The Year in Review
Looking Ahead
5 Stocks for 2012
---
Much like a roller coasters, the stock market produced plenty of action in 2011. And though I really like adventure rides, the recent action in stocks has brought a few too many sharp drops and loop de loops. The stock market, just like roller coasters, ended the year right where it started.
What about 2012? Well ... we know that politics in Europe and the U.S. will continue to be front and center for a while. But unknown events will also come into play--some good, some not so good. And I think we can expect the U.S. economy to continue to struggle, while some emerging economies such as Brazil will do well.
My conclusion: the 2012 U.S. stock market will be similar to 2011, with lots of ups and downs. So strap yourselves in and get ready for a great ride. I would be a lot more negative if I let the front page news sway me, but I believe the foundation for stock market values is built on the outlook for sales, earnings and dividends rather than political banter, bickering and grand-standing.
Based upon my quantitative fundamental analysis, the low for the Dow Jones Industrial Average will be 10,720 in 2012, and the high will be 13,180. The Dow will end 2012 at 10,950, in the middle of my forecast range.
A lot could happen in 2012 that would force me to revise my forecast. If the quagmire in Washington and Europe are resolved with some real long-term solutions, the U.S. stock market could rise considerably higher than 13,180. But if big banks start to fail in Europe, the Dow will drop.
What is your prediction for the U.S. stock market in 2012? Send me your forecasts for the Dow Jones Industrial Average for 2012, and I will summarize the results in January.
A year ago, I wrote this somewhat vague forecast: “2010 has been a very good year for value stocks ... 2011 might prove to be a bit more difficult.” This year, my forecast isn’t as vague, and will hopefully be more helpful in planning your investment strategy for 2012.
Which stocks will perform well in 2012?
If the stock market is going to behave (or misbehave) in a manner similar to 2011, then logically the same types of stocks will perform well again in 2012. Maybe I’m over-simplifying, but top-notch companies in leading industries continue to be undervalued and look very attractive.
I scanned my database to find five stocks with the right credentials to perform very well in 2012. Included in my choices is a conservative bond exchange-traded fund (ETF), which will add stability when the stock market takes one of those breathtaking dives when you least expect it. The other four picks are the stocks of U.S. companies with exceptional prospects for 2012. All of my choices pay dividends, and all are selling at bargain prices.
My first recommendation is Abbott Laboratories (ABT). Founded in 1888, Abbott is a solid company with a reasonable stock price and an above-average dividend. The company produces a wide range of prescription pharmaceuticals, infant and adult nutritional supplements, test and diagnostic equipment, and medical devices. Foreign sales account for 57% of total sales.
Abbott has paid dividends in every quarter since 1924 and increased its dividend every year since 1971--an amazing record. The dividend yield is now 3.5%, but will likely receive another healthy boost during the first half of 2012.
Abbott will split into two separate companies before the end of 2012. I believe the two companies will be worth more than the current company, and investors who wait will be justly rewarded!
Abbott is performing quite well with the help of strong sales in emerging markets and with recent acquisitions. Drug stocks, in general, lagged the stock market in 2011, but lately investors are beginning to notice the low price-to-earnings ratios, high yields and steady earnings growth. Sales will increase 6% and earnings will likely increase 9% during the next 12 months. Abbott’s price-to-earnings ratio, based on my 2012 earnings per share estimate, is 11.1, which is quite reasonable. Earnings will continue to increase at a 9% pace in future years. Abbott Labs is very low risk.
Advance Auto Parts (AAP), founded 80 years ago, is the second largest auto parts retailer in the U.S. The company mostly sells parts and automotive accessories to do-it-yourself customers, but Advance is now focusing on commercial customers such as independent garages, service stations and auto dealers. The company’s offerings of brand name and proprietary products include filters, spark plugs, wiper blades, brakes, fuel pumps, batteries, tools and 15,000 other products. Advance operates 3,627 stores in the U.S., Puerto Rico and the Virgin Islands.
After losing market share in 2010, Advance Auto made a noticeable comeback in 2011 by focusing on its commercial, e-commerce and do-it-yourself parts business. I expect sales to increase 11% and EPS to advance 16% in 2012 after increasing 5% and 27% respectively during the last 12 months.
