Our 10 Favorite Stocks for 2012 Top-quality names, most with dividends, could deliver gains of 15% to 20% next year. Think Berkshire Hathaway, Freeport McMoRan, Procter & Gamble, MetLife, Comcast, Daimler, Sanofi, Seagate Technology, Vodafone and Royal Dutch Shell. http://online.barrons.com/article/SB...484177542.html
By ANDREW BARY
After a volatile year, stocks are heading into the homestretch about where they began. The benchmark Standard & Poor's 500 Index finished the week at 1255, within a percentage point of where it started the year. The Dow Jones Industrial Average is up 5% in 2011, largely reflecting the strength of a single stock, IBM (ticker: IBM), which has risen 32% to 194 and dominates the price-weighted index owing to its lofty absolute share price.
Most equity strategists are optimistic at best about 2012. They're worried that earnings growth and strong corporate balance sheets will be offset, in investors' minds, by the tough economic backdrop and the European debt crisis. Barry Knapp, Barclays Capital's chief market strategist, recently set an S&P 500 target of 1330, 6% above Friday's close. He expects a "difficult" first half followed by a second-half rally.
The important offset to the economic and political situation is valuation. U.S. stocks look reasonably priced, especially with 10-year Treasuries yielding 2% and short-term rates near zero. The S&P 500 is valued at 13 times projected 2011 profits and about 12 times next year's projected earnings. Bulls cite the combination of attractive valuations and super-low rates. "I feel like a kid in a candy store…I don't know where to begin," said Joe Rosenberg, chief investment strategist at Loews, told Barron's in last week's interview ("The Best Opportunities in a Half-Century," Dec. 5). Rosenberg is partial to a range of blue-chip stocks.
We compiled a list of 10 stocks that could reward investors in 2012, including blue chips like Berkshire Hathaway (BRKA), Procter & Gamble (PG), Royal Dutch Shell(RDSA) and Britain's Vodafone Group (VOD). In this diversified selection, nearly all pay dividends, the exception being Berkshire, which is understandable given CEO Warren Buffett's extraordinary investment skills. The average yield is 3%, in line with that of the 30-year Treasury. Half of them have price/earnings ratios below 10 on next year's projected profits. The most expensive stocks, Berkshire and P&G, are valued at about 15 times estimated '12 earnings.
Four of our top 10 are European, reflecting depressed markets and high dividend yields there. European investors and managements have a preference for dividends over share repurchases, the reverse of the situation here.
We initiated this 10-stock compilation at the start of this year ("Hear, Hear," Jan. 3, 2011). That group has trailed the market this year (see table) mostly because of declines in General Motors (GM), JPMorgan Chase (JPM) and United Continental (UAL). Through Thursday, the 10 stocks were down an average of 6.9%, versus a 1.9% drop for the S&P 500. All our new favorites have the potential to generate 15% to 20% total returns in 2012. Here's a closer look.
Berkshire Hathaway
Warren Buffett rarely comments on the stock, but he sent a strong signal that he felt it was undervalued in September when the company announced its first share-buyback program in his 46-year tenure as CEO. The buyback announcement didn't amount to much because Berkshire set a limit on what it would pay -- a 10% premium to book value -- and the stock quickly traded above that threshold.
While the Class A shares have moved up 15% since the buyback announcement to around $116,000, they look appealing, trading for less than 1.2 times our estimate of year-end 2011 book value of $102,000. Class B shares trade around $78 and are valued at 1/1,500 of an A share.
Berkshire is in its best shape ever with a diversified business mix producing profits of about $7,500 per share annually, or $12 billion. Berkshire offers exposure to an improving economy, an upturn in property and casualty reinsurance rates and a rising stock market thanks to its $70-billion-plus equity portfolio, including a new $11 billion investment in IBM. Barclays analyst Jay Gelb carries an Overweight rating with a price target of $127,500. The chief negative is Buffett's age -- he's 81 -- and the lack of an obvious successor. Yet a healthy Buffett hopes to run Berkshire for at least another five years.
If Berkshire trades at a modest 1.2 times estimated year-end 2012 book of $112,000, the stock would trade around $135,000, 16% above current levels. Downside seems limited with the buyback in place, buttressed by $31 billion in cash.
MetLife
The big U.S. life insurer looks appealing based on two key measures: earnings and book value. At $31, the shares are valued at less than seven times projected 2011 profits of $4.92 a share and for a similar multiple of estimated 2012 EPS of $5.06. And the stock trades at just two thirds of estimated year-end 2011 book value of $49 a share. This is a conservative measure of book value, or shareholder equity that excludes investment gains.
