There is a certain optimism that lies at the heart of both New Year's resolutions and annual investment forecasts for the coming year. With the former, that optimism is based on the belief that we can muster the self-discipline and willpower that were lacking in the past. As for the latter, the optimism comes from thinking that we will be possessed with greater insight to make more profitable investment decisions. Both resolutions and forecasts are steeped in the illusion that turning a page on the calendar makes all of this easier, that maybe some special door to redemption opens wider when the clock strikes midnight on New Year's Eve. Another chance to adopt healthier habits or realize higher returns. Perhaps the true benefit of both exercises is that they lead us to acknowledge what we need to change, either in our lives or in our portfolios. When we are filled with the conviction of optimism, anything seems possible. Let the glass be half full for a few weeks, until we feel compelled to drink it empty.
This is the time of year when investment analysts and market prognosticators of all stripes roll out their lists of "best ideas" for the coming year. We'll take a look at some of those stock ideas, especially in light of how they fit with various economic and business trends that have been in place for some time now. First, let's take a short look into the rear view mirror at the year we are leaving behind.
Looking Back at 2011
As Bette Davis, playing Margo Channing in the 1950 movie All About Eve, famously said, "Fasten your seat belts. It's going to be a bumpy night" (often misquoted as "bumpy ride"). That quote would have made for an apropos prediction one year ago for the bumpy days and sleepless nights of 2011--about 365 of them. Consider the stock of Disney (DIS, $37), a stock I own as a long-term core holding, as an example. DIS is up close to 20% over the past three months, which is great. If we look back over the entire year, however, DIS is essentially unchanged, now trading at where it began 2011. That tells the story of how the overall market has behaved, with the S&P 500, a broad measure of the market, virtually unchanged over the last year. The Dow Jones Industrial Average (DJIA, 30 stocks) has fared better, up about 6% for the year, with McDonalds (MCD, $99) as the top performer, up 30%. Why McDonalds? That's worth keeping in mind as we look at some investment trends and themes that may extend into 2012. McDonalds has been in what I think of as the "sweet spot" that combines a larger trend with flawless execution by the company's management. MCD offers cheap, fast food (though probably not on your New Year's resolutions menu), and that's important in an economy where so many consumers are price-conscious. They are also effectively pursuing their ambitious plans for international expansion. We want to find other companies that may be positioned in such a sweet spot. As Mark Twain once noted, "History does not repeat itself, but it does rhyme."
The "Tale of Two Cities" Economy
Economic pundits and editorial writers have been telling us for some years now that the middle class in America is disappearing, due in part to the off-shoring of manufacturing, once the source of so many well-paying blue collar jobs. What gets my attention is when I see a major corporation investing real money to adapt to the trend. That is apparently what Proctor and Gamble (PG, $66), maybe the world's greatest marketing company, is doing. In a Wall Street Journal article from September 12, 2011, "As Middle Class Shrinks, P&G Aims High and Low," Ellen Byron details how the company, which has historically excelled by marketing its range of products to a vast American middle class, now is gearing certain of its products to the lower-end consumer and other brands to a separate higher-end consumer as the big middle evaporates. When P&G puts money behind it, you know there is more here than just a cyclical downturn in the business cycle. In an earlier post we looked at the discount stores (Ross Stores, TJ Maxx, and Dollar Tree), but there is another side to the tale, and that is the resilience of the high-end luxury market.
Coach (COH, $61), the retailer of luxury accessories for women and men, is a company that is successfully executing a global expansion strategy, especially in Asia. I would also consider Whole Foods Market (WFM, $70) as part of the high-end space, along with Hain Celestial Group (HAIN, $37), which makes natural and organic food and personal care products sold at places like Whole Foods. A trip to WFM might even be on your New Year's resolutions list, but even if you don't stick with healthier eating habits, this is a major trend that is likely to be in place for quite some time.
The New World of Energy
No, this is not about solar energy or wind power, two of the so-called "renewable energy" themes. This is about the same old oil and gas that's been in the ground and new technologies for getting it out. Through a process known as hydraulic fracturing ("fracking"), drillers can break up the rock in which oil and gas deposits are trapped. That's a big deal, because those trapped deposits have been inaccessible until the advent of the new technology. Fracking involves shooting massive amounts of water mixed with certain chemicals to break up the rock, and this has environmentalists up in arms. (Personally, I think the environmentalists just plain don't like the oil and gas industry, period. Gandhi could be running Exxon and they still wouldn't like it.) From all that I have read on the subject, I have to conclude that the process is safe as long as there are reasonable safeguards in place to protect drinking water sources from contamination. The fracking occurs below the water table, anyway. Unlocking these sources of energy could mean thousands of jobs here in the United States and make us a net energy exporter for the first time in about 60 years. The implications are significant not just in the economic sense, but also in the geopolitical sense.
