Drilling Into Last Year's Picks

 | Jan 07, 2014 | 3:00 PM EST
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We've got another year in the record books, and most long-only U.S. equity investors should be pretty happy. The average stock in the S&P 500 rose more than 32% for the year, so clearly the rising tide lifted most boats: Almost any recommendation to buy was buoyed by this robust market. Conversely, nearly any admonition to take a profit, or to sell, turned out to be a mistake.

So -- with the caveat that, in hindsight, it was far easier than usual to look good last year -- we review our 2013 performance. Overall our recommendations worked very well, as they generated strong absolute returns and, on average, better returns vs. the broad market. We've evaluated some of these winners below and, in most cases, we still like them and feel there is additional upside potential. We expect, in the upcoming weeks and months, to discuss taking profits in some of our picks.

We've also gone through some of our mistakes, which have generally fallen into two categories. First, many of these were stocks that gained ground, but not as much as the market did. Second, a number of our picks moved up nicely, but then they continued moving up after we recommended taking a profit. For that second category, if you bought on our initial recommendation and were fortunate not to sell, the shares are now overvalued in most cases -- so we'd suggest cashing out at the current juncture.

First, the Hits

Let's start by taking a look at some of our better recommendations.            

Morgan Stanley (MS) -- CEO James Gorman demonstrated the value of a more stable business mix. The bank's increased emphasis on wealth management, and its pared-back asset base in the institutional-securities business, has reduced risk and improved overall predictability for the enterprise. This, along with a very strong brokerage sector, led to the stock's strong 50%-plus gain for the year. We think there is more to come, and we believe the stock can trade into the high $30s.

Charles Schwab (SCHW) -- While the firm's earnings have not yet shown a dramatic recovery, the stock benefitted from the perception that U.S. Treasury interest rates have bottomed, and that this presaged a recovery in fee revenue from its customers' money-market holdings. That market mindset led to the shares' 65%-plus returns last year.

It's important to note that Schwab has used this post-crisis period to build its relationships with independent financial advisors, which in turn has enhanced the company's long-term business prospects. We believe Schwab has more than $2 per share in earnings power in a normal-interest­-rate environment, and we look for the stock to trade higher in 2014. Nonetheless, its dramatic 2013 move has put the price a lot closer to its fair value, and we have scaled back our position into its recent strength.

Schlumberger (SLB) -- This best-in-class oil-services company demonstrated, once again, that the firm's success in the most technically challenging and financially rewarding projects will generate superior returns for shareholders. The stock has put in a solid performance from the time of our recommendation, both on an absolute and a relative basis. Given its current levels, and with international oil prices above $100 per barrel, we expect the stock to be a winner again in 2014.

Thermo Fisher Scientific (TMO) -- This company's strong operating performance continued in 2013, helped by prescient positioning in growth areas of its businesses. In 2014, as Thermo's merger closes with Life Technologies, the combined entity should demonstrate the strong benefits promised in this transformative deal. While we don't expect the shares to repeat last year's more-than-65% gain, we do think the stock should continue to rise in 2014. As a result, we have lifted our target to between $120 and $125.

Qualcomm (QCOM) -- This stock has shown solid relative returns since the point when we recommended it in the back half of the year, but its performance lagged the market for the full year. Qualcomm's business continues to benefit from the ongoing mobile revolution, as the company commands a critical portfolio of patents, as well as know-how. The firm's enhanced focus on shareholder returns, combined with solid business trends, should help drive the stock higher in 2014.

Now, the Misses

As mentioned above, our 2013 misses fall into two camps -- and we'll start with the underperformers. These stocks were either were on the wrong side of a market rotation, or they just weren't given a lot of credit by the market for showing better business trends. In either case, they put in poor relative performance. It's important to note that these were flat or profitable investments; their performance just wasn't as good as that of the broad market.

Coca-Cola (KO) -- As with many companies in the consumer staples sector, Coca-Cola lagged as investors shifted to companies with more exposure to an improving business cycle. The strength of this company's global franchise and its profitability is unquestioned, even as sodas have been under pressure from more healthful alternatives. Coca-Cola is still a prodigious producer of free cash flow, and shares are attractively valued vs. historical metrics. We like this stock for 2014, and we believe it will provide solid gains in the upcoming year.

Devon Energy (DVN) -- This stock has suffered in the past few years due to its exposure to natural gas production. Recently, however, management has been aggressively repositioning its business to improve its stock price. Devon is selling conventional gas assets, creating a master limited partnership out of its gas-processing and pipeline facilities and buying a large unconventional oil asset at an attractive price. We believe the assets are worth well in excess of the current depressed stock price, and we expect the company to have its day in the sun in 2014.

McDonald's (MCD) -- As with Coke, McDonald's suffered in an out-of-favor sector last year. However, the fast-food chain also stubbed its toe on an operational level: Comparable-store sales disappointed for most of the year, even as new menu items were introduced with mixed results. Current share valuation is undemanding, and the stock also carries a 3.3% dividend yield. McDonald's isn't likely to be a home run in the coming year, but the stock should produce a total return above broad-market levels, and it stands to provide income and stability along the way.

The second category of misses comprises the picks that continued moving higher after we subsequently suggested taking a profit in them. So, while the initial recommendations were profitable, in hindsight we left too much cash on the table with these.

Vodafone (VOD) -- After we made good money in this name, we suggested you take a profit in the stock during the Verizon (VZ) takeover speculation. Our concerns lay in the harsh regulatory environment in Europe, coupled with what we thought was likely a full implied price for the wireless business.

Verizon did come in with a full price offer, but it turned out that the stub wireline phone business carried a much greater imputed value than what we could justify within the difficult industry structure. While AT&T (T) has expressed an interest in acquiring the remaining Vodafone businesses after the wireless sale to Verizon, we still believe the stock is fully priced at the current level.

Harris (HRS) -- While we like the company's management and competitive positioning, we thought the government sequester in early 2013 would limit defense spending and, thus, the upside of this stock. But the business hung in much better than expected, and Harris' fundamentals continued to improve, driving the stock price beyond our conservative target. At some point the government cutbacks will slow the defense sector's earnings, and we expect Harris to eventually be hurt by this trend. In view of this, we would use the stock's end-of-year strength to take a profit.

In investing, as in life, there will always be ups and downs. The key is to enjoy the benefits of the positives, and to minimize the impact of the negatives. We have met that mandate in the past year.

A belated Happy New Year to all, and may 2014 be a year of more plusses than minuses.

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