The S&P 500 took its worst drubbing in two months to start the trading week Monday. Among the reasons proffered for the sell-off was a delayed reaction to Friday's dismal jobs report, a downgrade of U.S. equities by Goldman Sachs and comments from the Federal Reserve's Jeffery Lacker in support of the central bank's tapering efforts.
It is only two weeks into the new year, but it looks like it will be a much different year for investors than it was in 2013. Last year's approximately 30% gain in equities was driven mainly by multiple expansion as overall earnings only showed gains of around 5% year over year. The market was significantly driven by sectors or stocks that had shining future prospects rather than current earnings, such as the small-cap biotech space and story stocks like Tesla Motors (TSLA).
I believe the market will be more volatile early in the year until investors get confirmation that the economy is indeed accelerating, the taper commences without undue impact to the markets or interest rates, and we get through earnings season without too many mishaps.
That being said, investors should not count on the same kind of multiple expansion, if any, in 2014. Equities are more likely to be driven by earnings growth, which means investors should roll out a new game plan this year. Heavily weighting equities with solid earnings prospects, lower volatility and reasonable valuations seems like a logical play.
Two equities meet these criteria and should outperform the market in 2014.
I continue to believe that Apple (AAPL) is one of the most undervalued large-cap stocks in the market. Although the stock had a roller coaster of a year, the shares ended 2013 pretty much where they started.
This should change in 2014. When Apple reports quarterly earnings later this month, it should deliver the first year-over-year earnings growth in more than a year. Margins should stabilize. In addition, its distribution deal with NTT DoCoMo (DCM) and its 60 million subscribers should deliver revenue growth and market share gains in Japan starting this quarter. Next quarter, the deal with China Mobile (CHL) should be a positive catalyst for growth in the Middle Kingdom.
Apple is just plain cheap at these levels. Even without its more than $140 billion hoard of net cash and marketable securities, the shares sell for 8x forward earnings. This is just about half the overall market multiple. The stock also has a 2.3% yield, is returning $8 billion to $10 billion per quarter to shareholders via dividends and stock repurchases, and revenue should grow in the 7% to 9% range in 2014.
After pulling back some 15% over the past couple of months on falling oil prices, Continental Resources (CLR) is offering an attractive entry point. Continental is the largest leaseholder in the Bakken Shale and it has seen production grow about 45% annually over the past three years. Growth should slow, but the company still should be able to deliver robust 20% annual production increases in the years ahead.
Given those growth prospects, the stock is providing an attractive valuation of around 14.5X forward earnings. The company has a consistent history of beating bottom-line estimates and is priced at 8x operating cash flow. It was just named as one of Barclays' top two picks in the large-cap energy space, and the stocks sells more than 25% below the mean price target held by the 28 analysts that cover the shares.
Neither of these large-cap selections is going to quadruple like Netflix (NFLX) did in 2013; however, they should deliver solid earnings growth, sport attractive valuations and outperform the market in a more challenging 2014 environment.