The other long-term theme here is the growing world demand for energy as economies around the world become more advanced and require more oil and gas.Who will benefit from the increased drilling activity? It's worth taking a close look at companies in the oil service sector, because more drilling means increased demand for their products and services. The blue chip company here is Schlumberger (SLB, $67), which provides technology and project management services to the international oil and gas exploration and production industry. A lesser-known company is National Oilwell Varco (NOV, $67), which manufactures and services the systems and consumables used in drilling. NOV has an impressive order backlog that goes out to 2014. My favorite of the major oil companies is Conoco Phillips (COP, $72), a global integrated energy corporation. COP recently announced the splitting of the company into an upstream (exploration and production) company and a separate downstream (refining) company. Moves of this nature can unlock value for shareholders, as the "sum of the parts" can be greater than the company is valued as a whole, single entity.
Shopping in Your Pajamas
I am sure there are still some people who think (mistakenly) of Amazon as a technology company. The truth, though, is that Amazon (AMZN, $173) is a technology company only in the sense that FedEx (FDX, $83) is an airplane company. The genius of both companies is that they used an existing technology (the Internet and airplanes) to totally remake their respective industries (retail and delivery). Online shopping is a major trend--no news flash there--and Amazon is chief among the many companies that are the beneficiaries of "pajama shopping." FDX and UPS (UPS, $73) will also benefit, because somebody has to deliver all those goodies. There are casualties as well, as there always are with what the economist Joseph Schumpeter called "creative destruction," and the brick-and-mortar bookstores are just the first among the companies that will either bite the dust or stagnate if they fail to adapt.
Being somewhat of a sentimentalist, I dread the prospect of having to someday explain to my grandson how people actually used to browse in something called "bookstores." I try to shop in such places whenever I can, but the stores are not doing much to help their own cause. A few years ago I went shopping at a local bookstore, and I was told by the sales person that the book I wanted was not in stock, but they could have it for me in two weeks. Two weeks! Had these people not heard of Amazon and FedEx? Just recently I was in the same bookstore and asked for the weekly edition of Barrons's. After a confused look from the clerk, I was directed to the Barron's educational series. If these retailers want to survive in real space instead of just cyberspace, they have got to think in terms of how their physical space can be a competitive advantage--top- notch customer service would be a nice start. One company that has figured this out is TJ Maxx (TJX, $65). Just take a look at their Website, http://www.tjmaxx.com. The company promotes a "treasure hunt" type atmosphere that derives from their business model of getting excess inventory of designer-label merchandise into the stores quickly. This drives their growing following of "Maxxinistas" into the stores frequently, and customers can post their latest finds on the company's Website. Look, someone got a Michael Kors bag for $149.99, was $248 retail. Let's go shopping--and I mean go literally, because you actually have to go there.(My wife and I were in TJ Maxx yesterday.)
Fifty-Seven Channels (and Nothin' On)
When Bruce Springsteen recorded that song, he wasn't being forward-looking enough. There are a whole lot more than 57 channels now, but he did get the part right about nothin' being on. Well, actually there is plenty on--just not that much worth watching. The point, though, is that something has to fill all of those channels, and that is why I have long held an interest in media content companies. My favorite company in this space is Disney (DIS, $37). In addition to the media assets that bear the Disney name, the company also owns ESPN, the ABC television network, Pixar Animation Studios, and Marvel Entertainment (Marvel Comics). Disney's total market capitalization (the market value of the entire company) is about $67 billion. To put that in some perspective, that is less than just the cash that Apple keeps in the bank. Another interesting company in this space is Viacom (VIAB, $45), which owns the Paramount film studio (which includes the Star Trek, Transformers, Mission Impossible, and Indiana Jones franchises), MTV, and Nickelodeon. Both companies own extremely valuable copyrighted assets, but the success of their stocks will depend on how adept they are at turning those assets into earnings. I think Disney's stock has a good shot at becoming the McDonald's of 2012.
The broad idea of content also includes video games. The two key players here are Electronic Arts (EA, $21), whose newest video game is based on Star Wars, and Activision Blizzard (ATVI, $12), known for Guitar Hero and World of Warcraft. The much smaller ($111 million market cap) Majesco Entertainment (COOL, $2.41) put itself on the map with the Zumba Fitness series. So, you can have yourself a little dance-fitness workout before heading to Whole Foods Market for some tofu--and you'll be keeping two New Year's resolutions!
I'll post the second part of this article within a few days. Please remember that I am not recommending that you buy any of the stocks mentioned here. I do suggest that you look further at any of them that pique your interest and talk with your financial adviser to determine if some of them might work with your risk level and portfolio diversification.
Happy New Year! Be safe, and remember.....
Life is short. Get busy.
Jim
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