MetLife (MET) gave an upbeat view on 2012 last week, noting that it has significant excess capital and will likely build even more next year, which would allow a higher dividend payout and significant buybacks.
After the analysts meeting, Nigel Dally of Morgan Stanley wrote that "the outlook looks significantly better than what is reflected in the current stock price." He has an Overweight rating on the stock and a $45 target price.
MetLife is expanding overseas, as well. Following its deal in 2010 to buy some of American International Group's life-insurance operations, MetLife now gets more than a third of its profits from outside the U.S.
Negatives include a low-rate environment that hurts reinvestment income and overall profits and a modest looming hit to shareholder equity from regulatory changes. These issues aren't major and appear well discounted in MetLife's depressed stock price.
Sanofi
This big French drug concern should more than survive its major patent expirations this year. It could generate some of the best growth among its peers starting in 2013. Sanofi (SNY) has an attractive drug portfolio that isn't well appreciated by U.S. investors, including treatments for diabetes, cancer and cardiovascular disease, vaccines and animal-health compounds.
The U.S. listed shares, now around $35, trade for under eight times estimated 2011 profit of $4.58 a share and yield 5%. Sanofi's valuation is one of the lowest among major drug companies. Next year's profit is expected to decline about 10% but then expand in 2013 and potentially increase 10% in both 2014 and 2015.
"Sanofi trades at a discount to almost every other large-cap" drug company, "yet its longer-term financial average is better than the group average," wrote Bernstein analyst Tim Anderson in a note last month. He has an Outperform rating on the stock with a $44 price target -- 25% higher than the current quote.
There's some debate about whether Sanofi overpaid when it bought biotech Genzyme for $20 billion earlier this year. Barron's argued that a buyback would have been a better use of corporate cash, but CEO Chris Viehbacher sees Genzyme as a key part of Sanofi's post-patent growth engine. One believer is Warren Buffett, whose Berkshire Hathaway has been a sizable holder.
Seagate Technology
Summer floods in Thailand have temporarily washed out about 25% of global disk-drive production and hurt Seagate's chief rival, Western Digital.
That is producing a financial windfall for the unaffected Seagate (STX) that may last through 2012. Beyond the supply disruptions, Seagate should benefit from consolidation. Likely to be winnowed down to just three main producers shortly -- Seagate, Western Digital (WDC) and Toshiba -- the industry should see greater pricing power and discipline.
Seagate trades for under six times estimated profit of $3 a share in fiscal 2012, which ends in June. Needham analyst and Seagate bull Richard Kugele has an above-consensus estimate of $3.92 a share for the current year and a $35 price target. The shares recently traded below $16. "Seagate is going to throw off more than half its market value in cash during the next four quarters," Kugele says. The company could boost its dividend, now providing an ample yield of 4.6%, buy back stock or reduce debt.
Bears say disk drives are on their way out as solid-state memory supplants them. Yet personal computers aren't going away and the explosion of Internet content creates storage demand that can be met economically only with disk drives. Seagate also benefits from a savvy and shareholder-friendly management team led by CEO Steve Luczo that is moving to cement Seagate's competitive position in an improving industry.
Vodafone
U.S. utility stocks -- telecom and electrics -- are among the richest sectors of the stock market, trading for about 14 times projected 2012 profits.
Yield-oriented investors can do better in Europe, where Vodafone, the leading global wireless company, trades at a discount to its U.S. counterparts and yields a fat 5%. Its U.S.-listed shares, now trading around $27, fetch 10 times estimated profit in the current fiscal year ending in March. That's a sharp discount to Verizon Communications(VZ), which trades for 15 times estimated 2012 profit.
Vodafone and Verizon share ownership of Verizon Wireless, the No. 1 U.S. cell-phone company and each company's best asset. Vodafone owns 45% and Verizon 55%. Investors haven't given Vodafone full credit for that valuable stake, which could be worth $75 billion, or more than half the company's market value. That will change in early 2012 when Verizon Wireless pays $10 billion in dividends to its corporate parents ("It's Time to Ring Up Vodafone," Nov. 14).
Last month's article opined that Vodafone could hit $35 in the next year, a 30%-plus total return. That's a nice potential gain for a low-risk stock.
Royal Dutch Shell
The three major international integrated oils -- ExxonMobil, Chevron, Royal Dutch -- all look reasonably priced, trading for eight to 10 times projected 2012 profits. What differentiates Royal Dutch is the highest dividend yield among the trio at 4.7%, double that of Exxon (XOM) and two percentage points higher than that of Chevron (CVX).
