We recently sat down with Mark Spellman, Portfolio Manager at Value Line Income & Growth (VALIX) and Daniel Dent, Portfolio Manager at DF Dent Premier Growth (DFDPX) to talk about their top buys and outlook for 2013. Their responses are below.
Comments & Outlook
Not surprisingly, Congress' just-in-time budget compromise didn't really address key issues such as debt and entitlements. So we now have a new deadline to worry about - March 1. As a result, the market will probably be more volatile over the next month or so. And we might retest last November's lows, since there's probably about 8 percent downside risk lurking in this market.
However, I am pretty positive about 2013 because the underlying economic statistics are showing gradual improvement. And I believe there's pent-up demand for capital goods and hiring. I think we'll see that unleashed in the second half of the year.
We look for income first, with capital appreciation a close second. We're able to buy stocks, convertibles or bonds, so we look at a company's entire capital structure and invest where we think the best value is.
Right now, I would say stocks are more attractive because bond yields are so low that they're not really pricing in much risk given the tight credit spreads. For instance, Intel Corp's (NASDAQ:INTC) stock currently yields about 4.5 percent, but its newly issued 10-year bonds yield only about 2 percent.
I like Intel, although it's a contrarian play since a lot of analysts seem to think there's not much innovation left there. I think they're getting carried away; the company's financial profile is great. It's selling at less than 10 times earnings and has big net cash on the balance sheet with lots of free cash flow.
Comments & Outlook
We analyze the market's prospects by comparing stocks' "earnings yield" with the yield on 10-year Treasuries relative to historical cycles. The earnings yield is derived by dividing earnings per share by the stock price - basically the inverse of the price-to-earnings ratio (P/E). This yield comparison lets us gauge the potential returns of bonds vs. stocks.
From 2000 through 2010, bonds significantly outperformed stocks. But now Treasuries offer yields well below the stock market's earnings yield. This suggests the old cycle has now run its course, and stocks are poised to deliver superior returns.
We look for companies with outstanding management teams that have high insider ownership and put shareholder interests ahead of personal enrichment.
We favor companies that dominate their particular niche, be it through a novel product or some other type of revolutionary approach, such as a distribution methodology or manufacturing system.
Beyond that, we hope to find companies whose current management team is the one that actually originated the firm's competitive advantage. This increases the likelihood that they'll already be reinventing the business before competitors can catch up to them by replicating their previous success.
Fastenal Co's (NASDAQ:FAST) management team is legendary for both their dedication to shareholders and their frugality. The company started out as an industrial distributor of fasteners via small outlets in strip malls. After rapid expansion, it sustained its high growth by extending its product line to other complementary products and services. Fastenal's latest advance is the installation of automated vending machines at customer sites that dispense the parts most commonly used by each client.
SEI Investments Co (NASDAQ:SEIC) has four divisions that serve the investment industry. The largest one, private banking, is the least profitable. To boost profitability at this division, SEI created a sophisticated software platform that investment managers use to maintain records and manage securities delivery. Though initially off to a slow start, this new system is beginning to gain traction both overseas and in the US, so we expect to see earnings accelerate.