Welcome to the good old days. In the years to come, that's how investors will characterize this juncture in market history. The years that followed the crushing 2000-2009 secular bear market, they'll say, were a particularly profitable time to be an investor in stocks.
The Top Ten List is certainly off to a profitable start, with each of the ten stocks outperforming the market from the date it was recommended in December, with returns ranging from 17% to 51%, compared to an S&P return for the same time period 8.6%. My working hypothesis - that these are the early days of a secular bull market - certainly colors how I'll manage around these positions in the months and years to come.
Translation: I'll be an aggressive buyer on weakness, while at the same time giving positions plenty of rope in an effort to generate the maximum gains possible.
Top Ten List Themes
The list is intentionally narrow in scope. Case in point: There isn't a single retail stock on the list. Retail's thin margins, coupled with generally hefty leverage and a landscape that is clearly overstored, make it vulnerable as incremental sales move online. I'll have more to say on retail and other problematic sectors of the market in future columns.
Here are the themes I targeted in assembling the Top Ten List in December:
- Growth in emerging markets will lead the charge in this economic cycle, bolstered by an ongoing and massive infrastructure buildout. (MTW, TEX, GE, MIL)
- The financials, brutalized beyond all reason during the bear market, will outperform the broader indices by a wide margin during this cycle. (BAC, C, HIG)
- Real state will eventually improve, and probably sooner than most observers expect. Rather than recommend the homebuilders, though, who had already enjoyed a sizeable move when the Top Ten List was compiled in December, I recommended ancillary beneficiaries of this dynamic. (WHR, USG, MWA)
With that in mind, here are my latest thoughts on five of the Top Ten stocks, based on their current quotes. Part two of this column will be posted over the next few days.
Four years ago, these two banks were leveraged up to their eyeballs, bloated with low-quality assets, funded by even lower-quality liabilities. And yet, investors were happy to pay two times book value for these businesses. Today, Bank of America and Citigroup trade at a fraction of book value, this despite the fact that these franchises are vastly stronger and healthier than they were before the credit crisis.
Nothing has altered the view I laid out in my Top Ten column, that BAC will reach $15 per share within two to three years, and that Citigroup has the potential to reach $100 per share by 2015. My intention is to own these stocks for the full cycle, perhaps to the end of the decade.
Data from Whirlpool's fourth-quarter earnings report were in line with my expectations. The company is doing an excellent job of controlling "in-house" variables (price increases, lowering fixed costs, capacity realignment, etc.). The stock has rallied strongly since the earnings report because the market was caught by surprise by 2012 earnings guidance of $6.50-$7/share.
It's a nice first step, but it's only the beginning. Even though the stock has already reached $70, something I anticipated in my December column would occur in the second half of 2012, it is important to remember that this year's earnings guidance is based on demand remaining at trough levels. Not only do I expect demand to ratchet higher as the year progresses, but my analytical work suggests significant margin leverage is embedded in this model. As I explained in my earlier column, this company's earnings power is $14 to 15 per share, something I think we'll see by 2014 or 2015.
It's really important to maintain balance when analyzing financials, materials and industrials; that is, companies with cyclical operating characteristics. Obviously, getting comfortable with staying power is important, but so is understanding what is "normal." In the case of the banks, a stock price of just half of conservatively stated book value is not normal (nor is it justified).
In the case of Manitowoc, a 4.9% operating margin in their crane segment is not normal - normal is two to three times higher. It gives MTW a potent combination of levers, both margin leverage and sale leverage, the latter clearly in evidence in the fourth quarter numbers, as the company posted strong sales growth of 17%. If anything, the view I outlined in December - that Manitowoc earnings growth will merit a $27 to 32 stock price in a couple of years - might prove too conservative.
General Electric (NYSE:GE)
My analytical work suggests General Electric is on the cusp of a breakout. Just about everything went wrong four years ago, and, in the upcoming quarters investors will finally witness the opposite, with just about everything going right for GE. Across the board, from Energy Infrastructure to Aviation to Transportation to GE Capital, it's becoming increasingly clear that GE's finest days lie directly ahead, and a return to past glories is not only possible, but probable.
As I said in my December column, "normal is right around the corner for GE, and when it occurs, the earnings power in this particular operating model will surprise a lot of observers." If I'm right about the magnitude and timing of earnings growth and dividend growth (to $1 per share by 2013), this stock is headed to $30 and beyond by the end of next year.
Look for Part 2 of this column to be posted in the next few days, when I'll review and discuss prospects for the remainder of the Top Ten list.
Disclosure: I am long GE, MTW, TEX, WHR, BAC, C, HIG, MIL, USG, MWA.