Taking Stock

Tony Crowell

The Year Of The Dragon

The Chinese New Year approaches, bringing in the Year of the Dragon, said to be a deliverer of good fortune. Stocks are anticipating this, up over four percent in the first three weeks of 2012. That’s over four percent better than they did last year, going nowhere after substantial swings both up and down.

It may be that investors have become accustomed to threats from dragons breathing flames of debt default, European currency collapse and political campaigns, predicting the end of the world. These issues each have their roots in excessive debt levels, solvable problems, given time and rationality.

Investor behavior is often irrational, as seen in exaggerated panic trading in overreaction to these threats. Economic recovery rather than austerity is the solution and there are growing signs that this is underway, particularly in the U.S., despite opposition political efforts to strangle it.

All the sound and fury of 2011 knocked stocks down to quite reasonable valuations. Overall corporate earnings continued to increase while stock prices went nowhere. Investors remain sensitive and the current wave of quarterly earnings reports will impact individual stock movements.

The S&P 500 trades for 13 times earnings, down from 15 a year ago and 19% less than its average since 1960. With interest rates still near record lows, this provides a reassuring margin of safety for investors in stocks. Dividend yields that are considerable higher than fixed rate investments are another plus factor, especially from companies that have developed the habit of regularly increasing them.

Big cap pharmaceutical companies fit this profile nicely. Once growth fund favorites with price: earnings ratios above 30, they fell from favor with increasing costs and uncertainties of new drug developments. Bristol Myers (BMY-$33 weighs in at 16 times earnings with modest growth in sales and earnings in the low single digits. It yields 4% with dividend increases in the past two years.

Novartis (NVS-$58) is trading at only 10 times earnings, possibly due to its European locus. It is based in Switzerland, hardly the home of a weak currency. Growth is above 10%. It also pays 4% and has increased its annual dividend for the last five years. Merck (MRK-$39) also yields 4%. Earnings for 2011 will come in around $3.75, another reasonable P/E of only 10.

All three of these produced returns, including dividends, well ahead of the general market last year. Should investor confidence continue to build, more cyclical stocks like industrials may be favored and these steady drug stocks may lag. They should be held and additional buys will be particularly favorable when made on the usual emotional overreactions to transient headline news.

Last week, I discussed Transdigm (TDG-$98) as an excellent example of a growing industrial company. It makes engine sensors, overhead bin latches and lighting systems for the world’s airliners. About 75% of its sales come from components for which it is the sole supplier. Sales were up 54% in the latest quarter. Its P/E is 18 but growth is faster.

Fastenal (FAST-$45) is a new buy recommendation. This Minnesota-based company makes, distributes and sells every conceivable type of bolt, nut, screw and related construction material. It has 2,500 retail locations in the U.S. and a dozen other countries. Sales are $2.8 billion, growing at 21%, with earnings are growing even faster, headed for $1.40-$1.43 per share for 2012.

That’s a P/E of 32, but its growth justifies that valuation. Yield is 2% with increases for two years. Unlike the overpaid officers of the financial institutions that have caused so much trouble, Fastenal’s CEO started with a part-time warehouse job and worked his way up.

Solid values lead to solid results that do wonders to slay dragons that hamper investor returns. Two other portfolio companies, IBM (IBM-$180) and Intel (INTC-$25), just reported their quarterly results as I write. They beat estimates and their stocks are up, as I believe our portfolios will be in this New Year.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. [email protected] 949.494.1376/

800.697.2622 www.crowellroberts.com

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