CWS Market Review – December 27, 2013

In last week’s CWS Market Review, I unveiled the 20 stocks for next year’s Buy List. This week, I want to discuss the changes we’re making in greater detail.

The five new stocks are eBay ($EBAY), Express Scripts ($ESRX), IBM ($IBM), McDonald’s ($MCD) and Qualcomm ($QCOM). Remember that the new Buy List goes into effect at the start of trading on Thursday, January 2. For tracking purposes, the Buy Prices will be the closing prices on Tuesday, December 31. I’ll have complete details on the blog.

I want to remind investors that good stocks often appear as dented merchandise. The question we should ask is, how severe and lasting is the damage? With each of the new buys, my analysis tells me the issues are manageable and the prices are well worth it.

Whenever I release my Buy List changes, I often get people asking me if I’ve completely lost my mind. Last year, for example, many readers questioned my selection of Microsoft ($MSFT). They told me all the mistakes the company had made, but what’s interesting is that very few people mentioned the price. Sure, any company can have problems. But as investors, we’re always looking at the impact those problems have on share price. Fortunately for us, MSFT has been a 40% winner this year.

Now let’s look at our five new buys.

Our Five New Buys for 2014

In less than 20 years, eBay ($EBAY) has grown to become the largest marketplace in the world. It’s a truly phenomenal business. The online auction house will generate revenue of $16 billion this year. I’m not a pure value investor and I think there are times where it’s worthwhile to pay a premium for growth; eBay is a good example ($CTSH is another). Wall Street expects eBay to earn $3.14 per share next year, which means the stock is going for about 17 times earnings. That’s above the market, but it’s not a gigantic premium. I like the current valuation. eBay’s revenues will rise about 15% this year, and the Street sees another 14% increase next year. Bottom line: You’re getting a strong brand for a good price.

Express Scripts ($ESRX) is a pharmacy benefit management company. It’s a very large outfit with more than 30,000 employees and a market value of $56 billion. Last year, Express Scripts bought Medco Health Solutions which had been spun-off by Merck ten years ago. Large deals like that are usually hard to digest and ESRX has been a market laggard recently. The stock got dinged a few weeks ago when it missed earnings by a penny per share. The shares have rebounded lately, but it’s still a very solid buy. Truthfully, I’ve wanted to add ESRX to the Buy List for many years, but I’ve always thought it was too expensive. The price action over the last two years tells me I was right. Now’s our chance. This is a strong company and it could be a breakout winner next year.

Few companies have taken as much abuse as IBM ($IBM) has recently. The stock gradually drifted lower over the last year. What else can be said about Big Blue? It’s one of the largest multinational tech companies in the world. IBM is involved in just about every facet of business technology. Without exaggeration, IBM makes some of the largest and smallest technologies on the planet. Their earnings have been pretty good. IBM said their goal is to earn $20 per share by 2015. They’re aiming to return $70 billion to shareholders by then ($50 billion in buybacks, $20 billion in dividends). I know that investors are skittish of stocks with high nominal share prices. Try not to let that scare you away from IBM. Even if you only pick up a few shares, IBM is a outstanding company.

McDonald’s ($MCD) is probably the unlikeliest of the five new buys. It’s not the kind of stock I’m usually drawn to, but the valuation and generous dividend yield made me a believer. Again, it’s a strong brand name trading at a discounted value. Make no mistake: McDonald’s is working through some problems, but it’s nothing they can’t handle. Wall Street hates MCD right now which is one of the reasons why I like it. As of Thursday’s close, the stock yields 3.3%. They’ve increased the dividend every year since 1976.

Qualcomm ($QCOM) is good value play in the tech sector. The company has no debt and it generates tons of cash. The shares are currently going for less than 14 times next year’s earnings. I’ve also been very impressed with QCOM’s management.

The Five Stocks We’re Deleting

Now let’s run through the five stocks being deleted. Note that I am referring to these stocks as “deletions” not as sells – I don’t believe there’s a pressing need for investors to ditch any of these five positions.

FactSet Research Systems ($FDS) has been one of my favorite Buy List stocks. There aren’t many companies whose earnings trend is as smooth as FDS’s. Unfortunately, I think the price here is just too much. The stock is going for 23 times trailing earnings. I wouldn’t mind adding FDS again to a future Buy List. Actually, this time was the stock’s second visit to our Buy List.

Harris ($HRS) has been a wonderful investment for us. The communications equipment stock is up over 42% on the year for us, and it just hit a new all-time high. My concern is that the business environment for HRS will be much more challenging over the next few years (government spending in particular). I have little doubt that Harris can handle these challenges well, but for now, I’d prefer to focus on companies with better prospects.

