From an individual investor's perspective, I find it truly interesting to focus on stocks that are large holdings in Jeremy Grantham's portfolio. I analyzed them and found some reasons why Jeremy Grantham could have been attracted to these investments. I look for companies that I can understand, with favorable long-term prospects that are operated by competent people, and, importantly, are available at attractive prices. I used whalewisdom.com to check Jeremy Grantham's holdings.
What is amazing about Microsoft is that the stock has been seen as "dead money" and "value trap" over the past few years, but I think that the tides are changing and that could take MSFT to a more normalized valuation above $32. Basically, Microsoft has plenty of legs remaining in several of its products (Office 2010, Windows 7, Kinect, etc.), has one of the most promising product cycles (Windows 8, Windows 8 Server, Office 12, etc.) in its history in front of it, and is levered to numerous secular trends (cloud computing, virtualization, big data, etc.), which should enable the company to outpace IT spending and outperform its peers for the foreseeable future.
I think that the recent Nook deal will position MSFT as a potential competitor to Amazon's (AMZN) Kindle and Apple's (AAPL) iPad. Argus research recently issued a report that while the deal, announced on April 30, is a small one for MSFT, they view it as an option on a potential competitor to AMZN/AAPL in the e-reader/tablet market. One significant benefit for Microsoft will be the embedding of a Nook e-reader application within Windows 8.
I like the fact that management, in the recent conference call explained that MSFT is the only company that can deliver a common identity, virtualization, management and development platform to its customers across both private and public clouds. Management also highlighted that Office 2010 momentum continues and in the online space, online advertising revs rose 9%.
Microsoft also leads the game console market. Management explained that they continue to have industry-leading console share, despite soft market. Xbox maintained its share leadership in the U.S. this quarter and it continues to expand the content available in Xbox live with the release of three new major entertainment applications.
In overall, Microsoft is a stock that has not innovated for lots of years and that made the stock a big "value trap." But that is changing now, as Microsoft is experiencing huge product releases in lots of categories. That will bring the "innovation" premium to MSFT that has not been there since 2000.
Valuation is extremely compelling. Microsoft shares are now trading at 10.8 times its trailing annual earnings compared to 43.6 times for the peer group and 13.9 times for the S&P 500. The significant discount to the peer group is on account of investor concerns regarding Microsoft´s share losses in mobile computing platforms and lack of innovation. Nevertheless, while this is a near-term negative, Windows 8 is expected to gain traction next year.
The stock is now trading at the low end of the historical range. The company is also trading at a significant discount based on forward estimates for fiscal 2012 and 2013. The current 75% discount to the peer group based on the 2012 estimate is somewhat greater than the historical average of 66%. Hence, the shares are likely to trade up.
I think that Grantham evaluated MSFT superb balance sheet. Microsoft reveals solid financial numbers, with nearly $52 billion in cash and cash equivalents, and about $12 billion in debt. The company is expected to generate more than $20 billion in free cash flow annually.
Johnson & Johnson (JNJ)
Johnson & Johnson aims at the development, manufacturing and marketing of pharmaceutical, medical, and consumer related healthcare products. Its worldwide business is segregated into three sectors: Consumer, Pharmaceutical, and Medical Devices & Diagnostics. For the full year 2011, these sectors contributed 23%, 37% and 40% respectively to the company's revenue.
JNJ has a very compelling acquisition strategy. The company made some deals that should boost the company's top line in the near term, such as:
Pharmacyclics Agreement: Johnson & Johnson signed an agreement with Pharmacyclics for the development and marketing of a mid-stage oncology candidate. Therefore, the company is looking to strengthen its oncology pipeline.
Synthes Deal: Through this acquisition, Johnson & Johnson is looking to enforce its medical device portfolio. Johnson & Johnson intends to combine its DePuy segment with Synthes business once the transaction is done.
Acquisition of Cougar Biotechnology: Through this acquisition, Johnson & Johnson enforced its oncology portfolio. The acquisition has proved worthy with the approval of prostate cancer therapy, Zytiga.
Agreement with Elan: Johnson & Johnson obtained all the assets and rights of Elan regarding its Alzheimer's Immunotherapy Program (AIP Program). The AIP Program represents Elan's interest in the collaboration with Pfizer for the research, development and commercialization of selective products for the treatment and prevention of neurodegenerative conditions, including Alzheimer´s disease (AD). The AD market, which is the third largest after cardiovascular diseases and cancer with respect to cost of treatment, means significant commercial opportunity.
