Friday, December 27, 2013

Top Stock Picks for 2014

As 2013 draws to a close, I want to provide my top stock picks for 2014. After the significant rally the market has experienced in 2013, it is harder to find compelling valuations in the market but these are some picks that currently stand out to me. I currently have my investments spread out over two accounts. The main account is a dividend growth investing account and my secondary account ('play account') is a bit more open to leave me some freedom to chase non-DGI picks (although it is free to also pursue additional DGI positions). As such, I will provide both DGI and non-DGI picks.

Dividend Growth Picks

Aflac (AFL) - provides supplemental health and life insurance products. The weak yen (vs. the dollar) has been a headwind throughout 2013 as the bulk of AFL's revenues and profits come from Japan. Despite this headwind, the underlying business remains very strong and AFL is near 52 week highs as we close out 2013. In late October, AFL increased its dividend 5.7%. This was the 31st consecutive year with a dividend increase. The yen may continue to be a headwind but AFL will continue to perform well. Could be a big breakout winner if the yen stops falling (BOJ/Abe will likely continue to play a key role here so it is unlikely to rise appreciably during 2014). Either way, valuation remains reasonable for such a great company.

Deere (DE) - manufactures and distributes agriculture and turf, and construction and forestry equipment worldwide. Deere is perhaps best known for its green tractors. 2013 marked a year of falling agriculture prices which has created concerns regarding future farmer spending on DE equipment. DE increased its dividend 10.9% in Q1 2013 which marked the 10th consecutive year with a dividend increase. As the global economy continues to pick up steam heading into 2014, expect the outlook for DE's end markets to improve and, with it, DE's stock.

Target (TGT) - operates general merchandise stores in the United States and is expanding into Canada. Obviously, Target is currently dealing with the fallout of the recent credit card hack it suffered. There continues to be headline risk here and the latest is that encrypted PIN numbers were also stolen. In addition, TGT's expansion into Canada has been more difficult than anticipated. In Q2 2013, TGT increased its dividend 19.4%, increasing its dividend streak to 46 years. As TGT moves past the credit card hack and its Canadian expansion picks up steam, look for this well run retailer to have a better 2014.

Cisco Systems (CSCO) - designs, manufactures, and sells Internet protocol (IP) and other products related to the communications and information technology industry worldwide. CSCO's recent stock weakness has been in large part due to reduced revenue and profit guidance from CSCO. In March, CSCO increased its dividend 21.4%. This was the 3rd increase after CSCO initiated a dividend in 2011. While some DGI investors look for at least 5 years (or more) of dividend growth before considering a position, CSCO's management has been clear about its intention to focus on returning cash to shareholders. I like this play because of CSCO's strong balance sheet, focus on returning cash to shareholders and current valuation. Feels a lot like MSFT heading into 2013.

Chevron (CVX) - one of the oil majors, this dividend champion appears to be attractively valued vs. its competitors, despite a bit of a pop in the past two weeks. In the 2nd Quarter, CVX increased its dividend 11.1% which was is 26th consecutive year with an increase. An improving economy will likely lead to higher oil prices and I like CVX's valuation in comparison to XOM & COP.

Non-Dividend Growth Picks

Ford (F) - offers vehicles primarily under the Ford and Lincoln brand names. Ford stock recently suffered a setback as a result of lower than expected guidance for 2014. In addition, there has been concern over CEO Alan Mullaly leaving F, either by retirement or to become CEO of MSFT. I think the market has over reacted to the guidance as Ford invests in its future. As we move through 2014, look for the market to realize the potential benefits of Ford's investments and that Mulally has more than sufficiently prepared Ford for his eventual departure.

BP (BP) - another one of the oil majors, BP continues to have potential liabilities from the Gulf spill hanging over the stock. BP does close out 2013 near its 52 week highs. BP announced in October that it was increasing its dividend 5.5%, its 3rd increase after reinstating the dividend back in 2011 after the oil spill. BP continues to trade at lower valuations than the other oil majors and I think it will continue to close the valuation gap as uncertainties regarding the liabilities from the Gulf spill continue to become clearer.

Speculative Play

J.C. Penney (JCP) - I want to stress that this is a very speculative play. JCP's business has deteriorated significantly over the past couple years and there is a very real chance the company could be forced to seek bankruptcy protection. As such, an investment in JCP can very easily lead to significant or total loss. The reason I list it is that I feel the brand still has some value. If management can successfully right the ship and begin to improve sales and reduce losses, this one could be a huge winner. The gambler in me wants to throw a small piece of my 'play account' at it and see what happens but for now I watch and wait. While its on my 'Top Picks' list, it is not the type of invesmtent I want to focus on so I will likely pass.

What are you looking at for 2014?

Disclosure - I am long AFL, DE, CSCO, and F calls.

