Portfolio Strategy Weekly Audio: Time to Focus on ROE A Stable Growth Update

Transcription

1 Portfolio Strategy Weekly Audio: Time to Focus on ROE A Stable Growth Update A 5 Minute Audio Brief Chris Senyek, CFA, CPA Head of Macro Research Chief Investment Strategist CSenyek@wolferesearch.com Chip Miller, CFA, CPA CMiller@wolferesearch.com Adam Calingasan, CFA, CPA ACalingasan@wolferesearch.com February 24 th 2015 DO NOT FORWARD DO NOT DISTRIBUTE This report is limited solely for the use of clients of Wolfe Research. Please refer to the DISCLOSURE SECTION located at the end of this report for Analyst Certifications and Other Disclosures. For Important Disclosures, please go to or write to us at Wolfe Research, LLC, 420 Lexington Avenue, Suite 648, New York, NY 10170

2 Pushing Out the Biggest Risk to our Bullish Call We remain confident that rising global liquidity will result in additional dollar strength, low and range bound interest rates, and higher stock prices in the months ahead. Last week s most important development was more dovish than expected January FOMC minutes, which reduced one of the key risks to our bullish market view. Fed Funds Futures: Implied Interest Rate Probabilities Rate Hike Expectations Were Pushed Out Last Week This Reduces the Biggest Risk to Our Bull Case Notes: We classify the market cycle based upon the rate of change in a three month moving average of the Conference Board s Leading Economic Index. We have made some manual adjustments around the mid-90 s EM crisis and 1998 Russian debt crisis, given the market began to look through economic weakness much sooner than usual during these time periods. Notably, we have made no adjustments to our framework for the late-90s TMT bubble or around the Financial Crisis. Sources: Wolfe Research Portfolio Strategy, Standard & Poor s, Compustat, Thomson Financial, and FactSet. 2

3 Risk Spreads Also Falling As oil has stabilized and as the global growth outlook has modestly improved, important measures of market risk/stress have fallen in recent weeks. Sources: Wolfe Research Portfolio Strategy, Bloomberg, Standard & Poor s, Compustat, Thomson Financial, and FactSet. 3

4 Key Investment Themes Currently one of our favorite thematic ROE baskets is our Stable Growth screen, which has been the second best performing stock theme that we track year-to-date. Notes: Market data as of 2/19/2015. Sources: Wolfe Research Quantitative Research, Standard & Poor s, Company filings, Bloomberg, and FactSet. 4

5 BUY STABLE GROWTH COMPANIES Most of our favorite early forward indicators, such as the ZEW U.S. Economic Expectations index, strongly suggest that U.S. growth is decelerating; and (2) U.S. economic surprises have turned decidedly negative over the past five weeks. However, we believe rising global liquidity and the positive effects of lower oil (on spending) will minimize further downside risk to growth in Our favorite early forward indicator the U.S. ZEW strongly suggests decelerating growth ahead We re not calling for the end of the cycle Sources: Wolfe Research Portfolio Strategy, Standard & Poor s, Bloomberg, Compustat, Thomson Financial, and FactSet. However, we remain confident in our below consensus 2015 U.S. GDP forecast of 2.5% 5

6 Rising ZEW Suggests Rising Market ROE The rebound in ROEs should be supportive of multiple expansion in the quarters ahead. Sources: Wolfe Research Portfolio Strategy, Standard & Poor s, Compustat, Thomson Financial, and FactSet. 6

7 ROE Should Outperform ROE factor performance really begins to kick into gear in the Early Deceleration phase of the market cycle. Buying High ROE Companies Generates Alpha Over Time The Factor Really Starts Working in Early Deceleration! Notes: We classify the market cycle based upon the rate of change in a three month moving average of the Conference Board s Leading Economic Index. We have made some manual adjustments around the mid-90 s EM crisis and 1998 Russian debt crisis, given the market began to look through economic weakness much sooner than usual during these time periods. Notably, we have made no adjustments to our framework for the late-90s TMT bubble or around the Financial Crisis. Sources: Wolfe Research Portfolio Strategy, Standard & Poor s, Compustat, Thomson Financial, and FactSet. 7

8 ROE Decomposition Looking at component trends for the overall market, it becomes clear that there s probably the most upside from asset turnover and leverage rebounding from historically low levels rather than additional margin expansion, lower interest expenses, or falling tax rates (outside of a comprehensive tax reform deal). Sources: Wolfe Research Portfolio Strategy, Standard & Poor s, Compustat, Thomson Financial, and FactSet. 8