AAP is benefiting from the aging of cars and trucks as owners stretch their years of ownership to avoid buying expensive new vehicles. At 12.4 times our 2012 earnings per share forecast, AAP is a bargain. The prolonged economic slowdown in the U.S. will spark better than expected results at Advance Auto. The company pays a small dividend yielding 0.3%. AAP is low risk.
Caterpillar (CAT), founded in 1925, is the world’s largest manufacturer of earth-moving equipment. In addition, the company makes diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. Caterpillar equipment is used in mining, logging and farming, and in the construction, petroleum and transportation industries.
Caterpillar completed the purchase of Bucyrus International in July 2011 for $8.8 billion. Bucyrus makes monstrous trucks, excavators, shovels, drills and underground mining equipment used in the mining of coal, iron ore, copper and gold. Bucyrus generates 30% of its sales in North America and 70% in other parts of the world. Sales in 2010 totaled $3.7 billion for Bucyrus compared to $42.6 billion for Caterpillar.
Sluggish economic growth in the U.S. and overseas is not affecting CAT’s business because many countries are catching up on infrastructure construction projects, which require new equipment from Caterpillar and other heavy equipment makers.
The rapid development of infrastructure in emerging countries such as Brazil, China and India provides a bright outlook for CAT for an extended period of time. In addition, roads, highways and bridges in the U.S. and other developed countries are in dire need of refurbishing and improvement. Finally, demand for Caterpillar and Bucyrus equipment will strengthen as a result of the need to replace aging construction and mining equipment.
I expect sales to increase 13% and earnings to increase 22% in 2012, buoyed by infrastructure spending and CAT’s recent purchase of Bucyrus. The dividend was recently increased for the 18th straight year and now provides a 2.1% yield. At 11.0 times my 2012 earnings per share estimate, Caterpillar is clearly undervalued. CAT is low risk.
FedEx (FDX) provides worldwide on-time air express delivery for packages and freight in 220 countries, and door-to-door delivery of small packages in North America. The company also operates 1,200 copy centers (formerly Kinkos), which offer various business services.
Holiday shipments for December 2011 likely increased a hefty 12%, boosted by customers’ switching to online shopping. Fedex’s freight rates were increased 6.7% in September 2011. Express rates will be increased 5.9% in January 2012.
The U.S. Postal Service (USPS), FedEx’s competitor, will cut costs and services beginning in 2012 to balance its budget. USPS estimates most deliveries will take two to three days within the U.S., rather than the current one to two day delivery. Customers will likely rely more heavily on FedEx and UPS to handle important deliveries.
FedEx will spend $2 billion on new aircraft to fly to additional destinations.
The expanded international operations will drive revenues and earnings growth in 2012 and beyond. Revenues will likely increase by 9% and EPS by 20% in 2012. The company pays a small dividend yielding 0.6% that could be increased soon. FDX is low risk.
iShares iBoxx $ Investment Grade Corp. Bond ETF (LQD) is an exchange-traded fund that trades on the New York Stock Exchange just like common stocks. LQD seeks investment results that correspond generally to the price and yield performance of a segment of the U.S. investment-grade corporate bond market as defined by the iBoxx $ Liquid Investment-Grade index. The fund typically invests at least 90% of assets in the bonds of the underlying index, and at least 95% of assets in investment grade corporate bonds.
LQD shares declined sharply in November during the European debt crisis, which has created an excellent buying opportunity for value investors. Investment grade bonds are backed by well-diversified U.S. corporations with strong balance sheets and record amounts of cash. I believe LQD is undervalued and will move noticeably higher during the next several quarters and provide investors with steady total returns. The expense fee of 0.15% is very low, and the dividend yield of 4.4% is attractive.
I will continue to follow Abbott, Advance Auto, Caterpillar, FedEx, iShares Corporate Bond ETF and other blue-chip, high-quality investments in my Cabot Benjamin Graham Value Letter. My next issue, coming soon, will focus on undervalued Canadian stocks. I hope you won’t miss it! Get started today.
Finally, I wish all you and your loved ones a healthy, prosperous new year!
Sincerely,
J. Royden Ward
Editor of Cabot Benjamin Graham Value Letter