JPMorgan Chase ($JPM) was a difficult call for me. We’ve done well with JPM and I still think the bank is a good value. However, the headline news and behavior of Jamie Dimon were just too much to bear. Ideally, I’d like to see JPM break itself up. I think that would be a huge benefit for investors, and I would certainly be interested in any of the Baby JP’s. I hope to see another big dividend increase in 2014.

Nicholas Financial ($NICK) was the easiest decision to make. As I’ve mentioned before, I’m not a fan of the “buy under” deal they made, but there doesn’t seem to be anything we can do. The buyer, Prospect Capital ($PSEC) seems to be a well-run closed-end fund with a rich dividend. The buyout is scheduled to take place in April at $16 per share. One benefit is that trading in PSEC is far more liquid than trading in NICK.

WEX Inc. ($WEX) was one of our more unusual stocks this year. The company provides payment processing info for vehicle fleets. WEX got off to a horrible start and was down 10% by early May. After that, the stock rallied dramatically off its low. The company posted good earnings, and the last report was particularly strong. This is a good company, but I think the price is a bit rich here.

Some of the other finalists for the 2014 Buy List were AbbVie ($ABBV), Target ($TGT), CVS Caremark ($CVS), Citigroup ($C), DaVita ($DVA), Transocean ($RIG) and Triumph Group ($TGI).

I’ll send out the next issue of CWS Market Review on Wednesday, January 1. The market is closed that day, but I’ll give you final results on the Buy List. I’ll also give you the Buy Below prices for our new Buys.

The Second-Best GDP Report in the Last 30 Quarters

On Thursday, the S&P 500 rose for the fourth day in a row. The index closed at yet another all-time high. Through Thursday, the Buy List is up 36.07% on the year compared with 29.16% for the S&P 500 (not including dividends).

There wasn’t much news this past week, but I wanted to mention last Friday’s GDP report. The government revised higher GDP growth for the third quarter up to 4.1%. That’s the second-best GDP number in the last 30 quarters (see chart below). Of course, it’s just a start, but if the economy can average around 4% for the next, say, three years, then we can finally make a serious dent in our sagging labor market.

The GDP report also confirms many of the other indicators we’ve seen, such as the stronger ISM reports, outperforming cyclical stocks and the spread between 2-year and 10-year Treasuries. The ISM report for November was the best report in over two years. Next Thursday, we’ll get the ISM report for December, and I’ll be very curious to see if the strong trend continues.

Fourth-quarter earnings season is set to begin in just two weeks. According to numbers from S&P, earnings for Q3 hit an all-time record. Much of the increase in EPS was driven by share buybacks which reduces the number of outstanding shares. For Q4, Wall Street expects earnings of $28.35 (that’s an index-adjusted number). At the start of the year, analysts were expecting Q4 earnings of $29.63. AS far as reductions go, that’s more modest than what we saw for earlier quarters this year. If profits come in line, that will come out to full-year earnings for 2013 of $107.40. That means the S&P 500 is currently going just a bit over 17 times earnings.

Despite the quiet week for trading, I wanted to comment on a few stocks. Does anyone else remember eighteen months ago when Bed Bath & Beyond ($BBBY) crashed 17% in one day? I do. That certainly cleared out a lot of traders. On Thursday, the stock broke out to a new all-time high and came within a few pennies of touching $80 per share. Good stocks bend, but they don’t break.

BBBY’s next earnings report, which will be for their fiscal Q3, is due to come out on January 8. The company has given us a range of $1.11 to $1.16 per share. For the full year, they expect earnings to range between $4.88 and $5.01 per share. I think they’re probably being a tad conservative. I expect BBBY to top $5 per share without much difficulty. This is an excellent company. BBBY is a buy up to $83 per share.

How about the rebound in Oracle ($ORCL)? It’s about time! ORCL had a tough year in 2013, but I think it will beat the market soundly in 2014. Oracle remains a buy up to $39 per share.

Before I go, I want to raise a few Buy Below prices. Fiserv ($FISV) has been on a roll after its split. I’m bumping up my Buy Below to $61 per share. Moog ($MOG-A) is closing in on being a 70% winner on the year. I’m raising our Buy Below by $3 to $71 per share. Lastly, I’m going to raise DirecTV’s ($DTV) Buy Below to $72 per share.

That’s all for now. The trading year ends next Tuesday. On Wednesday, the stock market will be closed for New Year’s Day. On Wednesday evening, I’ll send out our year-end issue which will run down how well our Buy List did. I’ll also include the Buy Belows for the new stocks. The important ISM report comes out on Thursday. 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!

– Eddy

Posted by Eddy Elfenbein on December 27th, 2013 at 9:01 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.