3 "Close-to-Perfect" Stocks

05/01/2012 8:15 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Trying to be perfect is different than being perfect, and these stocks are as close as you can come in a market that is far less than perfect, writes Richard Moroney of Dow Theory Forecasts.

The search for the perfect stock is a bit like the search for spiritual enlightenment—tough to achieve on this earth, but almost certainly worth the effort.

Relentlessly looking for the best available stock will keep you engaged in the trends driving the economy and corporate profits, and force you to consider the merits of stocks you already own. Even if you keep all your money in index funds, your market outlook will be better informed if you regularly appraise the prospects of the best-positioned stocks.

If you do invest in individual stocks, remember that finding five or ten or 25 perfect stocks is better than finding one. Spreading your bets among a basket of stocks you truly love will lower your portfolio’s volatility without lowering expected return. More important, diversifying will allow you to focus on a stock’s prospects—and not let your decision-making process be dominated by the impact of share-price movements on your net worth.

Also remember that you can’t always get what you want. Finding a single perfect stock is very difficult, so the best investors learn to compromise, aiming for perfection but doing what’s necessary to build a diversified portfolio. While academics say you need at least 30 to 50 stocks, our Focus List of 12 to 17 stocks strikes a nice balance between diversification and keeping your money in your best ideas.

Even 12 to 17 names are too many for some of our subscribers. We recently selected our favorite year-ahead picks for an advertising campaign, and below are a few of those; none have everything we're looking for, but they all have more than most stocks.

Aetna (AET)
The health insurer reported 0.4% sales growth for the December period, its first positive year-to-year comparison in seven quarters. But the health insurer’s profit margins have widened steadily because of declining medical-utilization rates, allowing for eight straight quarters of at least 9% growth in per-share profits.

March-quarter profits per share, due April 26, are expected to be down 3% despite 4% sales growth. But the consensus reflects Aetna’s fairly downbeat guidance on medical costs, and the company has a history of conservative forecasts.

The stock seems unduly cheap at nine times expected 2012 earnings—especially considering the potential for much better-than-expected results this year.

Agilent Technologies (A)
This company has a history of volatile results, though it has posted higher sales and operating income in four of the last five years.

April-quarter sales and earnings are expected to be roughly flat, ending an eight-quarter streak of robust growth. Growth is likely to accelerate in the July and October quarters, and Agilent seems cheap at 14 times trailing earnings.

The stock trades at a discount relative to both the electronics and the life-science groups—and relative to its own three- and five-year norms.

Intel (INTC)
The chipmaking giant does not have the earnings momentum of a typical Focus List selection, partly because its profit margins have narrowed over the past 12 months. Per-share earnings were down 3% on flat sales for the March quarter.

But growth seems likely to rebound in the second half of 2012, and consensus estimates for the full year are rising. Cash flow has been rising steadily, allowing Intel to ramp capital spending while maintaining an aggressive share-repurchase program.

At less than 12 times expected current-year earnings, Intel trades at a big discount to the semiconductor group and its own five-year norm.

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