10 Best Stocks For 2014

by: Difu Wu

2013 has been a very good year for US stocks, a good year for foreign developed market stocks, and a lackluster year for emerging market stocks, with year-to-date (as of Dec 24, 2013) total return of 30.8%, 21%, and -7% for the S&P 500, EAFE index, and Emerging Market index, respectively. My stock picks for 2013 returned 31.1%, slightly outperforming the S&P 500, despite 40% allocation to foreign stocks. While I still expect the bull market to continue in 2014, given the Fed's easing policies, not yet euphoric investor sentiments, and a still weak economy with room to expand, it is prudent to be more cautious and value-minded.

In this article, I offer 10 deep-value, safe dividend stocks for a conservative portfolio for 2014 and beyond. These picks will focus on defensive names that are large and prominent in their industries, conservatively financed, currently selling at low valuations, and expected to continue to generate predictable, satisfactory returns for many years to come. I chose these 10 stocks from various sectors, so that investors who buy only these stocks will own a well-diversified portfolio.

Also note that it has become very difficult to find value in US stocks, which have become overpriced in general, but value still abounds in foreign stocks, especially in emerging markets, so my picks for 2014 have a heavy foreign tilt. Though certainly possible, do not expect another 30% return, or even for these picks to outperform in 2014, but be assured that these are solid stocks poised to yield at least satisfactory returns for years to come. Here are my new picks:

1. AstraZeneca (AZN): A leading global pharmaceutical company with operations in over 100 countries, increasing presence in emerging markets, and a diversified product portfolio, AstraZeneca remains a safe long-term bet on the ballooning healthcare demands from an aging population worldwide. Management has been aggressive in acquisitions and investments to counter patent expirations and pricing pressure, and, despite the past year's rally, valuations remain low comparison both in its history as well as compared to its peers.

The balance sheet is relatively clean with a debt-to-equity (D/E) ratio of only 44%, and the company has a solid track record of profitability, with return on equity consistently above 20% over the past decade. The normalized P/E of 11 is a 58% discount from the industry's average of 26, indicating significant value. The stock still has plenty of room to run higher, as the company boosts its pipelines and the stock returns to favor.

2. Gazprom (OTCPK:OGZPY): This is the cream of the crop within the energy sector, which in turn offers strong value compared to the broad market. It is significantly undervalued, selling at an incredible 2.6 times earnings (which is a 74% discount to the industry's average of 10.1) and 60% discount to book value. Although arguably not as safe as Exxon Mobil (NYSE:XOM) or Chevron (NYSE:CVX), Gazprom's financials are still impeccable, with D/E only 14% and a high interest coverage of 92, and the currently extremely low valuations more than compensate for emerging market risks. Gazprom is a deep-value play and the current emerging market selloff is an excellent opportunity to get in.

3. Tesco (OTCPK:TSCDY): While most consumer staple stocks have become too dear to buy now [Procter & Gamble (NYSE:PG), for example, sells at a current P/E of 20 and a normalized P/E of 21], Tesco remains attractively priced, with a normalized P/E of 12.6, a 33% discount compared the industry average of 18.8. Tesco is one of the world's largest retailers, with a solid record of consistent growth. It has maintained consistently satisfactory margins around 6% and high ROE around 16% for the past decade.

The company is undergoing a transition period for the past 2 years and, while the efforts are beginning to pay off, the stock has plenty of upside once investors revise expectations upward. Management is projecting mid-single digit earnings and dividend growth and 12-15% return on capital. It is one of the best defensive stocks and should hold up well even if we should slip into a recession. It currently offers an attractive 3.9% yield.

4. China Construction Bank (OTCPK:CICHY): With an average ROE of 19% over the past 5 years, P/B of 1.1, and current and normalized P/E of 5.5 and 7.4, respectively, this is one of the most profitable and attractively priced stocks in the financial sector. This bank is, however, more risky with a high leverage of 14.5, which is a little higher compared to US banks of similar size, such as JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC), and Wells Fargo (NYSE:WFC), with leverages of 12.6, 9.7, and 9.8, respectively. These three US banks, on the other hand, are selling at significantly richer valuations, with normalized P/E of 15.7, 85.2, and 18.4, respectively, and their profitability over the past decade have been less predictable. Overall, the current risk-reward ratio favors CICHY.

5. International Business Machines (IBM): Like Microsoft (NASDAQ:MSFT), IBM is consistently profitable, with a diversified product portfolio that can help mitigate against downside risk in the high risk but highly lucrative technology sector. It has ROE consistently above 25% and compounded annual EPS growth of 21% over the past 10 years. Although its D/E of 1.4 is relatively high for a technology company, the stock has a low beta of 0.49, a testimony to the stability of its business model. IBM is currently selling at 14.9 times average EPS over past 10 years, which is a 40% discount to the industry's average of 24.9. It is currently selling in the bottom quartile of its 52-week trading range, offering a good buy entry.