9 Stable Growth Companies High ROEs (top quintile within sector); (2) growing EPS at least 10% in each of the past 3 years; and (3) relatively low sensitivity to historical bouts of emerging markets volatility. Ticker Company Sector Market Cap. ($ in millions) LTM Total Return SIM Score [1 = best; 5 = worst] SBUX Starbucks Corp. Cons. Disc. 70,337 29% % 9.3% 1.2% 29.8x -1% 23% ROST Ross Stores Inc. Cons. Disc. 20,138 46% % 45.0% 1.8% 22.5x 3% 0% ORLY O'Reilly Automotive Inc. Cons. Disc. 21,863 32% % 23.8% 5.6% 23.9x 4% 0% UA Under Armour, Inc. Cons. Disc. 15,682 40% % 0.2% 7.7% 68.1x 0% 6% DLTR Dollar Tree, Inc. Cons. Disc. 16,144 49% % 29.3% 6.7% 24.7x 4% 0% TSCO Tractor Supply Co. Cons. Disc. 11,819 34% % 21.2% 4.1% 28.6x 2% 0% PETM PetSmart, Inc. Cons. Disc. 8,593 29% % 14.9% 2.5% 18.8x 6% 6% KR The Kroger Co. Cons. Staples 47,002 87% % 31.9% 1.8% 21.4x 4% 0% SAM Boston Beer Co. Inc. Cons. Staples 4,005 36% % 45.5% 11.0% 39.1x 0% 0% TRV The Travelers Companies, Inc. Financials 40,583 31% 1 NA 14% 15.3% 2.5% 11.3x NA 4% RE Everest Re Group Ltd. Financials 8,690 22% 1 NA 15% 6.9% 4.1% 9.5x NA 44% JLL Jones Lang LaSalle Inc. Financials 7,387 35% 4 NA 18% 14.0% 1.9% 18.1x NA 56% WRB W.R. Berkley Corp. Financials 7,696 27% 1 NA 16% 10.2% 3.1% 14.4x NA 0% OHI Omega Healthcare Investors Inc. Financials 7,768 37% 2 NA 18% 18.7% 10.0% 23.9x NA 0% PRAA Portfolio Recovery Associates Inc. Financials 4,043-10% 4 NA 21% 12.5% 25.0% 11.4x NA 1% AMGN Amgen Inc. Healthcare 122,474 29% % 28.2% 0.9% 16.8x 6% 22% BIIB Biogen Idec Inc. Healthcare 92,610 21% % 1.3% 1.3% 23.9x 3% 30% MCK McKesson Corp. Healthcare 60,347 29% % 11.2% 0.6% 20.8x 4% 8% ALXN Alexion Pharma, Inc. Healthcare 35,510 3% % 7.1% 1.5% 31.4x 1% 58% ILMN Illumina Inc. Healthcare 29,229 17% % 13.6% 1.5% 63.4x 1% 50% CAH Cardinal Health, Inc. Healthcare 29,648 23% % 14.1% 1.2% 19.9x 5% 3% EW Edwards Lifesciences Corp. Healthcare 13,453 96% % 51.0% 0.6% 31.8x 8% 54% HSIC Henry Schein, Inc. Healthcare 13,100 20% % 17.1% 2.9% 23.9x 4% 39% PCYC Pharmacyclics Inc. Healthcare 12,387 22% % 22.0% 8.5% 121.8x 1% 0% PRXL PAREXEL Int'l Corp. Healthcare 3,511 17% % 10.4% 7.2% 23.0x 8% 45% UNP Union Pacific Corp. Industrials 117,878 40% % 19.7% 0.8% 18.6x 3% 10% HON Honeywell Int'l Inc. Industrials 81,674 14% % 6.8% 0.7% 17.2x 5% 41% RHI Robert Half Int'l Inc. Industrials 7,983 54% % 16.9% 2.1% 23.0x 4% 24% FLT FleetCor Technologies, Inc. Info. Tech. 16,684 30% % 2.1% 1.3% 25.5x 4% 30% TSS Total System Svcs, Inc. Info. Tech. 8,208 28% % 5.0% 1.7% 17.1x 6% 32% JKHY Jack Henry & Associates Inc. Info. Tech. 5,440 17% % 6.3% 0.9% 25.2x 6% 0% MMS MAXIMUS, Inc. Info. Tech. 3,727 25% % 30.6% 1.3% 24.9x 5% 25% TYL Tyler Technologies, Inc. Info. Tech. 3,731 20% % 14.5% 3.2% 48.6x 3% 0% GPK Graphic Packaging Holding Co. Materials 7,006 52% % 13.5% 2.0% 20.7x 5% 11% ITC ITC Holdings Corp. Utilities 10,225 17% % 20.0% 2.6% 19.0x -1% 0% Notes:*SIM = our proprietary Stock Idea Model, filter is 1500 largest US market cap. Companies, top quintile highest ROCE, minimum 20 earnings quality (out of 100), 3 years >10% LTM EPS growth and below average EM volatility sensitivity. Below average EM volatility sensitivity defined as outperforming the S&P 1500 on average during EM volatility spike periods in last 4 years. Sources: Wolfe Research Portfolio Strategy, Standard & Poor s, Company filings, Bloomberg, and FactSet. Market data as of 2/19/ Q14 EQ Score ROCE 6 Mo. Undiversified Return Short Interest / Float % 2015E P/E LTM FCFF Yield Foreign Sales 9

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