Over the holidays, I decided to drive to Orlando and give the Walt Disney Co. (NYSE: DIS) a few of my hard earned dollars. My 12 year-old son talked me into riding the Tower of Terror at Disney’s Hollywood Studios.
As a thrill ride, the Tower of Terror plays on three of humankind’s most basic fears: falling, the unknown and the dark. I wasn’t that concerned. In the investment biz, that’s just another day at the office.
But when it comes to the investing, I’ll be honest. I am a concerned about the stock market in 2015.
Here’s why: It’s all about earnings.
At the end of the day, an investor should buy a stock based on the underlying company’s ability to deliver quality, consistent earnings. Those earnings should also be purchased at a fair-to-discounted price as measured by a stock’s price-to-earnings ratio (PE).
In more bullish times, investors are sometimes a bit too optimistic about the future and will push stock prices and their attached PE’s higher. In bearish times, they often become too pessimistic and drive prices and PE’s down.
I took notice after working on this chart of peak PE ratios for the SP 500 Index.
The way the picture tells the story, we’re overly optimistic and at the same valuations as before the 2008-2009 crash.
So are we so positive? The current numbers don’t indicate a profoundly bullish market in 2015.
Consensus estimates for the SP 500's 2015 EPS are around $125. In 2014, the SP saw EPS at around $117.
If things go according to plan, the market would see EPS growth of about 6-to-7%. Curb your enthusiasm.
On a forward basis, that would put the market’s PE at around 16-to-17. While that’s not too terribly expensive historically, I question the earnings growth.
Although 5% isn’t bad, it does seem a bit anemic. I’d rather own stocks with earnings growth 400% better than the overall market’s with lower forward PE’s.
I’ve found three that are worth further research:
Olin Corp. (NYSE: OLN)
Like Warren Buffett, I like solid, consistent businesses that are easy to understand. Olin hits it on the screws in that department.
The company makes two things: Chlor Alkali products (chlorine and related stuff) and Winchester ammunition. While Olin falls into the diversified chemicals sector, its business is so focused that the stock is a little less vulnerable to the economic cyclicality of the sector as a whole. Chlorine is in damn near everything and Winchester is a solid brand in both the civilian retail and government market.
The stock trades around $22 with a forward (2015) PE of 12. Earnings per share for 2014 are estimated at around $1.40. In 2015, EPS is expected to rise 25%, to around $1.75 a share. The stock has an attractive 3.6% dividend yield and the company balance sheet is in good condition with a manageable debt-to-income ratio of 37%, which is nearly 20% lower than its peer group.
The Blackstone Group LP (NYSE: BX)
When it comes to the private equity business, Blackstone is the 900-pound gorilla. Yet the stock is one of the cheapest I’ve seen in a while.
The firm is a world-class fund raiser for private equity transactions. It also manages a private equity and real estate portfolio worth more than $200 billion and provides advisory services.
For 2014, EPS are expected to be $3.20. The 2015 forecast estimates a 15% increase, to $3.70. That puts Blackstone’s forward PE at just 10.3 based on a $33 unit price.
The 5.8% dividend yield should be in good shape thank to the cash generated by the spinoff of its investment management division. I profiled the company recently here.
Ford Motor Co. (NYSE: F) – After profiling the automaker last year, some of the best economic tailwinds have filled the company’s sails. U.S. economic growth combined with sub $2 per gallon gasoline should result in strong demand for the newly belled and whistled Ford F-150 truck.
After weathering the financial crisis of 2008 remarkably -- thanks mainly to prudent financial management and family stewardship -- Ford has emerged as one of the best of the "Big Three" automakers.
The beefed up product and pricing power should flow through to the bottom line. After pre-announcing softer 2014 EPS of $1.12, profits are expected to rebound nicely to EPS of $1.62 for 2015, which translates into a stellar 45% pop in earnings growth. At around $15 a share, that puts the 2015 forward PE for the stock at just 9.25. The 3.3% dividend yield is also a nice bonus.
Risks To Consider: The biggest risk facing all three names is macroeconomic headwinds. Diversified chemicals, financials and autos are three extremely, economically sensitive sectors. The best defense these stocks offer are their low valuations relative to the broader market.
Action To Take -- As a basket, these three stocks are expected to grow EPS by an impressive 28% -- nearly six times the expected EPS growth rate for the SP 500.
The average forward PE based on 2015 EPS projections is an extremely cheap 10.5. That’s a 57% discount to the market’s forward PE. I think that’s a much safer bet going into the New Year.
If these companies can continue to turn in solid operating results, then PE expansion to 14 -- still cheap relative to the benchmark -- is an easy target. The result, combined with a blended dividend yield of 4.2%, would be a total return in excess of 35%.
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