Try To Remember The Kind Of September . . .
As stocks exited the summer of 2014, the S&P 500 Index marked the year by closing at 2014. It backed off and is now around 1972; resumed momentum and September quarterly earnings reports should send it back by yearend above 2014 and probably through 2100. Despite recent selling, this index is still up 7% year-to-date and 2100 would be a 13% gain for the full year, a realistic goal if quarterly earnings can meet their current estimates.
Last quarter’s results were certainly encouraging. The 500 companies in the S&P 500 reported results up 8% on revenues over 4% with 65% beating earnings estimates. The estimated earnings growth rate for the quarter about to end is 6.2%. The 12-month forward P/ E ratio is 15, slightly above average; increasing earnings results would moderate this figure.
The energy sector recorded the largest dips in expected earnings growth with substantial reductions to earnings estimates coming from companies like Peabody and Noble Energy. The International Energy Authority cut its forecast for world rises in oil demand for the third month in a row, citing economic weakness in Europe and China. Meanwhile, growing supplies from shale oil in the U.S. are bringing new resources to market. Geopolitical disturbances add considerable uncertainties to energy price prospects, however, short-term decreases in expected earnings and longer-term increases in supply weaken the complacent assumptions that once underlay investments in energy stocks.
The largest increases in expected earnings growth come from the Health Care stock sector. Advanced medical stocks include Biogen (BIIB-$346), which raised its quarterly estimate from $3.01 to $3.45. This leading biotech is now looking at earnings exceeding $13 for 2014, up over 40% from last year. It’s a continuing buy in my portfolios as are Amgen (AMGN-$142), Celgene (CELG-$96) and Jazz Pharm. (JAZZ-$165).
The Telecom sector ranks high in expected earnings growth but this is entirely attributable to Verizon (VZ-$50). The mean estimate for Verizon Q3 2014 earnings is $0.93, up 21% from Q3 2013. Its estimate for the full year is for $3.55, a quite reasonable P/E of 14. Its 4.2% dividend yield with nine straight years of dividend increases makes it especially suitable for retirement accounts.
My newest recommendation seems less suitable for retirement accounts. Alibaba (BABA-$90 brought the September quarter to a ringing close with a remarkable initial public offering that raised $25 billion for China’s largest e-commerce company. The IPO valued Alibaba at $220 billion, more than Facebook or Amazon, for example.
It is a holding company that owns China’s version of eBay and another higher line online shopping network for major brands. Alibaba also owns a business-to-business commerce site and a cashless payment system similar to PayPal. As an excellent article in the current New Yorker points out, its success comes not from any breakthrough technology but rather through the explosive network effects that the Internet offers to early entrants and market leaders.
Morgan Stanley, Goldman Sachs and Alibaba’s four other lead underwriters priced its IPO at $68. Its stock price promptly popped to around $90, a moderate rise indicating a nicely priced IPO. Investors should not shed tears for missing the IPO as shares were available only to very substantial clients of these underwriters, particularly those who had previously participated in IPO’s.
Alibaba is trading at about forty times analysts’ estimates of 2015 earnings. That’s not cheap but it has hundreds of millions of active users in a country with twice the number of Internet users as this one. Its ownership structure is convoluted, essentially vesting control in its ubiquitous founder, Jack Ma. This concentrated control led the Hong Kong stock Exchange to reject its plans for an IPO there. The New York Stock Exchange seems to have modified its once haughty standards.
A hot IPO for an Internet stock might revive memories of the Internet bubble of 1997-2000 when the NASDAQ average doubled in a year. At the peak in 2000, there were 371 publicly traded Internet companies with a collective value of $1.7 trillion, most of which evaporated as over half these dot.com companies disappeared.
The majority never made a profit and died after burning through their venture capital. In contrast, Ali Baba in its latest quarter had about two and a half billion dollars in revenues and generated about two billion in profits, more than all the dot.com bubble companies combined.
These results show that Alibaba is hardly a bubble stock. The vast potential of the Chinese consumer market provides room for further growth. Investors should remember that the Federal Reserve’s last rate change was its tenth decrease in a row. The next change is expected to be an increase sometime in 2015, its first increase since the financial crisis.
Rates will likely remain near historic lows for some time but a future return to “irrational exuberance” would prompt the Fed into further rate increases. Such actions accompanied the end of the dot.com bubble when the Fed raised rates six times from 1999 to 2000. Although we are at least two or three years away from any sustained series of rate increases, investors should remember Mark Twain’s comment, “History doesn’t repeat itself, but it often rhymes.”
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 1995. [email protected] 949.494.1376/800.697.2622