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Microsoft, buyout firm show value, momentum

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Tuesday, Aug. 27, 2013, 12:01 a.m.
 

When I'm considering buying a stock, I don't pay much attention to whether it has been rising or falling. I just care whether it is a good value at the current price.

I'm aware, though, that many investors want stocks that are moving up smartly. Therefore, twice a year, I offer some “value plus momentum” stock recommendations.

Today's set of recommendations is the 23rd in a series that began in 2000. Twelve-month returns can be calculated for 21 of those sets.

Fourteen of those 21 sets have beaten the Standard & Poor's 500 Index. Seventeen have been profitable. The average one-year return is 19.4 percent, compared with 6.3 percent for the index. All figures include reinvested dividends.

My selections from one year ago did quite well. The returns were 62 percent for TRW Automotive Holdings Corp. (TRW), 56 percent for Western Digital Corp. (WDC), 28 percent for Mentor Graphics Corp. (MENT) and 15 percent for Darling International Inc. (DAR). The average return was 40 percent. By comparison, the S&P 500 returned a little more than 19 percent.

Keep in mind that past performance doesn't predict results. The results of my column recommendations are theoretical and contain no provision for trading costs or taxes. And the performance of my column picks should never be confused with the results I achieve for clients whose portfolios I manage.

This year through Aug. 23, the S&P 500 was up about 17 percent, including reinvested dividends. To be considered for today's “value plus momentum” list, a stock must have done even better than that, with at least a 25 percent gain year-to-date. It must sell for no more than 15 times earnings and have debt less than stockholders' equity.

About 4 percent of stocks meet those criteria. Here are four that I recommend.

The largest qualifying stock is Microsoft Corp. (MSFT), the monarch of Outlook, Excel, Explorer and Word. Its earnings growth rate for the past five years has been about zero, but analysts look for profits to grow about 29 percent this year, 7 percent next year and 10 percent the year after that.

What stands out about Microsoft is its profitability. It earned 30 percent on stockholders' equity last year and had a pretax profit margin of nearly 35 percent. The stock is up 30 percent this year but still sells for a reasonable multiple, 13 times earnings.

Last week, Steve Balmer announced that he will step down as CEO, and Microsoft shares rose on the news. I'm confident that an able successor can be found. The big question is whether Microsoft can thrive when the market for personal computers is shrinking and the market for mobile devices is expanding. I think it is a decent bet.

Smaller and more speculative is Capital Southwest Corp. (CSWC), a venture capital firm in Dallas. It was slammed for big losses during the financial crisis but seems to have regained its stride. Last fiscal year, it earned $7.00 a share. That was the company's second-best showing in the past decade, behind the $10.73 a share profit it notched in fiscal 2007.

Investors are scared of the stock, so it sells for only four times earnings. But I think it is a solid company. It has been public since 1961 and has provided financing to more than 240 businesses.

I also like KKR & Co. LP (KKR), a leveraged buyout firm. Most famous for the RJR Nabisco buyout of 1988, which was memorialized in the book “Barbarians at the Gate,” KKR has done about 160 deals in its history, many of them huge. It has a reputation for boldness and skill in crafting private equity transactions.

KKR has been public for three years and reported a profit each year. Its best year so far as a public company was 2012, and analysts think 2013 results will be a whisker better. Of particular interest is the 8 percent dividend yield.

Finally, I again pick Western Digital, part of the four-company oligopoly that controls the world market for computer disk drives. Yes, it was up 56 percent in the past 12 months, but it still sells for nine times earnings and one times sales, a down-to-earth multiple.

Skeptics say that hard drives are obsolete, or soon will be. I disagree; I think they will be around for years to come. The company is expected to post record earnings this fiscal year. And if the next big thing proves to be solid-state drives, Western Digital has a toehold there, too.

I own Western Digital personally and for almost all my clients. I own Microsoft for several clients and KKR for one client.

John Dorfman is chairman of Thunderstorm Capital LLC in Boston. He can be reached at jdorfman@thunderstormcapital.com or 617-542-8806.

 

 
 


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