6. China Mobile (CHL): With many telecom stocks, such as AT&T (NYSE:T) and Verizon (NYSE:VZ), selling at lofty valuations, CHL remains inexpensive, with a normalized P/E of only 10.8, a significant discount of 33% compared to the industry average of 16.1. CHL is conservatively financed with a low D/E of 0.04 and high interest coverage of 511, very favorable compared to those of similarly sized VZ, with D/E of 2.6 and IC of 7.3. While T and VZ have experienced negative growth, CHL had a compound annual EPS growth of 14% over the past decade. The recent emerging market selling is a good opportunity to buy this relatively safe dividend stock at an attractive price.

7. E.ON (OTCPK:EONGY): The high dividend yield utility sector has underperformed the overall market in 2013 due to the Fed's taper and rising interest rates, and many names are now selling at attractive prices. E.ON is distinguished among its peers by its healthy balance sheet with a low D/E of 0.5, which is less than half the industry's average of 1.1, as well as a diversified portfolio with great economy of scale. Amazingly, it is currently selling at a normalized P/E of 4.7, a 71% discount to the industry's average of 17.2. This valuation reflects such starkly low investor sentiment that it is difficult for this stock not to exceed expectations and greatly outperform as investor sentiment reverts to the mean.

8. Vale (VALE): This Brazilian mining company stock has been battered in 2013, along with emerging market stocks and the materials sector, offering a fine buying opportunity in this highly profitable business with consistently high ROE on a low D/E of 0.4, 24% operating margin, and 22% EPS growth over the past 10 years. Granted, the commodity boom might be over, but VALE is selling at only 4.8 times 10-year average earnings, a discount of 63% to the mining industry's average, providing a wide margin of safety.

9. Posco (PKX): This Korean steel company is a Warren Buffett holding, and for good reasons. It has averaged 9% compounded annual EPS growth over the past 10 years, has little debt with D/E of 0.35, and is selling at only 0.6 times book and 7.4 times average 10-year earnings, 41% discount from the steel industry's average of 12.5 times. It is a low cost producer with 4.1% operating margin, which is more than twice the industry's average of 1.8, providing a buffer during industry down cycles when others with lower margins are reporting losses.

10. Guangshen Railway (GSH): No portfolio would be complete without a railroad stock, and GSH is one of the more attractively priced among the leading railroad companies. As much as I love US railroad stocks like Norfolk Southern (NYSE:NSC) and CSX (NYSE:CSX), I can no longer recommend buying them at this point given their strong price performances in 2013 have put them at overvalued territory with normalized P/E of 19.2 and 18.9, respectively. GSH, in contrast, it sells at 12.5 times 10-year average earnings, a 23% discount to the railroad industry's average. With high oil prices likely to persist, railroad remains the best bulk transport option, likely for many years to come.

Stock Price ttm P/E* Normalized PE* P/B Yield (%)
AstraZeneca $59 16 11 3.1 4.8
Gazprom $9 2.6 - 0.4 -
Tesco $16 221 12.6 1.6 3.9
China Construction Bank $15 5.5 7.4 1.1 4.7
International Business Machines $183 13 15 10 2.0
China Mobile $53 10 11 1.8 3.8
E.ON $18 5 4.7 0.6 5.7
Vale $15 18 4.8 1.5 0.9
Posco $78 16 7.4 0.6 2.2
Guangshen Railway $23 15 12 0.7 2.5
Average** - 14 9.5 1.3 3.4

*ttm PE is calculated using earnings over trailing twelve months. Normalized P/E, or Shiller P/E, is calculated using average earnings over past 10 years, which is more indicative of value as it evens out fluctuations in earnings, especially for cyclical and sensitive sectors like materials, financial, industrial, technology, and energy. **Median is used for ttm P/E due to outlier in TSCDY and for P/B due to outlier in IBM; mean is used for normalized P/E and Yield.

Disclaimer: As much as I try to be as objective as possible, these stock picks are my personal opinion only. While these stock picks represent my best ideas, and I expect them to beat the market in 2014 and beyond, they may lose money. Further, given the strong foreign stock concentration, this portfolio may significantly deviate from the S&P 500 market benchmark, which is composed entirely of US stocks. The author and Seeking Alpha specifically disclaim responsibility for any losses incurred from application of the information contained in this article. Investors are well advised to do due diligence before investing in any stock. These stocks are intended to be held for the long term (over 5 years) and may lose money, especially over the short term. For the foreign stocks mentioned, I recommend holding them in taxable account, so that any foreign tax withheld can be refunded when filing annual tax returns. All data on these stocks are obtained from google.com/finance, morningstar.com, money.msn.com, and gurufocus.com. For further guidance on picking stocks, please read Security Analysis, by Graham and Dodd.

Disclosure: I am long AZN, OTCPK:OGZPY, IBM, CHL, VALE, PKX, CSX, NSC, XOM, PG, T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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