This article is part of our series that uses the idea of bracketology and the NCAA Tournament to pick a well-diversified portfolio to beat the market. Click through to the first article in the series, "Using Bracketology and the NCAA Tournament to Pick Stocks," for a description of the analogy and how it can be used to pick winners outside the sports arena.
This article covers industrials and healthcare, giving us another opportunity to load the portfolio with both growth and income. Looking at the healthcare sector as a singular group is a little oversimplified. The difference between the companies engaged in research and development of new drugs and those companies in the more mature parts of the sector is fairly large, and investors may want to separate out the various industries. Within the industrials sector, the most important factor is to which region is the company dependent as a growth driver. Growth in China is much more important for equipment maker Joy Global (JOY) than it is for Emerson Electric (EMR).
We have already covered six other sectors in the previous articles. We looked at energy and consumer discretionary in the second article, while the third article covered basic materials and utilities. The technology and consumer staples sectors were analyzed in the first article.
The idea behind the screening and then selection process is to find stocks with a rational chance of outperforming peers in their sector without having to spend all of your time watching the financial media and sifting through annual reports. After selecting their best picks from each sector, an investor would normally fill out the portfolio with sector funds to provide a general market exposure. This helps the portfolio to track market returns while maintaining the chance to outperform on the individual picks.
As I mentioned in the other articles, my investing style targets long-term holdings with significant return from dividend yield and so the picks tend to skew more conservative. Your own portfolio will differ according to your needs as an investor.
PDL BioPharma (PDLI) easily beat out Celgene (CELG) with an operating margin of 57% and one of the lowest price multiples in the sector. The dividend has been stable at $0.60 per share since March 2011 and should be relatively safe for the next year. While the shares are up almost 15% over the last year, they still have another 15% to go before they bump up against last year's high. The company reported strong fourth-quarter sales on cancer drugs Avastin and Herceptin, which are sold through Swiss drugmaker Roche. Net income jumped 27% to $49.4 million from a year ago as revenue grew 18%.
Johnson & Johnson (JNJ) is looking a little pricey at 15.5 times trailing earnings, but revenue should be stronger this year on the full inclusion of the Synthes acquisition. Expectations for 6% growth in sales and no significant change to margins, despite possible negative foreign exchange pressure, should bring earnings per share just higher than the $5.41 expected and a more reasonable valuation.
The shares have seemed to shrug off news of a large recall of its OneTouch VerioIQ blood glucose meters due to a problem with the meter when it reads glucose levels above 1,024 mg/dL. I have been critical of the company's ability to handle its recurring quality-control issues and decided that the return was not worth the risk in a March article last year. After considerable management efforts to address the problems, I turned bullish in October of last year and pointed to a shift in headline risk. The shares are up 19% since then compared to a 9% increase in the general market.
Despite a strong operating margin of 29%, AstraZeneca (AZN) has one of the cheapest multiples in the industry due to a weak pipeline. To address the pipeline issues, the company is focusing on RNA technology and hoping to make some major discoveries before peers enter the field. AstraZeneca partnered with Moderna Therapeutics, a Massachusetts biotech company, and has inked deals with other research firms in the past year. The dividend yield of 6% is nice, but some might question how they can keep paying out that much cash if R&D increases.
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Shares of Joy Global have come off their January high by almost 14% and are down 19% over the last year. Still, the company sports an operating margin above 97% of its peers and is cheaper on a price/earnings basis than 95% of competitors. The world's second largest maker of mining equipment is hoping on a rebound in coal demand from China to boost demand for its machinery this year. While the demand for coal may be turning, it could still be a couple of quarters before companies increase their capital expenditures and Joy Global is able to show a significant upside in revenue.
Emerson Electric was a fairly clear winner over smaller rival Eaton (ETN) with a stronger operating margin and a comparable price multiple. The dividend yield of 2.9% is attractive and has been increased by a compound annual rate of 7.6% over the last decade. CEO David Farr recently gave an interview to CNN where he offered his view on the renaissance in U.S. manufacturing and how the company is positioning for growth in data centers.
Shares of General Dynamics (GD) took a hit after the presidential election implied cuts to defense spending before rebounding, only to fall again in late January. The company warned of a large-scale layoff in Florida and California as the automatic budget cuts could lead to weakness in demand from U.S. Navy. Despite the near-term struggles, the stock has returned a compound annual rate of 11.8% over the last 10 years with 9.6% of that from income and a 2-for-1 split in 2006. The company may be a strong bet for a contrarian looking past the defense cuts, but I still like Joy Global for the long term.
The next article in this series will wrap up with a bracket for the financials and a review on the entire portfolio. Please feel free to forward any questions about the above brackets or any in the series, or just use the comment section below.