Portfolio Builder
The Prudent Speculator follows an approach to investing that focuses on broadly diversified investments in undervalued stocks for their long-term appreciation potential. Does that mean we build portfolios of 20 stocks...30...? More like 50 and up. We like stocks. And we like a lot of ‘em. We don’t rely nearly as much on "how many" as we do "in which," but we tend to invest in far more names than most. This expansive diversification, we find, potentially serves us well in two ways: we can further minimize the risk of individual stock ownership, while maximizing the likelihood of finding the truly big winners among the undervalued masses.
As for the "in which" part, readers should know we discriminate among potential investments primarily by their relative valuation metrics and our assessments of stock-specific risk. We buy only those stocks we find undervalued along several lines relative to their own trading history, those of their peers or that of the market in general. The prices at which we’ll buy and sell stocks incorporate a range of fundamental risks (e.g. credit, customer and competitive dynamic) that we believe the companies may face over our normal 3-to-5-year investing time horizon.
Each month in this column, we suggest to readers a group of ten stocks with which to populate portfolios. The list could serve as a portfolio foundation for new investors or as a pick-list for folks already maintaining well-diversified holdings. While other themes may be featured over time, our ongoing consolidation program has created opportunities (i.e. proceeds of sales) to simply add stocks each month to our newsletter portfolios.
Note that we are in no way suggesting that these stocks replace those featured in prior months as we will always issue a Sales Alert should we choose to exit a position.
This Month’s Theme
Given our penchant for broad portfolio diversification, we always have difficulty in selecting one, two or even a handful of stocks as our best picks. Of course, as the calendar turns, we are usually asked to tab our top selections for the New Year. As we welcome 2013, we have already unveiled 13 of our most liked undervalued companies on our Facebook page, each of which had previously appeared in the pages of this publication. In this issue, we unveil an additional 10 names, creating a well-diversified group of 23 Favorite Stocks for 2013.
Aetna (AET)
Aetna is one of the largest managed care organizations, covering almost 19 million members and focusing on three segments: Health Care, Group Insurance and Large Case Pension. At the firm’s recent investor day, management announced that the Coventry Health Care (CVH) purchase that was announced late last summer was still on track to close mid-2013, and is showing attractive synergistic opportunities. In addition, the company stated that it continues to generate strong free cash flow, while management offered a full-year 2013 operating EPS projection of "at least $5.40," which could be boosted post CVH-closing. Even with continued concerns about the implementation of the new healthcare laws, we think Aetna offers attractive upside as it has scale and financial flexibility to manage better than most insurers. We also view positively the company’s diverse product lines, improved pricing discipline, cost control initiatives and share buybacks (the firm has repurchased 33% of its outstanding shares over the past 5 years). The stock is trading for less than nine times the ‘13 EPS estimate, while healthy cash flows support the dividend. Though the yield is a modest 1.7%, it has been on the rise.
California Water Service Group (CWT)
California Water Service is the third-largest investor-owned water utility in the United States. The company has six wholly-owned subsidiaries operating in California, Washington, New Mexico and Hawaii. Four of the six are regulated by state public utilities commissions. The non-regulated businesses leverage the company’s expertise in operating water and wastewater systems and provide related utility services. The company serves more than two million people, generates more than $400 million in annual revenue and owns in excess of $1.5 billion in gross utility plant assets. We are attracted to the water segment of the utility space, as we think that fresh water will continue to become an ever-more precious commodity. We also like that CWT is currently operating in a seemingly favorable regulatory environment and that its management team possesses substantial operational expertise. CWT shares are attractively valued relative to those of its peers, while they sport a 3.4% dividend yield.
Diamond Offshore Drilling (DO)
Diamond Offshore, a global leader in deepwater drilling, owns and operates one of the largest fleets of offshore drilling units in the world. The company’s diverse fleet consists of 33 semisubmersible drilling rigs, seven jackups and five ultra-deepwater drillships (four of which are due for delivery in 2013 and 2014). As the search for global energy supplies moves further offshore, we like even better Diamond’s long-term prospects. Management continues to renew and modernize its fleet at seemingly attractive prices, and has implemented cost cutting initiatives and enhanced programs in efforts to reduce unanticipated rig downtime. The solid pricing in the oil markets should continue to support rig day rates, and the driller has been announcing a number of new contracts that are expected to generate in excess of $1 billion in revenue, further boosting Diamond’s existing multi-billion dollar contract backlog and augmenting its strong free cash flow generation. As a result, we think that the special dividends that have been paid out for quite a while now (financial Web sites generally won’t show the ‘true’ 5%+ yield) are likely to continue.
