How do you know if you own a “good” stock that will bring you capital gains? In today’s Smart Investing in Turbulent Times update, let’s answer that question the same way that professional equity portfolio managers answer the question: by focusing on earnings per share (EPS) and price/earnings ratios (P/Es).
When I speak with individual investors, they’re often surprised and pleased that I combine a growth stock strategy with a value stock strategy. I do this for two reasons:
1. I want to identify the highest-quality stocks possible; and
2. I want to minimize the inherent risk in stock investing.
If I only look for growth stocks, they might have astronomical P/Es. High P/Es add to the risk associated with owning stocks.
If I only look for value stocks, most often characterized by low P/Es, dividends, low debt ratios, and/or share repurchases, I could easily end up with stocks that have slowly growing or falling EPS.
But if I combine both growth and value stock selection strategies, I end up with stocks that have strong projected EPS growth and P/Es that are undervalued. As a bonus, dividends add to the EPS side of the equation, so that investors can look forward to both income and potential capital gains.
I want to show you how rare it is to find strong earnings growth and undervalued P/Es in well-known stocks, so that you can better appreciate the financial condition and prospects for the Smart Investing portfolio stocks.
Here’s a list of well-known companies, none of which I would buy right now. Some of these stocks have good projected earnings growth, while others will see their earnings fall in the coming year. Every single stock on this list is overvalued compared to its earnings growth rate.
* The P/E is based on the fiscal year-end in the chart, not on 2014 or 2015 numbers. At this late point in 2015, stock market professionals are using next year’s full-year numbers to make their investment decisions.
Please compare the stocks in the chart to the stocks in the Smart Investing portfolios, below. I’m including the EPS growth rate and P/E in each company’s description, so that you can see how my stock selection process identifies the cream of the crop in undervalued growth stocks.
As most of you know, U.S. stock markets continue to bounce around with higher-than-usual volatility. Many high quality stocks are revisiting their August-September lows right now. The S&P 500 is down -2.26% and the Dow Jones Industrial Average is down -3.13% year-to-date through December 11. That’s not fun, but it’s also not a disaster.
Falling oil prices and problems in the junk bond market are affecting good and bad stocks alike. Especially hard-hit sectors include energy, chemicals, metals and curiously, retail stocks. (I’m scratching my head over that one, but it is what it is. I expect the retail stock pricing problem to be temporary.)
Investors should hold on to quality stocks, pare back lesser-quality stocks--those with falling earnings--and add to their positions in stocks that have stable chart patterns.
Today, I’m lowering the ratings on Big Lots (BIG) in the Growth Portfolio and Robert Half International (RHI) in the Buy Low Opportunities Portfolio to Hold. Their stock prices are suffering; there’s no point in buying additional shares until the prices stabilize.
The Smart Investing portfolio stock that’s most likely to rise in the coming week is Adobe Systems (ADBE) in the Growth Portfolio.
Updates on Growth Portfolio Stocks
Adobe Systems (ADBE) is a software company. On December 10, Adobe Systems (ADBE) reported fourth-quarter EPS and margins higher than the Wall Street consensus estimates. Other key features of the earnings report include:
* The company finished its fiscal year (November year-end) with the addition of 2.7 million new Creative Cloud subscriptions--including 833,000 additions in the fourth quarter--for a total subscription base of over 6.1 billion users.
*The company achieved record quarterly revenue of $1.306 billion, and record annual revenue of $4.80 billion.
*The company repurchased 1.4 million shares of stock during the quarter, and 8.1 million shares during its full year.
*At least 11 Wall Street analysts raised their price targets on the stock.
*The long-term debt-to-capitalization ratio increased from 11% to 21%, which is still a relatively low number.
Wall Street’s consensus 2016 and 2017 EPS growth projections of 34% and 33% will likely change in the coming weeks, as analysts reassess Adobe’s outlook. The P/E is currently 33, indicating that the stock is fairly valued.
I might normally lower the rating on a fairly-valued stock. However, ADBE has so many bullish factors in place, that I expect the stock to continue climbing this month, fueled by the great earnings report, strength in the software sector, a bullish chart (during a weak market!), and institutional window dressing activity. Rating: Strong Buy.
Chemtura (CHMT) manufactures specialty chemicals. Chemtura will host an Investor Day in New York City on December 16. Investors may pre-register for the webcast on the company’s website. As analysts issue updated reports on CHMT, please expect volatility in the stock, in either direction.
Wall Street expects EPS to grow 90% and 30% in 2015 and 2016 (December year-end). The 2016 P/E is very low, at 14.8. CHMT reached new highs in November, and is now having a price correction with the overall market. I expect it to bounce at 27 a few times, before climbing again. Rating: Strong Buy.