Monday, December 23, 2013

Ignore and Embrace the Noise

Ignore the Noise

This is a phrase I have heard many times with regards to investing. This can be looked at from both a macro level and at a security level. For instance, at the macro level there is constant noise coming from Washington DC. With all the doomsday stories that will accompany a budget standoff or debt ceiling deadline, it can be easy for an investor to get uneasy. However, while there may be a short term effect from any given deadlock “crisis” the long-term picture and valuation of most companies is unlikely to be effected.

What I am more focused on with this post is noise that affects a specific company. A couple of years ago, someone reading the headlines could easily have concluded Johnson & Johnson (JNJ) was heading in the wrong direction as there was story after story with regards to various recalls and safety concerns at some of their factories. These headlines can be downright scary for any investor. Hindsight now shows that this was a great buying opportunity.

Whether it is McDonalds and concerns of the consumer shift to healthier foods or defense companies (LMT, GD, RTN, etc) ahead of the sequestration, there is a long list of companies that have been great investments despite headlines that may lead a person to a different conclusion.

Embrace the Noise

Noise can be very profitable for an opportunistic investor. When JNJ was struggling with Tylenol recalls and factory safety concerns an investor who ignored the noise could have spotted the buying opportunity by focusing on the fundamentals of the business. During this time, JNJ continued increasing revenue, increasing profits and increasing dividends. JNJ’s P/E, however, was compressing as a result of the negative sentiment surrounding the stock as the headlines continued to hit. As such, JNJ became a great bargain for a very high quality company. The key here is to focus on fundamentals of the underlying business and not just the headlines. If the fundamentals are also showing negative trends, then that is likely a company to avoid. However, if the fundamentals remain strong, noise can create compelling opportunities.

Current Noise

Right now there are a couple of companies I am watching that I believe are at potentially compelling valuations as a result of noise. One is Ford (F). Ford is down over 9% over the past week as a result of forward guidance that indicated 2014 would likely not be as profitable as 2013. The key here is to determine why. Is this a sign of deeper problems for Ford or is this a potential buying opportunity? 2013 is expected to be among the best years in Ford’s history with full-year automotive revenue increasing 10% and profit of approx. $8.5 billion. The company has cut the underfunded status of its global pension plans in half this year. Automotive operating profit margin increased year over year and profit came in higher than previously expected. 2014 will be the most aggressive product launch schedule in Ford’s history with 23 all-new or significantly refreshed vehicles being launched globally. Profit is expected to be in the range of $7 billion - $8 billion, down from $8.5 billion in 2013. This does not concern me as the aggressive launch will carry increased costs but will set Ford up for a stronger 2015 & 2016. So rather than seeing deteriorating fundamentals, I see a business that is investing in its future. I also see an improving balance sheet and overall strong financial performance. In addition, I would not be surprised if 2014 ends up stronger than expected (conservative guidance) and equals or even betters 2013 as the economy continues to improve here in the U.S. and in Europe. Now a pullback on headlines does not necessarily mean a company is undervalued but I like the valuation of Ford very much at these levels. Ford currently has a dividend yield of 2.6% and a trailing P/E of 10.7. I will look to do more in depth valuation analysis post in the future.

The second company I am watching is Target (TGT). Target stock has struggled over the past four or five months and is currently under pressure as a result of the security breach announced late last week which has resulted in up to 40 million credit and debit cards potentially being compromised. Timing on this breach was about as bad as possible for Target and, according to Reuters, transactions fell 3-4% this past weekend (last before Christmas) as compared to last year. In addition, Chase and other banks have imposed limits on debit card transactions for cards that were potentially compromised. This has the potential to affect millions of customers during the final holiday shopping rush which may cause greater inconvenience to Target customers, affecting their view of the retailer. It is too early to see how much of a lasting effect this will have on Target but this is a very well retailer. If they are able to regain the confidence of their customers, this may prove to be an excellent opportunity to pick up shares. Given the size of the breach, the easiest comparison is to the breach TJX experienced in 2007. TJX has rebounded strongly and I believe that this will be but a blip for Target as well. Obviously, Target’s experience may be significantly different than TJX but I will continue watching and look for a potential entry point as funds are available. I liked TGT’s relative valuation compared to many other dividend growth stocks prior to the breach and I continue to like it here under $62.

The Lesson

The lesson here is that noisy negative headlines can potentially lead to great investment opportunities if you are looking at a strong company and the underlying fundamentals of the business remain strong. Keep a list of companies you would like to own at the right valuation and monitor the “noise”. Happy Investing.

Divi Me Up

Dislcosure: I am currently long Jan 2015 $15 & $17 call options for Ford and have a limit order in to pick up shares at $15.00 (subject to change). I currently have no position in TGT.