I like to study the portfolios of value investors who have put together lengthy and outstanding track records. For example, a review of the equity holdings of value-based fund groups such as Berkshire Hathaway, Third Avenue Funds, or Tweedy Browne could point to potential investment opportunities. A fund's shareholder report, which lists its recent holdings, can usually be requested over the Internet, or in writing. In my case, I get it from whalewisdom.com. In the article I detail what Don Yacktman bought last quarter. Yacktman is the founder of Yacktman Funds, one of the top performing long-only, value oriented mutual funds.
Cisco Systems (CSCO)
Cisco is a strong idea I got from the Warren-Trades investment newsletter. I invested when the stock traded in the $17-$18 price level and institutions started to accumulate shares.
In the recent earnings report Cisco Systems beat market expectations. The company reported Q4 earnings of $0.47 per share, excluding non-recurring items, $0.02 better than the capital IQ consensus estimate of $0.45 while revenues rose 4.4% year/year to $11.69 billion vs the $11.61 billion consensus. It was very encouraging to see that during Q4, Cisco repurchased 108 million shares of common stock under the stock repurchase program at an average price of $16.62 per share for an aggregate purchase price of $1.8 billion. Also, management reported strong cash flow results. Cash flows from operations were $3.1 billion for the fourth quarter of fiscal 2012, compared with $3.0 billion for the third quarter of fiscal 2012 and $2.8 billion for the fourth quarter of fiscal 2011.
The stock went up considerably when management announced an increase of 75% to its quarterly dividend. Management explained:
"Cisco has the financial strength and flexibility to effectively invest in our business, pursue strategic opportunities, such as acquisitions, as well as return a minimum of 50% of our free cash flow annually through dividends and share repurchases to our shareholders."
I like Cisco. Despite a challenging macro environment, Cisco reported quarterly upside and a solid October guidance, with evidence of stability across key product segments and verticals. Valuation (4x ex-cash) and dividend increases (now $0.14 per quarter) are compelling reasons to invest in a relatively stable, large-cap name executing well on a turnaround strategy. I also like Cisco's very strong balance sheet, with around $42.0 billion in highly liquid short-term investments and another $6.5 billion in cash. Total debt is negligible and the debt to-total capital ratio is just 30.7%. Management returns value to customers through regular share repurchases. While the company could have returned a more significant amount, given the extent of its liquidity, the conservative payments are likely on account of the attractive growth characteristics that Cisco's markets continue to display.
I like Cisco's shares because it is evident that Cisco's strategy of pursuing opportunities in international markets and focus on new products and markets is paying off. Cisco is already the best entrenched company across the world and despite growing competition from several smaller players, the company appears to be holding its own. Additionally, the focus on new products resulted in continued margin expansion in the last quarter.
Apollo Group (APOL)
I do not like Apollo Group. Over the last decade, Apollo Group's revenue per share raced up at an annual rate of 22.8% as EBITDA grew 21.9%. Recently, however, revenue has been dropping off, falling from $4.9 billion in 2010 to $4.7 billion in 2011. I do not like to invest in companies that experience earnings declines.
The company has been experiencing revenue declines as enrollment rates have decreased. In the third quarter of 2012, its net revenue was $1.1 billion, an 8.5% decrease year over year due to a 9.1% decrease in its University of Phoenix revenue, as enrollment shrunk. Apollo generates almost all of its net revenue from tuition and fees. The company offset some of the losses with tuition increases and other fees.
I do not like Apollo because its industry is highly competitive and the business is exposed to risks not controlled by the company. Apollo Group derives a significant portion of its revenues from federal student financial aid programs, referred to as Title IV programs, which are administered by the Department of Education (DoE). The Title IV programs include loans given directly to students at below market interest rates by the Department of Education. A significant percentage of the company's students rely on the Title IV program funds to meet the cost of their education. The regulations and policies of the Department of Education, state education agencies, and the accrediting agencies change frequently.
Apollo Group is subject to risks relating to Title IV program integrity regulations. In order to remain eligible to participate in the Title IV funds, the company has to follow certain extensive rules/regulations. These include maximum student loan default rates, maximum debt-to-earnings ratios of its graduates, limitations on the proportion of its revenue that can be derived from federal student aid programs, elimination of incentive compensation to admissions advisors, standards of financial responsibility and administrative capabilities. If the company fails to comply with these rules, its institutions may lose eligibility to participate in Title IV funds.
Reserach In Motion (RIMM)
I think Research In Motion is highly speculative and I would avoid investing here. In the last earnings report, the company reported a Q1 GAAP loss of $0.99 on revenues of $2.8 billion vs. consensus estimates of breakeven earnings on revenues of $3.1 billion. Research In Motion's hardware gross margin actually turned negative (vs. 35% a year ago) because of the company's aggressive pricing to move older BlackBerry models. Even so, BlackBerry revenues were still down more than 50% from the level a year ago. Management believes that BlackBerry 10 will be a game changer when it arrives but I am quite skeptical. BlackBerry 10 will have to be perceptibly superior if RIM hopes to reverse the downward trajectory in its sales and earnings. I am bearish on RIMM shares.
I expect the next several quarters to be very challenging for its business based on these factors:
- Increasing competitive environment
- Lower handset volumes
- Potential impacts from the delay of its BlackBerry 10
- Increased pressure to reduce RIM's monthly infrastructure access fees
- The company's plans to continue to aggressively drive sales of BlackBerry 7 handheld devices.
I would avoid this stock because Research In Motion's core business is declining and I am skeptical on the fact that this company can launch a phone that could compete to Apple's iPhone and Samsung Galaxy.
Clorox reported a solid earnings report and I think that shares could represent an opportunity for conservative investors. Clorox reported Q4 earnings of $1.32 per share, $0.05 better than the Capital IQ consensus estimate of $1.27 while revenues rose 4.0% year/year to $1.54 billion vs the $1.53 billion consensus. Clorox management reaffirmed guidance for FY13, forecasting EPS of $4.20-4.35 vs. $4.30 Capital IQ consensus estimate.
After the earnings release, UBS wrote a bullish report. Clorox raised its target of CLX to $72 from $62. A UBS analyst explains that management deserves a lot of credit, but so does Clorox's Big Fish business model. UBS believes this quarter's result is a clear illustration that Clorox's continued investment behind advertising and innovation is widening the competitive advantage period over its smaller or less resourced competitors.
Clorox has a PE of 17x which is lower than its historical average P/E of 19x. The company has a solid business model and its dividend yield is 3.6% which should support the stock price some even if the market corrects. Good move from Yacktman.
Johnson & Johnson (JNJ)
I think that Johnson & Johnson is the best pharmaceutical company and I would recommend it to conservative investors. The stock is ideal for long term investors considering the company's financial strength and defensive business model. I like the fact that Remicade, the best selling drug at JNJ, continues to keep momentum. Contributing about 20.6% to pharmaceutical product revenues, the drug generated $5.5 billion sales in 2011, an increase of 19.1% compared to 2010. Remicade growth is driven by strong demand in the rheumatoid arthritis market, as well as a significant unmet need in the Crohn disease and ulcerative colitis markets. Approval for pediatric Crohn's, psoriatic arthritis and chronic severe plaque psoriasis should help drive growth.
JNJ has also a deep pipeline and its success will create a solid uptrend for the stock. There are many candidates in final stages of development which hold strong potential for Johnson & Johnson. The company expects to have 11 strong new filings between 2011 and 2015. I believe that considering that strong deep pipeline, successful commercialization of these products will be a boost for the top line that is yet not fully discounted by the market.
Disclosure: I am long CSCO.