Crucell: Johnson & Johnson acquired a Dutch biopharmaceutical company named Crucell NV. This transaction has not only helped enforce Johnson & Johnson's portfolio, it has also allowed the company to establish a presence in the vaccines market, given Crucell's expertise in the manufacture, discovery and commercialization of vaccines.
Agreement with Gilead: The companies have a license and collaboration agreement for the development of a once-daily antiretroviral HIV pill, Complera. Complera comprises Gilead's Truvada and Janssen Therapeutics (prior known as Tibotec Therapeutics) Edurant (prior known as TMC-278), a non-nucleoside reverse transcriptase inhibitor (NNRTI), for use in treatment-naïve HIV patients.
JNJ is also looking to increase its presence in emerging markets as they hold immense potential. Given the great potential, the company has set up manufacturing and R&D centers in Brazil, China and India. These countries are trying to make healthcare accessible to more people primarily by improving insurance coverage. In addition, emerging markets recorded 13% growth in 2011.
Even though I expect the company to continue facing headwinds in the form of EU and Japan pricing pressure, unfavorable currency movements, manufacturing issues and U.S. healthcare reform, I believe Johnson & Johnson´s diversified business model, lack of cyclicality, solid financial position will continue helping the company pave its way through tough situations.
Johnson & Johnson´s current trailing annual earnings multiple is 13.1, compared to the industry average of 12.7 and 13.9 for the S&P 500. Over the last five years, Johnson & Johnson's shares have traded in a range of 11.0 times to 16.7 times trailing annual earnings.
There is no doubt that Jeremy Grantham likes solid Companies for his portfolio. Johnson & Johnson carries one of the best balance sheets in the pharmaceutical industry and holds the coveted AAA credit rating that eludes its peers. Even with the likely small- and mid-cap acquisitions during the next several years, no deterioration to the company's solid financial position is expected. In addition, since equity is being utilized for 65% of the $21 billion acquisition of Synthes, I don't expect a meaningful deterioration of the company's financial health.
Philip Morris (PM)
I think that tobacco companies are masters in marketing consumer products, and Philip Morris is the best in the field. The company is enforcing its brand portfolio through innovation based on improved consumer understanding. Marlboro´s brand equity is being supported by the introduction of innovative packaging, new blends, and other line extensions, along with fresh execution of its iconic image. Likely is the L&M brand being revitalized by the introduction of products with a smoother taste and more attractive pack designs. Moreover, the portfolio of premium and high price brands (Parliament, Virginia Slims and Chesterfield) as well as the low price brands (Bond Street, Red & White, and Next) are being further developed and expanded.
PM is a company that has history of improving shareholder value through share repurchases and dividends. During the third quarter, the company increased its regular quarterly dividend by 20.3%, to an annualized rate of $3.08 per common share. Philip Morris also announced a new $12 billion, three-year share repurchase program and awaits to repurchase approximately $5.0 billion going forward.
I see in PM another solid pick from Grantham. Here is another evidence that he really likes solid, established names for his portfolio. Regarding valuation, Philip Morris shares now trade at 15.8 times the earnings set for 2012, a 25.4% premium to 12.6 times, the industry average. I think that premium is warranted given PM is the leader in the tobacco industry.
Philip Morris' financial shape is strong, and it can comfortably meet both its debt repayment schedule and interest payments. Although its debt/total capitalization ratio was 0.8 at the end of 2010, the firm's solid cash flows mean that EBITDA covered interest expense 12 times. With the firm generating free cash flow in excess of 20% of its revenue, Philip Morris should be able to pay down debt over time, and I forecast the firm's debt/EBITDA expense ratio to fall from 1.4 times in 2010 to 1.0 times by 2020.
I think that one thing that differentiates Google over other technology big leader is its focus on innovation, launching products and services that create win-win situations, so that both users and advertisers can benefit. The success of this strategy is the underlying reason for the company´s phenomenal growth since inception, and one of the main reasons why Google is different. As Google generates significant cash from operations and also holds a huge cash balance, management has the flexibility to pursue expansion in any area that exhibits true potential. The company is believed to have the financial muscle to overcome any short-term adverse conditions to generate significant growth in both revenue and profits over the long term.
