Picking High-Growth Companies: How to Find the Next Apple

Picking High-Growth Companies: How to Find the Next Apple
by Alexander Green, Investment U Chief Investment Strategist
Friday, February 17, 2012: Issue #1711

Apple’s share price exceeded $500 this week, giving it the largest market cap of any U.S. company.

Apple (Nasdaq: AAPL) so successfully sells computers, phones and other electronic gadgets that recently announced fourth-quarter profits soared 118% on a 73% increase in revenue. This is unheard of for a $475-billion company.

To put this in perspective, earnings at the companies in the S&P 500 stock index are on track to post a 6.6% year-on-year rise for the fourth quarter. Yet once Apple’s earnings are factored out, the expected fourth-quarter gain shrivels to just 2.8%. This so skews results that many Wall Street analysts are now stripping Apple from the index before weighing valuations and making forecasts.

Of course, it’s just a matter of time before Apple’s torrid growth begins to wane. It’s not possible for $500-billion companies to keep growing at the rate of $5-billion companies… or even $50-billion companies.

So the key is to search for the next Apple. But how do you find it?

Fortunately, the factors that make a great-performing stock are well known and have been intensively studied by academics and researchers. We know the key characteristics that top-performing stocks generally possess before making their parabolic moves up.

Here are just a few:

1. Double-digit sales growth. You can only grow the bottom line for so long by cutting costs. Every business needs to have healthy top-line growth before it can generate robust and sustainable long-term earnings growth. Note that sales at Apple jumped 73% last quarter.
2. At least 25% quarterly earnings growth. In an economy as weak as this one, most companies can’t meet these first two hurdles. But, again, Apple is seeing earnings growth at more than four times this rate.
3. A return on equity of 17% or more. Return on equity – an excellent measure of management’s efficiency with capital – is calculated by dividing earnings per share by book value per share. (This is one of Warren Buffett’s key metrics, too.) Note that Apple’s return on equity is a whopping 46%.
4. New products and services. Apple is the king of innovation, regularly bringing out not just new versions of products but entirely new products: iPods, iTunes, iPhones and iPads.
5. High-quality management. Never forget that every company is essentially a team of people. And just as every great sports franchise needs a highly qualified coach, so does each company require a visionary leader. Apple’s co-founder and former CEO Steve Jobs was one of the greats. Now that he’s gone, it will be interesting to see how the new management performs.
6. Institutional support. The vast majority of shares traded on the major exchanges are mutual funds, hedge funds, pension plans and endowments. You want to own the same stocks the institutions are buying. And, indeed, institutions own more than 70% of Apple’s outstanding shares.

These are some of the key criteria that companies need to meet to generate superior long-term returns for shareholders.

We may not see another company in our lifetimes that transforms the business landscape the way Apple has. But there are plenty of great innovators out there, including Amazon (Nasdaq: AMZN), Google (Nasdaq: GOOG), Genentech, eBay (Nasdaq: EBAY), Costco (Nasdaq: COST) and Intuitive Surgical (Nasdaq: ISRG).

These companies – and others like them – are likely to be among the best-performing stocks in the years ahead.

Good Investing,

Alexander Green

World’s Most Contrarian Investment

World’s Most Contrarian Investment
by Alexander Green, Investment U Chief Investment Strategist
Monday, February 13, 2012: Issue #1707

How do you identify great contrarian investment opportunities?

Two ways. First, rather than limiting yourself to your national borders, you seek out opportunities worldwide. Next, you insist on two essential factors: abject pessimism and extreme valuations. That’s exactly what we have in European stocks today.

Ask your friends and neighbors which stocks in Europe they’re buying right now and they’ll ask you to sit down so they can feel your forehead. After all, no one in his right mind would buy stocks in a region where socialist policies reign, economic growth is almost nonexistent and the currency – the euro – is coming apart at the seams, right?

Wrong. The fact that almost no one is enthusiastic about Europe right now – indeed, most see it as a ticking time bomb – tells you that sentiment is entirely negative.

How about valuations? Those are compelling, too. The benchmark MSCI Europe Index, for example, currently sells for just 9.8 times estimated 2012 earnings, versus an average of 17 times earnings over the past 25 years. Plus, the drop in prices has boosted the dividends on many of the well-known global companies based in Europe.

Lower Values, Higher Dividends…

In sum, you have low valuations, high dividends and extremely negative sentiment. Yet the vast majority of investors reading these words won’t plunk a dime in these markets. (And, if history is any guide, a year or two from now they’ll scratch their heads and say they just can’t fathom how European stocks could have rallied so strongly.)

Not that buying contrarian investments in this troubled region doesn’t present some risks. After all, the European Central Bank (ECB) is propping up troubled banks. Many Eurozone countries are teetering on the brink of recession. And there’s a decided lack of bold political leadership in the region.

But the good news is that all these factors are already well known and fully priced into European stocks. (That’s why they’re so darn cheap.) Meanwhile, the U.S. economy has stabilized – reducing a big risk to the global economy – and the ECB has at least addressed liquidity problems at the banks.

