CWS Market Review – December 25, 2015

December 25, 2015
“All men’s miseries derive from not being able to sit in a quiet room alone.”
– Blaise Pascal

Merry Christmas!​

Last week, I unveiled our Buy List for 2016 (you can see the full list here). In this week’s CWS Market Review, I’ll go into more depth on our changes and why we’re making them. I’ll also update you on our Buy List for this year. With a week to go, we’re holding a nice lead over the S&P 500. This will be the eighth time in the last nine years that we’ve beaten the overall market. Once again, patience and prudent investing have served us well.

The stock market is closed today for Christmas. Next week will be the final trading week of the year. In next week’s issue, I’ll have a summary of the 2015 Buy List, and the precise weightings for the 2016 Buy List.

As usual, the 20 stocks will be equally weighted, using the closing price on Thursday, December 31. For track-record purposes, I will assume the Buy List is a $1 million portfolio, with $50,000 allocated to each of the 20 stocks. Also in next week’s issue, I’ll have the Buy Below prices for our five new stocks. Now let’s take a look at where the 2015 Buy List stands.

Another Market-Beating Year for Our Buy List

We’re wrapping up the tenth year of our Buy List. For the last decade, we’ve followed the exact same rules—20 stocks, no trading and five changes each year.

We lost to the market in our first year, but then beat it for the next seven years in a row. That streak came to an end last year, when we lost to the S&P 500 by a little less than 2%. I’m happy to report that we’re back to our market-beating ways this year.

Through Thursday’s close, our Buy List is up 4.75%, while the S&P 500 is up by 0.10%. (Hey, we’re beating the market nearly 50 to 1!) Once we include dividends, our Buy List is up 5.94%, while the S&P 500 is up 2.20%. I always consider the final performance number to be the one with dividends included. As a very rough rule of thumb, the S&P 500 has yielded about 2% for the last few years, while our Buy List has yielded about 1%.

Note how well we’ve done despite getting battered by stocks like Qualcomm and Bed Bath & Beyond (both are down over 33%). That’s because the Buy List is well diversified. This is an important lesson investors need to understand. The market gods are capricious and unforgiving. I certainly didn’t think a Spam stock was going to be a 53% winner this year. But that’s what happened. Every week or so, I’ll get an e-mail that says, “Eddy, if you could buy just one stock….” Sigh. Sometimes I think preaching sound investing is a losing battle.

Here’s an interesting fact: The daily changes of our Buy List correlate 96.5% with those of the S&P 500. That number would scare the bejeezus out of any hedge-fund manager. They spend lots of time and energy trying to zig when the market zags. But for us, that’s not so important. We’re not trying to get 500% a year. In fact, it’s the going-for-the-fences strategy that often winds up causing a fund to get schlonged. Note the Pascal quote in this week’s epigraph.

I also want to clarify an important point. For track-record purposes, I rebalance the Buy List each year, but there’s no need for you to rebalance your portfolio each year. That’s only necessary when a position may grow to an unusually large weighting in your holdings. Then it might be a good idea to cut back on it and reallocate the funds to other positions. But that kind of rebalancing is only needed every three years or so, assuming you start with a well-diversified portfolio.

The New Additions for 2016

Now let’s look at 2016. The five new stocks for 2016 are Alliance Data Systems, Biogen, Cerner, HEICO and Stericycle.

First, let me explain how I go about selecting our stocks. A big mistake many investors make in stock selection is that they use a top-down approach. By this, I mean that they’ll say to themselves, “What’s going to be really big in the future? I know! Biotech! Or green energy! Or China. Or a Chinese green energy firm that does biotech!”

That’s the wrong approach. The right way is to find a few companies that are really, really good at what they do. What they do is secondary. I realize that sounds counterintuitive, but remember that in a free-enterprise economy, just about any task can be profitable. Check out the impressive long-term chart of Smuckers (SJM). I find it reassuring that very few hedge funds have come close to the performance of the jelly people.