Delta Air Lines (DAL) will host an Investor Day on December 17. You may access the live webcast by registering on Delta’s website. This will be an important day for analysts, who will tweak their research recommendations, based on management’s statements and forecasts. Please expect volatility in the stock, in either direction.
I have Delta at a Buy rating, rather than a Strong Buy, due to the company’s intended purchase of a 49% stake in Grupo Aeromexico. The purchase will potentially increase Delta’s debt obligations to levels that don’t meet my investment criteria. We’ll know more in a few months.
Wall Street’s 2016 consensus EPS estimate increased again last week. EPS are expected to grow aggressively at 40% and 25.3% in 2015 and 2016 (December year-end). The 2016 P/E is extremely low, at 8.5, and the dividend yield is 1.1%.
As with software stocks, airline stocks are currently showing more strength than the broader market. DAL rose to new highs in recent weeks, had a correction, reached new highs in December, and is now trading between 49 and 52. I expect additional capital gains as soon as the current market correction is resolved. Rating: Buy.
D.R. Horton (DHI) is a homebuilder. Wall Street expects EPS to grow 17% in 2016 (September year-end), the 2016 P/E is 13.7, and the dividend yield is 1.0%. The stock broke past annual highs in late November, and is now trading between 30.50-33.00. I expect DHI to climb past 33 this winter. Rating: Strong Buy.
E*Trade (ETFC) offers financial brokerage and banking products and services. Last week, analysts increased their 2016 EPS growth expectation to 36.2% (December year-end). The 2016 P/E is very low in comparison, at 18.3. ETFC’s price rebounded nicely from the August market correction, and is now trading between 28.50-31.00. Rating: Strong Buy.
Priceline (PCLN) is an online travel service company. PCLN is fairly valued, with 2016 EPS projected to grow 18.8% (December year-end) and a 2016 P/E at 18.7. (The stock reached a P/E of 26 or higher in each of the last nine years.) PCLN reached new all-time highs in November, then experienced a big pullback. I believe the stock will rebound toward the November high of 1,476 this winter, barring unforeseen bad news. Rating: Buy.
Royal Caribbean Cruises (RCL) Wall Street expects EPS to grow 29.1% in 2016 (December year-end). The 2016 P/E is very low in comparison, at 14.8. RCL’s dividend yield is 1.6% and the ex-dividend date for the next quarterly dividend is December 17. RCL reached a new high in October, just over 100. The stock will likely trade between 91 and 100 for a while before continuing its upward climb. Rating: Strong Buy.
Vulcan Materials (VMC) produces construction aggregates. The stock remains dramatically undervalued, despite its huge 2015 run-up. Wall Street expects EPS to grow 66% in 2016 (December year-end), and the 2016 P/E is very low in comparison, at 28.1. VMC reached an annual high in late November, then corrected with the recent weak stock market. Rating: Strong Buy.
WellCare Health Plans (WCG) WCG is an aggressive growth stock in the managed healthcare sector. Wall Street expects EPS to grow 34.1% in 2016 (December year-end), and the 2016 P/E is very low in comparison at 17.3. The stock price has been stuck in a sideways trading pattern, with strong support at 77. Be prepared for continued volatility. Rating: Buy.
| Growth Portfolio | |||||
|---|---|---|---|---|---|
| Security (Symbol) | Date Added | Price Added | Price 12/14/15 | Total Return | Rating |
| Adobe Systems (ADBE) | 10/6/15 | 85 | 93 | 9% | Strong Buy |
| Chemtura (CHMT) | 10/6/15 | 31 | 27 | -10% | Strong Buy |
| Delta Air LInes (DAL) | 10/6/15 | 46 | 50 | 9% | Buy |
| D.R. Horton (DHI) | 10/6/15 | 31 | 31 | 2% | Strong Buy |
| E*Trade Financial (ETFC) | 11/12/15 | 29 | 29 | -1% | Strong Buy |
| Priceline (PCLN) | 10/6/15 | 1,275 | 1,298 | 2% | Buy |
| Royal Caribbean Cruises (RCL) | 10/6/15 | 92 | 92 | 1% | Strong Buy |
| Vulcan Materials (VMC) | 10/6/15 | 94 | 95 | 1% | Strong Buy |
| WellCare Health Plans (WCG) | 10/6/15 | 84 | 78 | -7% | Buy |
| Growth Portfolio Total Return | 0.60% |
Growth & Income Portfolio
Growth & Income Portfolio stocks have bullish charts, good projected earnings growth, dividends of 1.5% and higher, low-to-moderate price/earnings ratios (P/Es) and low-to-moderate debt levels.
