CWS Market Review – October 21, 2011

The stock market continues to improve albeit in a hesitating manner. Last week, the S&P 500 broke above its 50-day moving average and this past Tuesday, the index closed at its highest level in two-and-a half months.

So has the bear finally left us alone? Unfortunately, it’s too early to say. The market is stronger than it was but there are still plenty of hidden—and not-so-hidden—risks out there. The problems in Europe are still bad but at least the authorities finally realize that they can no longer drag their lederhosen. For now though, all eyes are on the third-quarter earnings season which is now in full swing.

In this issue of CWS Market Review, we’ll take a closer look at earnings season. So far, all four of our Buy List stocks that have reported have topped expectations. I’m happy to report that our Buy List is leading the rebound. In the last 13 trading days, our Buy List has gained more than 11.3%. If this keeps up, 2011 will be our fifth-straight year of beating the overall market. As usual, prudence and patience have served us well.

Now let’s look at the most exciting news this week which was the break-up announcement of Abbott Labs ($ABT). The company stunned Wall Street on Wednesday when they said that they’re breaking themselves into two separate companies: a drug business and a medical devices business. I’ve long been a fan of ABT. This company throws off tons of cash and has a solid balance sheet.

The problem for Abbott (and what attracted me to it) is that the market is clearly wary of giving their drug business a decent valuation. Humira, Abbott’s blockbuster rheumatoid arthritis drug, will rack $6.5 billion in sales this year. But there are fears that competitors will move into that space and knock the legs out from under Humira.

Due to these worries, the entire company’s valuation has suffered. But as I’ve noted before, Abbott is much more than Humira. They have a strong business in medical devices which hadn’t been getting the market love it deserves. So Abbott did the logical step and announced the break-up. Interestingly, it’s the medical devices business that will keep the Abbott name. That probably tells you where the priorities lie.

The spin-off will happen sometime next year so it won’t impact this year’s Buy List. As a general rule I like spin-offs, especially when good companies do them. What often happens is that a highly profitable division feels that it has to “carry the weight” of a larger organization. Once the division is unmoored from its parent company, it’s able to be more flexible and find new areas of growth.

Also on Wednesday, Abbott reported third-quarter earnings of $1.18 per share which was a penny more than estimates. Abbott narrowed their full-year guidance from $4.58 – $4.68 per share to $4.64 – $4.66 per share. That means the stock is going for 11.6 times this year’s earnings which is less than the overall market. The full-year range implies a Q4 range of $1.43 to $1.45 per share which is a nice jump over the $1.30 per share from last year’s Q4.

Shares of Abbott responded positively to the break-up news and the stock currently yields a healthy 3.55%. For the year, Abbott is a 12.82% winner for us which is a lot better than the market’s loss of 3.36%. I congratulate Abbott on their bold move and I rate the stock a strong buy up to $58 per share.

Two other healthcare companies of ours reported earnings this past week. On Tuesday, Johnson and Johnson ($JNJ) reported earnings of $1.24 per share. This beat Wall Street’s consensus by three cents per share but was a penny less than my forecast. The bottom line is that this was another solid quarter for J&J.

In last week’s CWS Market Review, I said that JNJ could raise both ends of their full-year forecast by five cents per share. Well, I was half right. The company raised the low end of its forecast by a nickel per share. The new EPS range for 2011 is $4.95 – $5.00 per share which implies a Q4 range of $1.08 – $1.13.

The share price dropped a bit on the news but not too badly. JNJ continues to do well. This is a very well-run firm; Johnson & Johnson is a good buy up to $67 per share.

The other healthcare stock to report was Stryker ($SYK). After the close on Wednesday, the company reported earnings of 91 cents per share which was two cents better than estimates; plus Stryker raised their full-year guidance. The new guidance is $3.70 – $3.74 per share which is up from $3.65 – $3.73 per share. That implies a Q4 range of $1 – $1.04 per share.

Last week, I wrote that I like Stryker but that it would be better at a cheaper price. Sure enough, the stock dropped on the good earnings report. Stryker closed Thursday at $48.28 which is a decent price (less than 13 times this year’s earnings). However, if you’re able to get Stryker below $45, you’ve gotten a very good deal.

The upcoming week will be a very busy week for us; we have five Buy List stocks reporting earnings. On Tuesday, Reynolds American ($RAI) reports. Then on Wednesday, AFLAC ($AFL) and Ford ($F) are due to report. Finally on Thursday, Deluxe ($DLX) and Gilead Sciences ($GILD) will report.

The one I’ll be watching most eagerly is AFLAC ($AFL). Simply put, the selling of AFLAC shares reached ridiculous levels over the last several weeks. At one point, the stock was trading at $31.25 though the company has told us repeatedly that it expects to earn between $6.09 and $6.34 per share in operating earnings this year.

Well, Wednesday will be the time of reckoning. In the last earnings report, AFLAC said that it expects Q3 operating earnings to range between $1.54 and $1.60 per share. My numbers say that’s too low. I think AFLAC can easily make $1.64 per share. They may also have good things to say about next year as well. I’m going to raise my buy price for AFLAC to $43 per share.

Three months ago, Reynolds upset Wall Street when it missed earnings by four cents per share (which I suspected would happen). That was pretty unusual for Reynolds but the stock has recovered very nicely. The current estimate for Q3 is for 73 cents per share which seems about right.

The other earnings report to watch will be from Ford. The company is fundamentally very sound despite the stock’s poor performance this year. I’m also pleased to see that the latest union contract has been approved. Wall Street currently expects Ford’s third-quarter earnings to come in at 45 cents per share which is below the 48 cents per share from the year before. I think there’s a good chance here for a large earnings beat.

That’s all for now. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on October 21st, 2011 at 8:15 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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