If in the early 1980s you had been prescient about the personal-computer revolution, you probably would have invested in Wang, DEC and IBM. That’s the weak part of a top-down approach. Even if you’re right on the top part, that doesn’t mean you’re going to be right on the down part.

You may have noticed that again, we don’t have any energy stocks. That’s not me making a prediction on the energy market. I simply couldn’t find anyone I liked at the moment. I also realize that hinders some of the Buy List’s diversification. You may also notice that there are a lot of healthcare stocks on the Buy List. Again, that’s not a sector call on my part. It just so happens that a lot of my favorite stocks are in healthcare at the moment. Still, I don’t believe the new Buy List is unduly weighted towards healthcare.

I also know that many investors really don’t like stocks with high nominal prices. I’m sorry, but this is a fear you’ll have to get over. There are lots of great stocks that go for over $200 per share. You can always buy fewer shares.

Now let’s look at our five new stocks.

Alliance Data Systems (ADS). These are the guys behind the rewards programs for many different companies. It’s one of the businesses you would never think is as profitable as it is. ADS has grown its EPS very steadily for the last several years: $5.16, $5.86, $7.63, $8.71, $10.01 and $12.56. The company expects $15 for 2015, and $17 for next year. I think they can top both of those. Again, don’t let the high share price scare you.

After I got done making fun of biotech, here I am adding Biogen (BIIB). But I like it. Like a lot of biotech stocks, Biogen has gotten slammed this year. In March, it crossed $480 per share. Now it’s around $300. There are about 400 publicly traded biotech stocks. Only about 10% are profitable in any meaningful sense. Biogen is one, and it’s a good one. The recent numbers have been quite good. The company also took a painful but necessary step in cutting its workforce. Biogen also has one of the highest profit margins you’ll see, about 34%. Only the mafia and the government get higher than that.

Cerner (CERN) is a healthcare IT company. What Fiserv is to finance, Cerner is to healthcare. This is another stock that’s been chopped down this year. CERN was over $75 in April and now it’s near $60. Last month, the company gave a weak outlook for 2016. They see earnings ranging between $2.30 and $2.40 per share. Wall Street had been expecting $2.53 per share. Still, that’s a nice increase over the $2.07 they should earn for 2015, and the $1.65 they made last year. Cerner is a solid company.

HEICO (HEI) is exactly the kind of company I love to find. HEICO is a defense and aerospace contractor. They’re not well known. They’re kind of boring. And they’re very profitable. In fact, the stock was just upgraded by Bank of America Merrill Lynch. Please note that I’m recommending HEI, the common shares. There are A shares which have slightly different voting rights. Of the five new stocks, HEICO is the only one that pays a dividend, but it’s pretty small (0.30%).

Stericycle (SRCL) is a medical-waste-management company whose stock got clobbered last earnings season. SRCL plunged from around $150 to $120 per share, which is about where it is today. The company missed earnings by 10 cents per share. I’m not sure why a profit miss is valued with a P/E Ratio of 300, but in this case, it was. Some of the earnings miss was due to the dollar, and some was due to a business slowdown. Stericycle said that should pass. I like that this business has high fixed costs. Also, almost all of their revenue comes from long-term contracts. Stericycle is poised for a good year.

The Six Deletions

We’re deleting six stocks this year. I often asked about why a stock may go off the list. The most common reason is that the company somehow changes into something different from the firm we added.

This year, for example, Ball Corp. is different from the company we added. They’re in the process of merging with Rexam. I wish them well, but the fact is, that’s a major merger, and it’s not the same old Ball that we knew.

Another good example is eBay. The stock was flat for us last year, but I was eager to keep it for 2015. I know the PayPal spinoff would lift the shares. I thought the combined entities would return 20% for us in 2015. It turns out I was a little too optimistic. The combined investment has made about 15% for us, which is still quite good. I’m not a big fan of eBay as a stand-alone company. I suspect that PayPal will be bought out by somebody within the next three years, perhaps sooner.

