Stock-Pickers Should Buy the Dips

 | Apr 19, 2013 | 10:00 AM EDT
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As many expected, there has been more volatility in the stock market in April than we saw in the first quarter. Owing in part to the horrific bombing in Boston, the beginning of earnings season and the meltdown in gold, this volatility has increased markedly this week.

However, even with the greater swings, there remains a more grounded, less fearful stock market environment than we saw in 2011 and much of 2012. We have not heard negative broad strokes about the direction of the U.S. economy. Nor has there been rising concern about the ability of the Europeans to keep a lid on the euro zone.

We share in this underlying confidence about the direction of the U.S. economy. After a lengthy shakeout of excess inventory and widespread foreclosures, housing is starting to play its classic role as the primary driver of the economy out of recession and into sustained economic recovery. Guidance, as well as earnings from bellwether companies, continues to be favorable. Interest rates and inflation remain low, aided by weakening prices for oil and other commodities.

This relatively benign macro picture should allow for the maintaining of a fundamental-oriented, individual-stock-focused market as the year unfolds.

But in contrast to more recent fear-based markets, dips should be viewed as buying opportunities rather than as reasons to cut and run from the market. Strong businesses continue to be fairly and in some cases compellingly priced.

So while buying on dips might not look brilliant after a few weeks, over the ensuing six to 12 months, it is likely to look quite astute. Here are a few strong businesses that we like that we would be adding to into their recent weakness.

JPMorgan (JPM) reported another record-beating quarter with $1.59 per share in earnings. Adjusting for reserve releases, JPMorgan still beat with EPS of $1.41 compared with the $1.39 consensus estimate, thanks to stronger trading revenue in the corporate and investment bank. All of the major divisions at the bank reported solid and improving results, solidifying JPMorgan's position as one of the pre-eminent banks after the financial crisis. JPMorgan has beaten analyst consensus estimates in 19 of the last 20 quarters. Since the loan, investment and interest rate cycle has yet to pick up, we believe that there are still more gains to come, and we look for meaningful multiple and price-to-book value expansion on top of the earnings growth.

Wells Fargo (WFC) was another major bank that reported better-than-expected earnings, with $0.92 per share. Better loan growth, strong cost controls and continued moderating credit expenses helped produce the upside results. This is the eighth quarter in a row in which Wells Fargo has reported record earnings. The company still has many opportunities to redeploy low-earning cash balances and to improve costs because of a still-high 58.3% efficiency ratio. As with JPMorgan, the banking cycle has yet to pick up for Wells Fargo, so more good results should be in store.

Charles Schwab (SCHW) reported slightly weaker earnings results of $0.15 per share, compared with the consensus of $0.16. Revenue was in line, but expenses overshot on higher compensation payments. The company expects this to moderate for the balance of the year, and its guidance for earnings per share for the year was at or slightly above the pre-earnings release consensus. While the firm reported another record quarter of client inflows totaling $43 billion, net interest margin and retail trading activities continue to weigh on Schwab's results. Overall, Schwab continues to show some of the best asset-gathering metrics in the financial services industry. The true earnings power of the franchise will ultimately shine in a more normal interest rate and equity market environment. Many analysts believe that Schwab is in a hibernation period and that earnings could easily double to $1.70 to $2 a share in more normalized times.

Emerson Electric (EMR), TE Connectivity (TEL) and Schlumberger (SLB), have not yet reported, but they should have in-line earnings and solid outlooks.

Emerson has been reporting modestly improving monthly order rates during the current quarter, on the basis of continued demand for process controls and automation equipment from emerging-market economies. Management continues to enhance its competitive position with select acquisitions and divestitures. A notable move will be the upcoming divestiture of part of its power management business, which has been a drag on results.

TE Connectivity should report an adequate quarter on rebounding North American automotive production. Some investors worry that the company's numbers could be mixed because of its large European automotive operations. However, the outlook in the upcoming year should continue to be positive, thanks to rising global auto production and enterprise connectivity solutions.

Schlumberger spoke at a mid-March investment conference and lowered guidance compared with the consensus for the quarter. We are confident that its results will come in line with that discussion, and we expect an upbeat outlook. Schlumberger should have better than group earnings and revenue growth for the balance of the year, driven by its strong offshore operations (an area of the market that is experiencing a strong up cycle) and less-than-peer-group North American land drilling presence (an area that is struggling of late).

We like all of the names discussed above, and we believe that current prices represent compelling entry points.

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