Big Lots (BIG) is a discount retailer. Wall Street expects EPS to grow 11.5% in 2017 (January year-end), the 2017 P/E is 11.7 and the dividend yield is 2.0%. (BIG traded at a P/E of 15 or higher in each of the last five years.) I have a strong sense that analysts overreacted considerably, when they lowered the 2017 EPS number after Big Lots’ third-quarter report this month.
I’m lowering the rating on BIG from Strong Buy to Hold. There will be plenty of time to buy once the share price stabilizes. Please give your Big Lots shares a little time to recover. There’s absolutely nothing wrong at the company, and the fundamentals are GREAT. The stock market is simply being skittish. Rating: Hold.
Carnival (CCL) is a cruise vacation company. Carnival will report fourth-quarter results on December 18. Investors may access the earnings simulcast on the company’s website. Wall Street expects EPS to grow 26.8% in 2016 (November year-end), the 2016 P/E is quite low at 15.4 and the dividend yield is 2.4%. (CCL traded at a P/E of 19 or higher in each of the last five years.) CCL is trading between 49.50-54, and could surpass 54 this winter. Rating: Strong Buy.
Federated Investors (FII) is a global investment management company. Wall Street expects EPS to grow 24.2% in 2016 (December year-end), the 2016 P/E is very low at 14.3 and the dividend yield is 3.5%. (FII traded at a P/E of 20 or higher in seven of the last 10 years.) The weak stock market has pulled FII down to recent price support at 28. Rating: Strong Buy.
GameStop (GME) owns and operates 6,200 video game and electronics stores in the U.S., Canada, Australia and Europe. Wall Street expects EPS to grow 11.7% in 2017 (January year-end), the 2017 P/E is 7.2 and the dividend yield is 4.8%. The stock is wildly undervalued, both in comparison to its EPS growth and dividend, and also compared to its historical P/E range. The stock traded at a P/E below 7 only once in the last 10 years!
The chart remains bearish, despite no serious news on the company’s outlook. The stock price will need to stabilize before it can recover. The rating will be on Hold until the stock price stabilizes, at which point I’ll encourage bargain-hunters to snap up shares while the dividend yield remains high.
I would like to reiterate that there is no problem at the company, and the current low stock price is simply a reflection of investor skittishness toward retail stocks. Rating: Hold.
General Motors (GM) Wall Street expects GM’s EPS to grow 12.7% in 2016 (December year-end), the 2016 P/E is 6.3 and the dividend yield is 4.2%. (GM traded at a P/E of 9 or higher in each of the last five years.) The stock recovered nicely from the August market downturn, currently trading between 34 and 36.50. The next upside resistance level is at 38/39. Rating: Strong Buy.
H&R Block (HRB) is a leader in tax preparation services. H&R Block hosted an Investor Day for analysts this month. The company is rolling out Block Advisors, which offers year-round tax planning, payroll and bookkeeping services. Morgan Stanley analysts expect a dividend increase in the coming months, and for the company to repurchase $4 billion to$5 billion of stock in the next three years.
Last week, HRB reported slightly-lower-than-expected second-quarter results, sending the stock price down to strong price support at 32, where the stock also bounced in August. The earnings miss was attributed to foreign currency effects on revenue and one-time costs associated with its recent bank divestiture and acquisitions. Pointedly, there has been no change in analysts’ expectations for full-year results. Wall Street expects EPS to grow 20.0% in 2016 (April year-end), the 2016 P/E is 15.6 and the dividend yield is 2.5%. I do not expect prolonged difficulty with the stock price. Rating: Strong Buy.
| Growth & Income Portfolio | |||||
|---|---|---|---|---|---|
| Security (Symbol) | Date Added | Price Added | Price 12/14/15 | Total Return | Rating |
| Abercrombie & Fitch (ANF) | 11/9/15 | -- | -- | 15% | Sold 11/30/15 |
| Big Lots (BIG) | 10/6/15 | 49 | 38 | -22% | Hold |
| Carnival (CCL) | 10/6/15 | 50 | 51 | 2% | Strong Buy |
| Federated Investors (FII) | 11/30/15 | 31 | 28 | -10% | Strong Buy |
| GameStop (GME) | 10/6/15 | 43 | 30 | -30% | Hold |
| General Motors (GM) | 10/6/15 | 32 | 34 | 7% | Strong Buy |
| H&R Block (HRB) | 10/6/15 | 36 | 33 | -8% | Strong Buy |
| SanDisk (SNDK) | 10/6/15 | -- | -- | 27% | Sold 11/2/15 |
| Union Pacific (UNP) | 10/6/15 | -- | -- | -5% | Sold 11/2/15 |
| Growth & Income Portfolio Total Return | -2.20% |
Buy Low Opportunities Portfolio
Buy Low Portfolio stocks have neutral charts, strong projected earnings growth, low-to-moderate price/earnings ratios (P/Es) and low-to-moderate debt levels. (Dividends are not a portfolio requirement, but some of the stocks will have dividends.) Investors should be willing to wait patiently for these stocks to climb.
