Oracle’s revenue rose 2% to $9.28 billion, which was $100 million more than the forecast. Taking a closer look at the revenue side, we see that new software sales fell 1% last quarter. These sales are important, because they’re often recurring revenue. Oracle had given us a wide range for quarterly software sales: between -4% and +6%.

On the hardware side, sales fell 3% to $714 million. These are low-margin sales, and Oracle is working to phase out these systems in favor of their premium hardware. Free cash flow rose 14% to $14.6 billion. On the conference call, Oracle said their free cash flow now exceeds that of new Buy List member IBM ($IBM).

For Q3, Oracle said they project earnings to range between 68 and 72 cents per share. The Street had been looking for 70 cents per share. The company also said it sees revenue for this quarter rising by 2% to 6%. The Street was at 4%. Importantly, Oracle projects new software sales to rise between 1% and 11% this quarter. It’s taken Oracle a while to implement its strategy, but it appears to be paying off. I’m raising my Buy Below on Oracle to $39 per share.

Ford Drops on Lower Outlook

Shares of Ford Motor ($F) got nailed on Wednesday after the automaker lowered its earnings forecast for next year. The company said it will earn between $7 billion and $8 billion next year (pre-tax), which is down from probably about $8.5 billion this year. Ford also said that its profit margins and cash flow will fall next year. The stock lost 6.3% on Wednesday, which was the biggest drop since 2011. Ford fell another 2.2% on Thursday.

While this announcement is disappointing, I still like Ford for the long term. The reason is that Ford’s problems largely revolve around dealing with its growth. The company is introducing 23 new models next year including 16 in North America. Product launches are very expensive, and they turned out to be pricier than Ford expected. They’ve also been hiring a lot more folks. That’s quite different from suffering due to a lack of sales.

Keep in mind how the auto biz works. You need to make large up-front investments in people, plants and factories for new launches, and the payoff may be years down the road. The number of launches next year is more than double this year’s number. What Ford is doing is playing for an earnings rise in 2015 and 2016.

Looking at sales by region, Ford said that pre-tax profits will fall in North America, but will rise in Europe. The company has had a difficult time in Europe, but they seem to be turning a corner. The bottom line is that Ford has had a very good year this year, and they’re not resting on their laurels. I’ve been very bullish on Ford, and the lower price makes me like it even more. To reflect this week’s sell-off, I’m lowering my Buy Below to $17 per share. This one is for patient investors.

A few things before we go. Fiserv ($FISV) split its stock 2-for-1 earlier this week. This has been a very good stock for us this year. I’m raising the Buy Below to $58 per share. I also want to lift CA Technologies ($CA) to $34 per share. Lastly, I’m raising the Buy Below on Cognizant ($CTSH) to $101 per share.

That’s all for now. The stock market will close at 1 p.m. on Tuesday and will be closed all day on Wednesday for Christmas. Despite the shortened trading, there will be a few important economic releases next week, such as personal income, orders for durable goods, and new home sales. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review. I hope everyone has a wonderful holiday season!

– Eddy

Posted by on December 20th, 2013 at 7:05 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.