In its last earnings report, Google reported Q1 (MAR) earnings of $10.08 per share, excluding non-recurring items, $0.44 better than the Capital IQ Consensus Estimate of $9.64; also net revenues (including TAC) rose 24.5% year/year to $8.14 billion vs. the $8.15 billion consensus. Aggregate paid clicks, which include clicks related to ads served on Google sites and the sites of our Network members, increased ~39% over the first quarter of 2011 and increased ~7% over the fourth quarter of 2011.
The weak side of the story is that average cost-per-click, which includes clicks related to ads served on Google sites and the sites of our Network members, decreased ~12% over the first quarter of 2011 and decreased ~6% over the fourth quarter of 2011. As of March 31, 2012, cash, cash equivalents, and short-term marketable securities were $49.3 billion.
After the reported earnings, Needham noted that Google's 1Q12 revenue was in line with expectations, and pro forma EPS above expectations. Net search revenue was modestly ahead of its expectations with strong query volume and paid clicks offsetting declining cost-per-click (CPC) rates (I think it was the weakest side of the story).
Google is a big cap leader I really like and recommend. It has a superb moat, super strong balance sheet and it operates in an industry that offer high growth opportunities in the near future.
Pfizer currently operates through several sectors Primary Care, Specialty Care, Oncology, Established Products and Emerging Markets, Animal Health, Consumer Healthcare and Nutrition. Pfizer reported worldwide sales of $67.4 billion in 2011 (up 1%). While sales from the Biopharmaceutical segment came in at $57.7 billion, down 1%, the Animal Health sector posted sales of $4.2 billion, up 17%. Consumer Healthcare and Nutrition contributed $3.1 billion and $2.1 billion to 2011 sales, respectively.
One of the most important reasons to invest in PFE is the effect that the past cost cutting measures will have in the bottom line. This company has been undertaking massive restructuring and cost-cutting over the past four years. Management is also looking to concentrate its efforts on areas that may offer the most potential like oncology and geographic regions like Asia. Management announced a new goal of increasing its Asian market share and expanding operations in China.
Pfizer announced a cost-cutting program in January 2009, which is expected to deliver cost savings of approximately $3 billion per year. About $1 billion of these savings is expected to be reinvested in the business, resulting in an expected $2 billion net cost reduction. In addition, as a result of the Wyeth acquisition, Pfizer generated synergies of more than $4 billion, which are expected to result in $2 billion to $3 billion in net cost savings after reinvestment in the business. Pfizer awaits about half the cost reduction from selling, informational and administrative expense with the balance being contributed by R&D and manufacturing.
Pfizer is also looking to reward shareholders through share buybacks and dividends. I was pleased to hear that the company intends to increase its dividend payout ratio to 40% (from 33%) by the end of 2013. Pfizer, which returned about $15 billion to shareholders in the form of dividends and share buybacks in 2011, expects to return about $11 billion to shareholders in 2012.
Cost cutting efforts and share repurchases will drive near-term revenues, but it is important to understand that longer-term growth will be dependent on the success of drug development. Pfizer is now trading at 9.4 times the 2012 EPS estimate, a multiple that I consider attractive. Pfizer´s strong cash flows are believed to whittle down this debt quickly during the next few years, although this company needed $22.5 billion in debt to finance the Wyeth acquisition. Moreover, following the acquisition, Pfizer held more than $25 billion in cash.
Other Stocks Grantham Likes
Grantham invests similar to Warren Buffett. They both look at solid companies, with established moats and strong financials. Grantham also holds a considerable position of Coca-Cola (KO) and Wal-Mart (WMT).
I think the decision to invest in KO is wise. Recently Argus Research Argus raised their target on KO to $84 from $78 after Q1 results benefited from price increases, strong volumes and a more favorable product mix. Argus is particularly encouraged by the company's double-digit volume growth in India, as well as by high single-digit growth in China. They believe that KO shares are undervalued at 17.3 times their 2012 forecast, compared to a five-year average annual range of 15.9-20.5. The stock also appears favorably valued based on price/sales and price/cash flow multiples.
I also like WMT. Recently Warren Buffett spoke in favor of his WMT investing, considering the Mexican scandal. Buffett said that the bribery scandal does not change his perspective about the business and recently the stock beat both top and bottom lines, a fact that explains that the business is solid.
Disclosure: I am long GOOG.
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