Why is Legg Mason Sticking With Apple? You May Be Surprised

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Apple (NASDAQ: AAPL) remained Bill Miller’s top stock pick in the third quarter, leading us to believe that he sides with the company's fundamentals rather than the bearish technical arguments that many analysts are making at the moment (see Apple Will Hit $390: Analyst). Miller is the chairman of the Legg Mason Capital Management mutual fund and is considered a contrarian by most standards, one that looks for value-oriented opportunities. Miller focuses on buying cheap stocks and holding them over the long-term. He believes that excess returns – alpha – have little to do with accounting measurements of value – such as low P/E or price-to-cash flow ratios – and more to do with return on capital changes.

Apple is down over 20% during the last three months and appears to be a value play when stacked up against its tech peers. Apple now trades at 12x earnings, below Google (22.5x) and Microsoft (15x). Apple should be able to excel this holiday season with a robust portfolio of new products – including the iPhone 5 and iPad Mini. On the sell-side, sales growth is expected to come in at 25% for 2013, then slow to only 15% in 2014, as Apple products continue to saturate their existing markets, though its worth mentioning that these estimates do not factor in the effects that a product like the Apple TV would have on sales.

Despite expectations of slowing growth, the long-term earnings growth rate for Apple remains above that of other top tech investment options. Wall Street expects Apple to grow its EPS by 20% a year over the next half-decade, which gives its shares a paltry PEG ratio of 0.5. Google and Microsoft are more expensive, and sport more conservative growth estimates of 13.5% and 9%, respectively. With over $120 billion in cash, there are many opportunities for Apple to unlock value for shareholders. These opportunities range from increasing its dividend – currently yielding 2% – to share buybacks and aggressive acquisitions.

JPMorgan Chase (NYSE: JPM) was another top pick of Miller’s, having moved up from Legg Mason’s third largest 13F holding to 2nd last quarter. JP Morgan pays the riches dividend yield among top banks at 2.8% and trades in line with other major peer Wells Fargo on a P/B basis – around 1.2x.

We believe that JP Morgan warrants a premium book valuation given its more diverse product offering, whereas Wells Fargo is heavily reliant on mortgage banking. A recent surge in refinancings lifted Wells Fargo to trading levels in line with JP Morgan, but the latter can continue its above average performance in its trading and investment management segments. With a doubling of his position, billionaire Ken Fisher – founder of Fisher Asset Management – also became one of the top fund owners of JP Morgan last quarter (see Ken Fisher’s latest stock picks).

Lowe’s Companies (NYSE: LOW) moved into the top five and was Legg Mason’s 3rd largest 13F holding. Lowe’s trades in line with top peer Home Depot on a P/E and long-term growth basis, but Lowe’s has a P/S that is nearly half that of Home Depot. Lowe’s has an equally impressive market position and is expected to open ten new stores in 2013, with same store sale growth of 3% next year. An uptick in housing starts next year should prove to be a key driver of this growth.

Metlife (NYSE: MET) moved into Legg Mason's top five, moving from 7th in 2Q to 4th in 3Q. Metlife has the lowest P/B of other life insurers at 0.7x and the lowest P/E at 13x. Metlife also offers investors a solid dividend yield at 2.2%. Top line growth will be driven by a recovering U.S. economy that will help boost group life sales. Metlife also has very robust growth prospects in international markets, which are expected to boost earnings in this segment by 25% - driven by Latin American operations. When considering Metlife’s growth prospects, we are reminded of Apple, where Metlife also trades at a mere 0.5 PEG.

Last but certainly not least, Johnson & Johnson (NYSE: JNJ) jumped to the 5th largest holding in Legg Mason's 13F portfolio after a 20% boost last quarter. Recent acquisitions, including that of Synthes, should be a fundamental driver of Johnson & Johnson’s expected 8% revenue growth in 2013. This sales growth should also convert to an 8% growth in earnings for 2013, with nearly $0.15 worth of EPS growth coming from Synthes.

Drug sales will also continue to drive Johnson & Johnson, whilst its medical device segment offers product diversification. Johnson & Johnson maintains a robust drug pipeline and despite its premium 24x P/E – compared to major drug peers – we still believe investors can find value in the pharma company. With a forward P/E of 13x, Johnson & Johnson’s 2013 growth is under-appreciated. We believe Johnson & Johnson is strongly positioned to either accelerate growth via acquisitions or boost its current 3.5% dividend yield, as it has nearly $20 billion in cash and only $17 billion in debt. Billionaire George Soros also committed to Johnson & Johnson last quarter, upping his stake over 1,000% (check out George Soros’ newest picks).

To recap: we believe that all of Miller’s top picks exhibit some of the best value characteristics that he and Legg Mason look for. Apple continues to innovate – generating new return on capital avenues with a bevy of new products – and JP Morgan is adapting nicely to an ever-changing financial marketplace. We see Lowe’s as the top value play in the home improvement retail space and Metlife as the top life insurer. Johnson & Johnson is one of the top pharma stocks loved by hedge funds, and for good reason, given its diverse product mix and solid dividend.

This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Apple, Johnson & Johnson, and JPMorgan Chase & Co. Motley Fool newsletter services recommend Apple, Johnson & Johnson, and Lowe's Companies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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