Investing at the Crossroads

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

“The global economy is in the midst of a cyclical slowdown.”
“...we are at important crossroads in every major economy.”

Those two quotes are taken from PIMCO's Economic Outlook report that was recently posted to the company's website. They aren't very positive and neither is the rest of the report. Basically, the report outlines the company's very public view of the so-called new normal. This slow growth, deleveraging world won't be an easy place to survive for any investor, let alone stock investors.

In fact, the seers at PIMCO expect the United States growth rate to slow from around 2% to the 1.5% range, which keeps us within a whisper of recessionary levels. Europe will be slower and Japan will be slower still. Even China, which PIMCO expects to grow between 6.5% and 7.5%, is facing material issues in its government transition that could threaten its long-term growth rates. If you believe PIMCO, the world is an ugly place. So what are these doom and gloom investors buying? I took a look at the largest holdings of PIMCO Dividend and Income Builder Fund (PQIIX) to get an idea and three household names stood out: Microsoft (NASDAQ: MSFT), Pfizer (NYSE: PFE), and Walgreen (NYSE: WAG).

Microsoft was the fund's largest holding at just over 3.25% of assets, as of the end of October. Most people know the company for three things: Windows, Office, and Xbox. These are big businesses that appear to have years of prominence left. One of the big concerns, however, is that technology changes have given competitors Apple (AAPL) and Google (GOOG) solid positions in new markets like the Internet and mobile computing. Such concerns are 100% justified.

Despite the obvious headwinds, however, Microsoft's three big franchises are so big, that the company can afford to step into other areas and, frankly, fail miserably. Anyone remember the Zune music player? In fact, the Xbox wasn't an instant success and required years of investment before Microsoft saw a dime of earnings. Now, it is one of the leading game machines on the market with its highly innovative Kinect device. Success in the music space, however, was harder to come by and the company effectively gave up on the effort. This hasn't been a bad thing, however, as music players have, for the most part, been absorbed by cell phones.

Cell phones are a weakness, too, however. That said, the company's most recent foray is in operating systems for smart phones, an area that is dominated by Apple and Google. Microsoft has formed an alliance with cell phone maker Nokia (NOK) that has produced some highly regarded phones. Even if the phones lack customer demand, Microsoft will probably just keep trying. Since this is a market where it truly needs to succeed, it won't give up the chase easily. A 3.5% dividend yield and a strong balance sheet make Microsoft an interesting choice for investors seeking technology exposure and income from a still dominant industry player.

Pfizer is the world's largest drug company and a nearly 3.2% of assets holding in the fund. Size brings a lot of benefits in the pharmaceutical space because research is everything and research is expensive. Moreover, new drug candidates can be unpredictable, leading to the need to have multiple research efforts going at one time to ensure that at least some new drugs make it through the application process. A company with the size and scope of Pfizer can afford to throw a lot of pasta against the wall in the hopes of finding a few stands that stick.

There is no doubt that Pfizer has some major headwinds to deal with, though. In fact, some are of its own making. For starters, Lipitor, one of the company's biggest drugs, has lost patent protection. This will cut into the top and bottom lines right away without anything to fully replace the lost revenue. Additionally, integrating its recent purchase of Wyeth, which helped cement the company's industry position, is likely to be a complicated affair. The integration of any purchase comes with risks, but in the pharmaceutical space losing key research staff because of a culture shift can lead to massive setbacks. Three, upper management has been cutting costs, including on the research and development side of the business. So-called brain drain, even beyond the Wyeth issue, could be a longer term risk that won't be apparent for several years.

Still, the company is financially strong and has historically performed reasonably well. It is highly likely that Pfizer will not only survive its current challenges, but thrive over the long term. A dividend yield around 4% makes this Dow-30 member a good option for dividend investors.

Walgreen is the largest pharmacy in the United States with a brand name and reach that spans from coast to coast. At 2.4% of the fund's holdings, it easily makes it into the top 10 list. Despite its industry position, Walgreen has seen its fair share of hardship over the last year or so. The first big issue was a dispute with pharmacy benefits manager Express Scripts (ESRX) that led to a material loss of customers and revenue for Walgreen. Although that dispute has been resolved and the pharmacy seems to be regaining customers, many have begun to question the wisdom of management's choices in picking this fight.

Adding fuel to the fire was the recent partnership, likely to be purchase eventually, with European pharmacy Boots. This deal moves the company well beyond the U.S.'s boarders and into completely uncharted territory. While Boots has a material position in Europe, there are questions about the viability of an international pharmacy. If the partnership doesn't work out, it could be a very costly mistake.

Longer-term the company faces other headwinds, most notably the encroachment of more diversified retailers that might use their pharmacy departments as loss leaders. Wal-Mart (WMT) and Target (TGT), for example, both have pharmacy departments. One need not look far beyond the grocery isles at these dominant companies to understand that they have the financial strength, distribution capabilities, and store base to take on once specialized retail formats (grocery stores) and win material market share.

Still, Walgreen is a big player in an industry that is likely to see increasing demand from an aging population. It is financially secure and making an effort to move beyond its usually conservative comfort zone (which is understandably scary for investors). With a yield at a historically high 3%, investors willing to go along for a bumpier ride than Walgreen has been known for historically may find the recent price alluring.


<img height="104" src="/media/images/user_14110/signiture_large.jpg" width="214" />

ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft. Motley Fool newsletter services recommend Microsoft. 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!

blog comments powered by Disqus