It's a Good Time to Buy All-Weather Laggards

 | Feb 15, 2013 | 11:00 AM EST
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Even after the strong start to the year, we remain bullish in our stock market outlook for the balance of the 2013. The economy is recovering and corporate earnings continue to be solid. Nevertheless, after the very sharp recent gains, we expect stocks to slow down for a bit.

Rather than chase the recent winners, we suggest searching the market for those stocks that have good 2013 prospects but have lagged during the recent rally.

Readers might recall that we have touted a barbell approach of value-oriented higher growth potential holdings on the one hand, and all-weather, dividend-oriented large blue chips on the other. The year has started strongly for the first group and less so for the second.

Therefore, in the nearer-term, we would focus on that all-weather group that offers high current income and a lower beta. This will give some added balance to the barbell while also providing some stability in the event of a market pull-back.

Two all-weather stocks we have talked about in the past that we think are timely now are Consolidated Edison (ED) and Merck (MRK). While we do not expect either to provide outsized investment returns, we do think both should trade higher as the year progresses; and each also offers a healthy dividend income along the way.

Consolidated Edison ($56.36) is one of the largest regulated utilities, with a long history of operating and financial consistency. Essentially 100% of its earnings come from owning highly regulated electrical utility generating plants and transmission systems.  The earnings, cash flows and dividend consistency from these operations are higher than the utility averages.  

During the recent quarter, ED reported weaker than expected earnings of 69 cents per share versus 73 cents consensus due to one-time Hurricane Sandy costs. Management guided to flat earnings for 2013 due to continued storm related expenses. However, management expects the business to return to normal in 2014. At that point, the company will be comfortable with asking regulators for rate relief due to the storm. 

ED's shares are flat over the past year and have not participated in the recent market rally.  Nevertheless, ED should be a key holding for any investor looking for balance, dividends and low volatility in a portfolio. The stock currently has an above average 4.3% dividend yield and a strong A+ investment grade credit rating. Investors expect 2% to 4% earnings and dividend growth per year. The company has a long history of raising its dividend, and it should also provide some modest capital appreciation potential as the current 14.6x price-to-earnings ratio is in-line with its long-term average.      

Merck ($41.19) is a leading global pharmaceutical company. The firm has a long history of consistent revenue, earnings and dividend growth. Merck reported fourth quarter earnings in line with estimates of 83 cents per share. Earnings will be down in 2013 due to the recent loss of patent protection on Singulair, one of its top drugs, as well as the negative impact on the devaluation of the Venezuelan bolivar. 

The stock has been weak over the past quarter due to these earnings and product concerns.

Nevertheless, Merck should continue to be able to generate strong earnings and dividends going forward.  The stock currently has an above average 4.2% dividend yield and a strong A++ investment grade credit rating. Earnings and dividends should grow 2% to 3% per year in the upcoming decade. The firm has a long history of raising the dividend. The stock should also provide better than average capital appreciation potential since the current 10.7 P/E trails both the company's and the industry's long-term averages of a 12x to 14x. One additional beneficial wild card could be a possible restructuring of MRK's business portfolio to unlock shareholder value, as was done by Pfizer (PFE), Bristol Myers (BMY) and Abbott Labs (ABT).

There are always opportunities to pursue in all market environments. For value-oriented types like us, it gets harder after the market has had a good run. Nevertheless both ED and MRK offer top-drawer quality, consistency and a good point of entry right now. 

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volatility is quite low here, and we could see some downsides here in the short term. ...



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