Plus, a weaker euro is actually boosting the earnings prospects for the many companies that export to other parts of the world where economic growth (and currencies) are stronger.

Prime examples are:

• Siemens AG (NYSE: SI),
• Nestle (Pink: NSRGY),
• Novartis (NYSE: NVS), and
• BMW (OTC: BAMXY.PK).

So how do you play this contrarian investment opportunity? One of the best ways is with a low-cost, Europe-focused ETF like the Vanguard MSCI Europe Fund (NYSE: VGK). It’s easily the least expensive ETF in the sector with annual expenses of just .14%.

Companies in the U.K. account for around 34% of VGK’s assets, while France, Germany and Switzerland make up approximately 40%. The fund holds more than 450 stocks, but a quarter of its $2.4-billion portfolio is in its top 10 holdings, which include Vodafone, Royal Dutch Shell and HSBC Holdings. You’ll earn a 4.4% dividend here.

If you want to benefit even more from a potential slingshot recovery in these markets, try the WisdomTree Europe SmallCap Dividend Fund (NYSE: DFE). It keeps a third of its assets in smaller British companies and the rest in small-cap stocks in the Eurozone.

Remember, when an equity market rallies, the small-cap issues generally outperform larger stocks. And your contrarian investment will get a whopping 5.8% dividend here.

So there you have it, two great ways to play one of the most compelling opportunities in the world right now. Of course, most investors simply cannot bring themselves to invest against the herd. That’s how they got stuck in internet stocks a decade ago and residential real estate five years ago.

It’s also why this is perhaps one of the best contrarian investment opportunities today.

Good Investing,

Alexander Green

The Best Buy Signal of 2012

The Best Buy Signal of 2012

by Alexander Green, Investment U Chief Investment Strategist
Monday, January 02, 2012: Issue #1677

Investors are scared right now and it’s not hard to see why.

Economic growth is anemic. Unemployment is high. Banks are saddled with toxic assets. Problems in the Eurozone continue to fester. Residential real estate is sinking in a mire of short sales and foreclosures. And both federal and state governments – not to mention consumers themselves – are drowning in a sea of red ink.

We have all heard these negatives repeated daily and cycled endlessly in the national media.

However, these reports often leave out or play down the good news: Inflation is low. Short-term rates are near zero. Energy and food prices are declining. Emerging market economies – which are end markets for the developed world – are still booming. Corporate profits are at an all-time record – and have been for seven quarters now. And stock valuations are low. (The S&P 500 has historically traded at an average of 16 times earnings. Today it’s less than 14 times earnings.)

Last year I shared another key insight with you. It has always been a positive indicator for stocks when the Dow yields more than Treasury bonds.

This makes sense when you think about it. Shares are riskier than bonds. Investors should demand a higher yield. Yet almost never since 1958 have stocks yielded more than Treasuries. Today they do, however. The 10-year bond yields just two percent. The Dow yields 30 percent more.

If you’re still not convinced that equities are a good place to be in 2012, let me draw your attention to one of the strongest indicators of all…

Contrarian Investing Works

It’s a truism that no one consistently predicts the stock market. (That’s why money manager and Forbes 400 member Ken Fisher calls it “The Great Humiliator.”) However, there’s a straightforward system that offers a reasonable prospect of timing the market reasonably well in the future.

A 25-year study published last year in The Journal of Financial Economics found that if you had simply invested in the S&P 500 when equity fund flows were negative (redemptions exceeded new investments) and into 90-day Treasury bills when fund flows were positive (new investments exceeded redemptions) you would have substantially outperformed the market while spending nearly half the time in riskless T-bills.

In other words, contrarian investing works. This system would have you do the very inverse of what the great mass of investors is doing. (It turns out they have god-awful instincts, so it pays to buck the consensus.)

Bear in mind, if you’d followed this system, you wouldn’t just have earned higher returns than being fully invested. You would have done it with far less risk, spending nearly half the time in riskless T-bills.

I mention this because the Investment Company Institute recently reported that investors are yanking billions out of equity funds virtually every week and pouring the money into ultra-low-paying money market accounts. The Wall Street Journal further reports that “investors have continued to consistently pull money from U.S. equity funds since August.”

I’m trying to contain my glee. Who says no one rings a bell in the stock market?

The fear and pessimism about both the economy and the stock market are way overdone and fully discounted in current stock prices. If you can’t be stirred by low interest rates, low inflation, low valuations and record profits, you really should ask yourself two important questions:

1. Is logic or emotion governing my decision making about my portfolio?

2. If I don’t invest in stocks – the greatest wealth creator of all time – how am I going to meet my long-term financial goals?

We’ll talk more about these issues in the weeks ahead. But, for the record, I think 2012 will be a good year for the stock market and – although virtually no one expects or believes it – perhaps even a barnburner.

Good Investing,

Alexander Green