Freeport-McMoRan (FCX)
Freeport-McMoran is the world’s largest publicly traded copper and molybdenum producer, and the 8th largest gold producer. Shares have rebounded some since a sharp decline in early November when the company announced that it was acquiring Plains Exploration & Production Company for approximately $6.9 billion in cash and stock and McMoRan Exploration for $3.4 billion in cash. Investors are concerned that the move into fossil fuels moves the firm too far from its core competencies, but we believe the deal is transformational and the diversification of commodity and country risk will ultimately prove beneficial to shareholders. Upon completion of the transactions, management estimates that 74% of EBITDA will come from mining and the remaining 26% will come from oil and gas, while its key assets will be world class and globally diversified. We remain positive on long-term copper fundamentals, as well as energy, seeing long-term demand being driven by strong emerging-market growth. Shares currently trade for 11 times consensus earnings estimates and offer shareholders a 3.6% dividend yield.
Corning (GLW)
Corning is the leading designer and manufacturer of glass and ceramic substrates found in liquid crystal displays, fiber-optic cables, automobiles and laboratory products. The company has five primary divisions—display technologies, telecommunications, environmental technologies, specialty materials and life sciences. We believe that while there may be short-term headwinds to overcome, the company is well-positioned to take advantage of its market-leading product lines over the long-term. Gorilla Glass, Corning’s ultra-popular mobile device component, has been gaining positive momentum lately and has a lot of potential to grow in the LCD glass space. We feel that the company will continue to progress as the economy improves, particularly in the Telecom and Specialty Materials businesses. Corning’s inexpensive valuation (P/E ratio of 10) and 2.9% dividend yield currently offer an attractive entry point.
Intel (INTC)
Intel, the leading global semiconductor manufacturer, supplies advanced technology solutions for the computing industry. Its primary products include microprocessors, chipsets and motherboards for a broad array of computing devices. We expect to see continued growth in demand for chips from Intel, particularly in data center enterprise applications. While sales of its latest processors, code named ‘Ivy Bridge’, might still suffer from some excess capacity early in the year, we believe that Intel will be operating optimally by the time the next generation of ‘Haswell’ processors come to market mid-year. Additionally, the company continues to develop its foundry
business and maintains a sizeable technological lead over its competitors with ‘Triple-Gate Transistors’ that process commands more efficiently, while using less physical chip space. We also like that Intel has a diversified revenue stream, low levels of debt, a competitive assortment of products and 4.4% dividend yield.
Microsoft (MSFT)
Microsoft is the Redmond, Washington-based worldwide leader in software, services and solutions that "help people and businesses realize their full potential." Launched in 2012, sales of the company’s flagship Windows 8 operating system have been slower than initially expected, though we believe that over time Microsoft will benefit from the unique design. The operating system was built from the ground up, comes complete with an app store and can be implemented across a broad array of form factors, opening up diversified revenue streams and helping to facilitate a seamless user experience from smartphone to tablet to PC and beyond. In addition to those features, a refreshed Microsoft Office suite and fluid access to cloud data storage should prove tremendously beneficial to the bottom line, while normal teething problems in new interfaces, like integrated touch-screen technology, are likely to make consumers somewhat slower to adopt the platforms. Enterprise customers should also adopt Windows 8, though at a relatively slower clip, in order to allow IT departments to work out glitches before applying them across large user groups. We look favorably upon the company’s improving growth prospects across its business segments, and we are drawn to the dividend yield of 3.4% and the modest P/E ratio of less than 11.
Staples (SPLS)
Staples, a leading office products retailer, has tumbled 30% since last March as soft employment numbers and reduced business spending have dampened sales and operating margins. While rumors of a private takeover of the company still swirl on occasion, we believe that such an event is unlikely in the near-term. We think that the company has the ability to forge ahead on its own, continuing to work hard growing its breakroom supply, copy and print businesses. While sales growth has been dismal, earnings are near record high levels. We feel that the bottom line will continue to benefit from cost control initiatives and improved operational execution in international markets, though a soft demand environment in Europe might be a headwind in the early part of the year. Still, we like that management has slowed domestic expansion of its superstore concept and shifted more resources to Staples.com. The company currently sports an attractive P/E ratio of less than nine and a generous 3.9% dividend yield.