The bull case on Royal Dutch is that cash-flow growth is accelerating as new energy projects in places like Qatar and Canada come on stream and that its dividend, unchanged since 2009, will start to rise in the next year. Net debt levels are down sharply, falling to $20 billion in the latest quarter.
"We estimate Shell's free cash flow will outstrip its current dividend by 50% to 100% consistently during 2012-2014," wrote Morgan Stanley analyst Martijn Rats, who sees 9% annualized dividend growth in the next three years.
Shell's U.S. listed shares, now around $70, could top $80 in the coming year, according to Morgan Stanley's projections.
Freeport McMoRan Copper and Gold
Copper is critical for developing economies and Freeport McMoRan Copper and Gold is the largest investor-owned producer in the world with a diversified resource base on four continents.
Freeport shares, around $39, are attractive based on several measures, including earnings, dividend yield and asset value. The stock is down 36% this year thanks to a 20% decline in copper prices to $3.40 a pound. Yet Freeport is very profitable at current copper prices, given mining costs of less than $1 a pound. The stock trades for eight times both 2011 and 2012 profits. It yields 3.7%.
Recent copper-mining transactions suggest that Freeport is significantly underpriced. If Freeport ever went on the block, it likely would fetch a nice premium and attract a range of bidders, including mining giant BHP Billiton (BHP) and even China, which accounts for over a third of world-wide demand.
Freeport has a great balance sheet with no net debt and huge reserves of nearly 100 billion pounds of copper, plus a large amount of gold. Investors worry about a drop in Chinese demand and a labor strike at a large Indonesian mine that has effectively shut down production. The China risk seems already reflected in the stock price and the Indonesian strike probably gets settled next year.
Comcast
The cable-TV industry doesn't receive much credit on Wall Street for its dominant position in providing high-speed Internet access to consumers.
And for Comcast, the country's largest cable provider, the lucrative Internet business may now be more important than TV services. "Cable companies are infrastructure companies, not media companies, and they're winning the battle in most of America" versus the telecom industry, notes Craig Moffett, the cable and telecom analyst at Bernstein. Moffett has an Outperform rating and $32 price target on the stock.
Comcast (CMCSA) shares, at $23, trade for 12 times next-year earnings. Moffett expects the company to lift its dividend and boost its share-repurchase program during 2012 using its growing free cash flow. The stock yields 2%.
Comcast is still working to turn around the flagging NBC broadcast-TV business, which is in last place in prime-time ratings and losing money. Fortunately, NBC represents just 6% of Comcast revenues and probably has nowhere to go but up. Investors have been waiting for Comcast to aggressively return cash to shareholders, and that may start in 2012.
Procter & Gamble
With its broad array of popular brands -- including Tide, Bounty and Pampers -- and its global marketing muscle, P&G offers a low-risk way to play the growth in developing countries. The stock, a laggard in recent years, trades around $65, or 15 times projected profits in its current fiscal year, ending in June.
P&G yields over 3% and another dividend increase is likely in 2012. Throw in buybacks and P&G is returning about 7% to shareholders each year. If dividends increase in the next 10 years at anything like the pace of the past decade, P&G could be yielding 5% or more by 2020 based on the current share price. P&G is like a bond with an increasing yield.
Wall Street has been critical of the company for focusing too much on developed markets and higher-priced products, but P&G's strategy is changing. Bernstein analyst Ali Dibadj has argued that P&G needs to undertake a large restructuring initiative to cut costs and shift its "center of gravity" from its headquarters in Cincinnati to the emerging markets, where it gets about 30% of sales.
The company believes it's capable of high single-digit to low double-digit annual earnings growth. That's double the growth of electric utilities, whose shares trade in line with P&G. Dibadj, who upgraded P&G to Outperform in the summer, has a target price of $73 on the shares.
Daimler
Luxury-goods makers ranging from Coach and Tiffany to LVMH and Richemont, are in vogue with investors, but the maker of Mercedes Benz, arguably the ultimate vehicle brand, is very much out of favor.
Daimler's U.S.-listed shares (DDAIF) trade around $45, down from a peak of $79 in the spring, and fetch just six times projected 2012 profit. They yield 6%. Investors are worried about several issues, including costs, an aging lineup of high-end Mercedes cars, the lack of profit momentum and troubles in Europe, where Mercedes gets half its sales.
Yet Daimler has a great balance sheet with more than $15 a share in net cash and investments. It's also one of the largest global makers of trucks, and its Mercedes franchise is strong in status-conscious China. Even detractors concede Daimler looks appealing based on a sum-of-the-parts analysis. It's one of the world's great industrial companies. The stock looks too cheap to ignore.
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