With high unemployment>, fears of Fed tightening and worries about Europe's sovereign debt casting a pall over the market a year ago, I went shopping for stocks. As I said then, I didn't want to be distracted by interesting but extraneous issues of global finance, focusing instead on the bread and butter of stock investing: revenue and earnings.
I'm glad I did. Stocks have rallied since then, with the Standard & Poor's 500-stock index up 25% through Thursday. The five stocks I recommended last year (and bought myself) were Amazon.com (AMZN), United Therapeutics (UTHR), Under Armour (UA), Salesforce.com (CRM) and Chipotle Mexican Grill (CMG) . This may be the best portfolio I've ever picked: As a group, they have more than doubled, gaining a collective 111%.
Today investors are still fretting about high unemployment, the prospect of higher interest rates and Europe's debt crisis. So I figured it was a good time to revisit my methodology, both to reassess last year's picks and come up with some new recommendations. Last year's group has done so well that it makes me nervous: that kind of outperformance is hard to sustain.
I again focused on the basics: revenue and earnings. Earnings are important, but as has been evident from recent earnings news, companies have proved very adept at cutting costs and squeezing more productivity out of their work force. That's great, but it can only go so far. Equally if not more important to me is a combination of earnings and sales growth. So I screened for stocks with 50% or more year-over-year earnings growth (excluding special items that often distort earnings patterns).
Last year, on the heels of the recession, I settled for relatively modest 10% revenue growth, but this year I raised the bar, seeking stocks with 30% or more year-over-year revenue increases. And I excluded microcap stocks, setting $1 billion as the minimum market capitalization.
This exercise yielded 77 finalists. To winnow the list, I took into consideration this year's very different market environment. With stocks having gained so much, the market has gone from undervalued to arguably overvalued and due for a correction. So I looked for value stocks by weeding out companies with forward price/earnings ratios that seemed too high compared to the market's average forward P/E of 14.
Of course, "value" is a relative term when considering companies with such strong growth trajectories. With that caveat in mind, I selected five companies that I find particularly appealing right now.
I plan to buy or add to my positions in all five, as I did last year. We're not at a Common Sense buying threshold, which would be 10% below the most recent high on the Nasdaq, or 2548. (The Nasdaq hit a new high of 2831 on Thursday.) Until then, I plan to buy some shares with proceeds from other sales, but since I never buy when the market is hitting a new 52-week high, I may well wait for at least a modest correction. But in this environment, expectations can be dangerously high. Fossil (FOSL), the fashion watch manufacturer, made my list of finalists, but when it released earnings this week which strongly beat analysts' projections its stock nonetheless dropped 7%. Another finalist, Network Appliance (NTAP), reported strong earnings and revenue gains of 60% and 25%, respectively, on Thursday. Its shares promptly dropped over 6%.
Here are this year's winners:
This was the only one of last year's winners to again make my list of finalists. Paradoxically, United Therapeutics (UTHR) was also the worst-performing of last year's winners, gaining a relatively modest 18%. Why Wall Street has largely shunned a biotechnology company focusing on patients with chronic and life-threatening illnesses, such as heart disease, is a mystery to me, but it represents an opportunity for investors. The company announced fourth-quarter and full-year results this week, reporting a surge in both earnings and revenue. So what if the quarterly results were slightly below some estimates? For a company with this kind of growth earnings soared 443% and sales increased 63% over the past year the forward price/earnings ratio is a modest 23, and the price/growth ratio a mere 0.30.
Ascena Retail Group
Ascena Retail Group (ASNA) made the list of finalists last year under its old name, Dress Barn. But I cut the company after interviewing some fashion-conscious women who dismissed the Dress Barn look while conceding they'd never been to a store. Dress Barn may not be a Prada or Versace, but I'm not going to get into women's fashion, a subject on which I'm far from expert. Ascena's results speak for themselves, so it must be doing something right. (Besides Dress Barn, it operates Maurices and Justice stores.) I like the idea that it's not pegged to any one look or to fickle teenage taste. Its forward P/E is a mere 14, and women's apparel sales should continue to benefit from rising consumer confidence.
Cliffs Natural Resources
If the commodities boom has legs (I think it does), then Cliffs Natural Resources (CLF) seems compelling. Like Dress Barn, it recently changed its name (from Cleveland Cliffs). It's not as large or well known as Brazil's Vale, or as diversified as a BHP Billiton (BHP) or Rio Tinto (RIO), but like its larger rivals it produces iron ore and metallurgical coal with operations in the U.S., Canada, Australia and Brazil. Cliffs blew away estimates when it reported earnings this week; earnings more than tripled on a 74% leap in revenues. Shares jumped 7% on the latest earnings surprise, but still trade at a forward P/E of just 9.
Caterpillar (CAT), the sprawling construction and mining equipment maker, is in nearly every booming sector: mining, agriculture, construction, emerging markets. No wonder its numbers are stellar: earnings more than tripled on a 62% surge in revenues. Yet the stock trades at a modest forward P/E of 17 and a price/sales ratio of just 1.55. If these trends continue, as I believe they will, Caterpillar shares should continue to gain, even though this kind of rapid growth in a company this big (its market capitalization is nearly $66 billion) can't be sustained indefinitely. (I already own Caterpillar shares and have previously recommended them.)
Capital One Financial
Only one bank made my list of finalists: Capital One Financial (COF) . As one of the country's largest consumer lenders, its results are highly leveraged to the financial health of consumers, especially their ability to make home, car and credit card payments. Capital One should continue to be a strong beneficiary of an improving economy, higher employment, and steadying home prices, assuming those rosy trends continue. Its shares also come with value pricing: a forward P/E of about 10 (and a trailing P/E of under 9).