Wells Fargo & Co (WFC)
Wells Fargo is a San Francisco-based financial services company with $1.4 trillion in assets. Founded in 1852, WFC is the second largest bank in the U.S. by deposits, and the largest by branches (over 9,000). Wells serves one in three U.S. households, and offers a wide variety of financial products ranging from banking, investments and insurance, to mortgages and commercial finance. While the income statement has continued to suffer from the low interest rate environment, Wells’ unique business model (which leads us to think of it as not simply a bank) helped the company turn in a solid Q3 with EPS coming in at $0.88 per share versus consensus estimates of $0.87. We like that the firm has a good reputation with its customers, and has a solid and growing foothold in metro America and the heavily populated coastal regions. WFC has good capital levels and appealing core earnings power, which could experience improvement as credit quality increases and cost cutting takes hold. We also believe that interest rates will eventually rise, helping the company’s all-important net interest margin. The stock now trades for less than 11 times forward earnings estimates and offers those looking for mega-cap financial exposure a 2.5% dividend yield. What’s more, we think that there is plenty of room for the payout to ratchet higher in coming years.
Waste Management (WM)
Waste Management is the leading provider of comprehensive waste management services in North America. Through subsidiaries, the firm provides collection, transfer, recycling and disposal services, not to mention its ownership and operation of numerous waste-to-energy and landfill gas-to-energy facilities. WM has a dominant domestic market share in trash hauling and overall landfill capacity. Its revenue stream is well diversified both geographically and by business segment. While trash volumes continue to be on the relatively weak side, and the company endures mix and margin compression, we believe that WM shares are appealing. No doubt, headwinds will remain, but we think the company will be able to drive long-term increased profitability via eventual favorable pricing and we note that headway has been made in improving the overall operating cost structure. Management still expects to continue to generate attractive free cash flow (in excess of $1 billion for fiscal 2013) and remains willing to reward shareholders via dividends and share repurchases. Historically low volatility WM shares are currently yielding a healthy 4.2%.
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Important Disclosures
Nothing presented herein is, or is intended to constitute, specific investment advice or marketing material. Information provided reflects the views of Al Frank Asset Management (AFAM) as of a particular time. Such views are subject to change at any point and AFAM shall not be obligated to provide notice of any change. Any securities information regarding holdings, allocations and other characteristics are presented to illustrate examples of the types of investments or allocations that AFAM may have bought or pursued as of a particular date. It may not be representative of any current or future investments or allocations and nothing should be construed as a recommendation to follow any investment strategy or allocation. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. While AFAM has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third-party information presented herein. No guarantee of investment performance is being provided and no inference to the contrary should be made. There is a risk of loss from an investment in securities. Past performance is not a guarantee of future performance.
AFAM is an Investment Adviser, registered with the SEC, is notice filed in the State of CA and various other states, and serves as editor to The Prudent Speculator and the weekly e-mail updates; (TPS: ISSN 0743-0809). AFAM is sub-adviser to two proprietary mutual funds and serves as manager to separate managed accounts. Many of the securities contained within this newsletter mentioned are analyzed, recommended and transacted in by AFAM and/or its associated persons for client and personal accounts. It is also possible that AFAM and/or its associated persons may take a position in a security that is inconsistent with the recommendations provided in TPS or may purchase securities not mentioned in TPS without notice to its subscribers.
Past specific recommendations: Investment recommendations provided herein are subject to change at any time. Past and current recommendations that are profitable are not indicative of future results, which may in fact result in a loss. See prudentspeculator.com or contact AFAM at [email protected] for a list of all past specific investment recommendations. Performance and characteristics of AFAM portfolios and securities are subject to risks and uncertainties. The stocks selected for listing and discussion in the newsletter were based on proprietary analytical work performed by AFAM, and not based on performance, meaning that they are chosen irrespective of profits or losses. The securities presented do not represent all of the securities bought, sold or recommended.
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The Prudent Speculator: January 2013 Page 4