Qualcomm and Oracle were easier decisions. The companies have performed very poorly this year. Just about everything that could go wrong with Qualcomm, did. In many ways, I felt my decision to add QCOM was justified. It was financially strong, with high cash flow and solid dividends. But that’s not enough. The company is under attack from all sides. They need to break themselves up but management is against the idea.

I feel more optimistic for Oracle. The company indicated that things should get better from here, but I’m tired of waiting for the promised turnaround. These things take time. With a company like Ford, I’m much more willing to wait.

Moog was a hard decision. I like the company a lot, but this was a very challenging year for them. They lowered guidance three times this year. That really stung. For its part, Moog is optimistic for 2016. I hope things improve over there, since this is a sound company.

Buy List Updates

After the closing bell on Tuesday, Bed Bath & Beyond (BBBY) issued a press release that said that fiscal Q3, which ended in November, will come in below its previous guidance. The official earnings report doesn’t come out until January 7, but they wanted to give us a heads up.

Bed Bath now expects Q3 revenues to rise to $3.0 billion. That’s an increase of just 0.3%. They had previously expected sales to rise between 1.8% and 4.0%. They also expect same-store sales to fall by 0.4%. The previous guidance was for an increase between 1% and 3%.

Now for earnings. BBBY sees Q3 earnings ranging between $1.07 and $1.10 per share. The previous range was $1.14 to $1.21 per share. Note that a miss on the top line is inevitably a larger percentage miss on the bottom line.

This isn’t good news. The stock dropped 4.6% on Wednesday and reached a new 52-week low. However, I’m more concerned about a slowdown during their crucial fiscal Q4 (December, January, February). This news suggests that Q4 won’t be good, but we can’t confirm by how much. Bed Bath & Beyond gave us a small hint when they said they expect same-store sales to rise by 1% from the beginning of December through Christmas.

Bed Bath & Beyond reached the final round in my debate regarding stocks to vote off the island. Ultimately, I thought the price was low enough to keep them around for another year. While this week’s news is unpleasant, it doesn’t alter my outlook. I’m lowering my Buy Below on BBBY to $53 per share.

This week, Express Scripts (ESRX) said it sees earnings next year ranging between $6.08 and $6.29 per share. Wall Street had been expecting $6.04 per share. That’s a nice increase.

“Our focused model of alignment has positioned us uniquely in the healthcare-services landscape to improve health outcomes and lower costs for our clients and patients,” said George Paz, CEO and chairman of Express Scripts. “No one matches our focus on serving clients and patients, and we remain confident in our continued growth and returning exceptional results to our shareholders.”

“The fundamentals of our business allow us to deliver solid financial results while making investments to continue our growth as a leading independent PBM and healthcare provider,” said Tim Wentworth, President. “We have an aligned book of business and a deep set of innovative solutions to help clients and patients. As we create value for our patients and clients, we create value for our shareholders.”

Express also reiterated its guidance for growth in 2015 of 13% to 14%. That’s what they said with the last earnings report, when they also gave a full-year range of $5.51 to $5.55 per share. Unfortunately, Wall Street was not impressed by the higher guidance, but I am. Express Script remains a buy up to $92 per share.

A few other points to mention. Wabtec (WAB) was upgraded by Stifel. Ross Stores (ROST) was upgraded by Cowen. They said ROST’s merchandize is “un-Amazonable.” I like that word.

That’s all for now. The stock market will be closed next Friday for New Years Day. There’s really not much in the way of economic news. Expect most market commentary to focus on 2016. Remarkably, the S&P 500 has only had one down calendar year since 2003. We’re very close this year. 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


Named by CNN/Money as the best buy-and-hold blogger, Eddy Elfenbein is the editor of Crossing Wall Street. His free Buy List has beaten the S&P 500 seven times in the last eight years. This email was sent by Eddy Elfenbein through Crossing Wall Street.

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