Pasadena, CA,-based PRIMECAP Management Company, established in 1983 by co-founders Howard Schow, Mitchell Milias and Theo Kolokotrones, manages over $60 billion in three PRIMECAP Odyssey Funds, and for a limited number of institutional clients, including the Vanguard Group. Its investment philosophy is value-based and grounded in fundamental research, and with a long-term investment horizon. Although the firm does not have an industry focus, about 60% of its holdings are in the tech and healthcare sectors. By capitalization, a large majority, almost three-quarters are large-caps, and most of the remaining are mid-caps, with small-cap equities accounting for less than 5% of its holdings. For a fund, its size, the portfolio is actually very concentrated with just over 250 positions at the time of its latest Q3 filing.
The following are PRIMECAP's most bullish picks that are also trading at a discount compared to their peers (see table):
Research In Motion Ltd. (RIMM): RIMM is a Canadian manufacturer of Blackberry handheld devices for the mobile communications market. PRIMECAP added $132 million in Q3 to its $346 million prior quarter position in the company. RIMM is also undervalued, trading at less than 4 P/E on a trailing-twelve-month (TTM) basis, and at 0.8 P/B, a steep discount compared to its closes peers. For example, leading PC, mobile devices and portable digital music player innovator Apple Inc. (NASDAQ:AAPL) trades at 10-11 forward P/E and 5.1 P/B, and leading Finnish manufacturer of mobile phones and telecom infrastructure products Nokia Corp. (NYSE:NOK) trades at 15 forward P/E and 1.2 P/B. RIMM is down about 70% in the past year, down after reporting several disappointing quarters as it faces stiff competition from both Apple Inc.'s iPhone and mobile devices based on Google's (NASDAQ:GOOG) Android operating system. However, its shares have recently perked up based on rumors that the company had hired Goldman Sachs (NYSE:GS) to explore strategic options, fueling continued speculation of a buyout at a high premium due to the stock's low valuation.
Microsoft Corp. (NASDAQ:MSFT): MSFT is the world's leading software company. It develops operating systems, business software and other applications for servers, PCs and intelligent devices. MSFT's online efforts include the MSN network of Internet products and services and alliances with companies involved with broadband access and various forms of digital interactivity. PRIMECAP added $135 million in Q3 to its $1.41 billion prior quarter position in the company. MSFT is undervalued, trading at a steep discount at 9-10 forward P/E and 4.0 P/B compared to averages of 35.4 and 4.4 for its peers in the computer software group, while earnings are projected to rise at a modest 6.0% annual rate from $2.69 in 2011 to $3.02 in 2013. The stock has basically flat-lined in a narrow range between the mid-$20s and mid-$30s for most of the last 10 years since the 2000 crash, and continues to trade in that range.
Qualcomm Inc. (NASDAQ:QCOM): QCOM is a designer of CDMA-based, RF and power management ICs for system software used in wireless handsets, modem cards and networks. PRIMECAP added $97 million in Q3 to its $831 million prior quarter position. QCOM is trading within striking distance of 10-year highs, approaching levels it last saw just after the 2000-02 market crash. Its shares trade at a discount 14-15 forward P/E and 3.5 P/B compared to averages of 39.0 and 3.3 for its peers in the wireless equipment group, while earnings are projected to grow at a respectable 11.7% annual rate from $3.20 in 2011 to $3.99 in 2013.
Amgen Inc. (NASDAQ:AMGN): AMGN develops therapeutics based on cellular and molecular biology to treat anemia, cancer and inflammatory diseases. At $3.39 billion, including $34 million added in Q3, this is PRIMECAP's largest position in the portfolio. The stock has mounted a huge rally recently, and is at almost five-year highs. It trades at a discount 11-12 forward P/E and 2.5 P/B compared to averages of 22.4 and 11.3 for its peers in the biotech group, while earnings are projected to increase at a modest 6.2% annual rate from $5.21 in 2011 to $5.87 in 2013.
The following are positions in its portfolio that PRIMECAP is most bearish about (see table):
Monsanto Co (NYSE:MON): MON is a manufacturer of corn and other crop seeds and crop protection products for growers worldwide. At $542 million, this was PRIMECAP's largest sell in Q3, reducing the position to $1.20 billion. MON trades at 19-20 forward P/E and 3.9 P/B compared to averages of 10.1 and 1.7 for its peers in the agricultural products group, while earnings are projected to increase at a rapid 17.6% annual rate from $2.96 in 2011 to $4.09 in 2013. The stock has mounted a huge rally in the last seven trading days after the company reported a blockbuster November quarter in which both revenues and earnings beat estimates by a wide margin.
Oracle Corp. (NYSE:ORCL): ORCL develops database and middleware software and business application software and hardware systems for enterprises. PRIMECAP cut $132 million in Q3 from its $1.39 billion prior quarter position in the company. ORCL shares recently took a nose-dive after its November quarter came up short, missing on both analyst revenue and earnings estimates, prompting many analysts to downgrade the stock and slash price targets. While the company blamed the weakness on an increase in last-minute approval for large deals, as well as a chip transition for its server business, the concern is that ORCL may be lagging in product strength and could head down to Microsoft-like valuations in the high single digits. Currently, ORCL trades at 10-11 forward P/E and 3.2 P/B compared to averages of 38.9 and 4.5, respectively, for its peers in the computer software group, while earnings are projected to increase at a modest 7.6% annual rate from $2.22 in 2011 to $2.57 in 2013.
Potash Corporation of Saskatchewan, Inc. (NYSE:POT): POT is the world's largest integrated fertilizer and related industrial and feed products company by capacity. PRIMECAP cut $143 million in Q3 from its $1.26 billion prior quarter position. POT trades at a fair 10-11 forward P/E and 5.0 P/B compared to averages of 10.1 and 3.6 for its peers in the fertilizer group.
Other companies in its portfolio that PRIMECAP is bearish on (see table) are Swedish manufacturer of wireless and fixed-line telecom networks and handsets LM Ericsson (NASDAQ:ERIC), in which it cut $149 million; satellite-based digital television programming provider DirecTV (DTV), in which it cut $150 million; major discount chain retail store operator Target Corp. (NYSE:TGT), in which it cut $164 million. Additional companies that PRIMECAP is bullish on, but are not trading at a discount to peers, include brokerage house Charles Schwab (NYSE:SCHW), in which it added its largest position in Q3 at $346 million; and healthcare products and related services provider Johnson & Johnson (NYSE:JNJ), in which it added 299 million.
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Note to Table: The companies selected to be included in both the Top Buys and Sells and Top Holdings categories in the table were picked on both an absolute basis, i.e. the highest dollar amounts of buys and/or sells, as well as those amounts relative to their market-cap. That way, the list is not biased toward the largest companies in the group.
Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix by Edgar Online, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
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