Updates on Buy Low Opportunities Portfolio Stocks
Axiall (AXLL)--formerly Georgia Gulf Corp.--manufactures chemicals and plastics. Wall Street expects EPS to grow 81% in 2016 (December year-end), the 2016 P/E is shockingly low in comparison at 12.0. The dividend yield is large at 4.1%.
Stocks in the chemical sector have fallen in tandem with oil sector stocks, despite AXLL’s strong earnings outlook. There could be additional downside to the stock price, as commodity stocks are taking the brunt of market volatility this year. AXLL could appeal to patient traders, aggressive growth investors, value investors and growth & income investors. Rating: Buy.
Boeing (BA) assembled its first 737 MAX jet last week, with its first flight scheduled for early 2016 and first delivery scheduled for the third quarter of 2017.
Wall Street expects EPS to grow 14.3% in 2016 (December year-end), the 2016 P/E is 15.0 and the dividend yield is 2.5%. BA had a strong rebound after the August market correction, most recently trading between 141 and 150.50, where it will likely remain in the near-term. Rating: Hold.
Boise Cascade (BCC) is a leading U.S. wholesaler of wood products and building materials. Wall Street expects EPS to grow 37.2% in 2016 (December year-end), and the 2016 P/E is super-low at 12.0. BCC is revisiting its October lows, and has bounced around between 25 and 32 in recent months. Rating: Buy.
Harman International Industries (HAR) is a manufacturer of vehicle audio systems. Wall Street expects EPS to grow 14.0% and 17.8% in 2016 and 2017 (June year-end), the 2016 P/E is 13.8 and the dividend yield is 1.5%. (HAR traded at a P/E of 26 or higher in four of the last five years.) The stock price has been suffering with the weak stock market, and could fall further, although there’s no recent bad news. Buy.
Intuit (INTU) is an industry leader in financial management software solutions. Wall Street expects EPS to grow 34.4% in 2016 (July year-end), the 2016 P/E is 27.5 and the dividend yield is 1.2%. INTU’s price improved steadily since the August market correction, although it has plateaued in recent weeks. Rating: Buy.
Johnson Controls (JCI) operates in the areas of energy management and auto batteries. Last week, the company announced October 2016 as the spin-off date for its automotive seating and interiors business. In the interim, Johnson Controls will suspend its share repurchase plan, until the spinoff is completed.
Wall Street expects EPS to grow 10.8% and 11.3% in 2016 and 2017 (September year-end), the 2016 P/E is 10.4 and the dividend yield is 2.9%. The P/E reached 17 and higher in nine of the last 10 years. The share price has revisited its lows from August-September. Rating: Buy.
Robert Half International (RHI) is a staffing and consulting company. Wall Street expects EPS to grow 15.3% in 2016 (December year-end), the 2016 P/E is 14.8 and the dividend yield is 1.7%. The P/E has traded between 17and 22 and higher in each of the last five years.
RHI fell last week due a rating downgrade at Deutsche Bank, although there was no bad news related to the company. RHI has the weakest chart among Smart Investing portfolio stocks. I’m changing the rating to Hold until the chart turns more bullish. Rating: Hold.
Whirlpool (WHR) is a global appliance manufacturer. Wall Street expects EPS to grow 18.5% in 2016 (December year-end), the 2016 P/E is very low at 9.9 and the dividend yield is 2.5%. WHR has traded in a P/E range of 9 to 15 or much higher in each of the last five years. The weak stock market has pulled WHR’s price down to its September-October lows. Rating: Buy.
| Buy Low Portfolio | |||||
|---|---|---|---|---|---|
| Security (Symbol) | Date Added | Price Added | Price 12/14/15 | Total Return | Rating |
| Axiall (AXLL) | 11/9/15 | 22 | 15 | -31% | Buy |
| Bank of New York Mellon (BK) | 10/6/15 | -- | -- | 11% | Sold 11/6/15 |
| The Boeing Company (BA) | 10/6/15 | 135 | 143 | 6% | Hold |
| Boise Cascade (BCC) | 11/9/15 | 30 | 26 | -15% | Buy |
| Harman International Industries (HAR) | 10/6/15 | 105 | 90 | -14% | Buy |
| Intuit (INTU) | 10/6/15 | 91 | 96 | 5% | Buy |
| Johnson Controls (JCI) | 10/6/15 | 43 | 40 | -9% | Buy |
| Robert Half International (RHI) | 10/6/15 | 51 | 46 | -10% | Hold |
| Whirlpool (WHR) | 11/3/15 | 160 | 144 | -10% | Buy |
| Buy Low Portfolio Total Return | -7.50% |