In Part 1 of this article, we focused on three stocks that have good potential to appreciate in an improving economic environment but which also can grow earnings and dividends in more difficult times.
It is not unusual for companies with all-weather business models to underperform more economically sensitive stocks during a bull market. However, they more than earn their keep when the overall market is declining.
The other component of the "barbell" strategy is to also invest in more economically sensitive companies that should have superior appreciation prospects in an improving economy. Let's focus on three of them:
Archer Daniels Midland (ADM), a major agricultural commodities processor, reported better-than-expected results for the quarter of $0.68, compared with a $0.59 estimate. The company had reported disappointing results for the past three quarters, because of the European financial crisis and because of excess supplies of commodities, ethanol in particular.
But ADM is beginning to see a rebound in most of its key markets. Its core soybean and grain units reported better volumes and processing margins on rising global demand and tighter supplies. Investors are also speculating that ADM should benefit from an anticipated rebound in ethanol processing economics as smaller players in the industry reduce capacity.
At the recent price of $33.05, ADM trades for 13.2x projected 2012 EPS of $2.50 and just 10.5x the 2013 estimate of $3.15. We have found that the best valuation metric for ADM is price to book value. On that basis, the company currently sells for 1.1x its price to expected year-end book value, compared with a historic norm of 1.4x.
ADM should be entering a multi-year period of better worldwide demand. Simultaneously, management is aggressively reducing costs and cutting capital spending. The firm's fundamentals and stock price should recover over the next two years.
Dell (DELL), a major provider of computer systems and services, continues to report solid earnings and is expected to earn $2.10 a share in 2012. Management has continued to drive the company toward a greater focus on higher margin and on more recurring enterprise products, software and services. It is doing this primarily via a steady stream of acquisitions of smaller niche players whose products and services Dell can then distribute through its global sales and distribution infrastructure.
Earnings per share for 2012 are expected to be flat with 2011, but analysts expect earnings to trend higher thereafter toward $2.20 to $2.40. At the recent stock price of $15.44, Dell trades for 7.4x 2012's EPS of $2.10. Dell also has $5 a share in net cash, equal to one-third of its market cap, and a 14% free cash flow yield.
The company should ultimately see a strong price recovery, as a shift to higher-margin products will boost its fundamentals. That improvement should in turn shine a light on the absolutely low valuation level, also providing an impetus for a higher stock price over time.
Staples (SPLS) is the leading independent office supply company in North America. It also has significant operations in Europe, Asia and South America, which together account for 20% of 2011 sales. In addition, Staples is the second-largest Internet retailer behind Amazon.com.
In a difficult economic environment, Staples grew operating income last year in its two North American operations; however, disappointing results in its international operations pulled down overall results. Several factors, including improving employment trends in the U.S., tightened cost controls and a projected gradual improvement in international results, could meaningfully enhance both its earnings and its stock price.
At a recent price of $15.09, Staples' P/E multiple is at a 10-year relative P/E low. The company has a 12% free cash flow yield and a dividend yield of 2.9%.