Revisiting Predictions Made at the Start of the Year

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

Back in January, when the economy seemed to be recovering, China was not a significant concern and the Fed looked like it was going to continue easing for an indefinite period, I picked three stocks that I believed were solid buy and hold investments for 2013.

However, since then the global economy and outlook have changed, so how has the portfolio performed and is there still a thesis for investment?

Originally, I picked the stocks based on three criteria, Safety - Visa (NYSE: V) for its highly cash generative nature. Cyclical - Caterpillar (NYSE: CAT) for its world leading position and cyclical nature. Yield- Altria (NYSE: MO), for its rich heritage and 5%+ yield.

So, how have these companies got on?

Company

Return

Total Return

Caterpillar

-8.4%

-7.7%

Altria

12.2%

15%

Visa

20.5%

21%

Equally Weighted Return

9%

9.4%

S&P 500

12.4%

 

Unfortunately, an equally weighted basket of the three stocks has underperformed the S&P 500 by 3.4%, or 3% including dividends. Caterpillar has dragged the portfolio down.

Is it time to give up?

Defiantly not, Caterpillar has underperformed so far this year as concerns about the Chinese economy mount. However, the original thesis for investment still stands. In addition, both Visa and Altria have outperformed the S&P 500 on a total return basis over the period.

So is there still time to invest?

Yes I believe there is. Unlike many in the market right now, I am still extremely bullish on Caterpillar, why, well these are the original reasons I gave for investment, and they still stand:

  • Caterpillar has been around in different forms since 1906, surviving two world wars and the Great Depression.
  • Caterpillar is a great long-term investment, with total shareholder return in the top 25% of the S&P 500.
  • Caterpillar has a return on investment almost double that of its competitors.
  • Caterpillar has a 5-yr dividend growth rate of 7% compared to the industry average of 1.2%.

In addition, Caterpillar is cheap, in fact it is cheaper now than when I first recommended the stock back at the beginning of the year. Indeed on a TTM P/E basis, Caterpillar is now cheaper than it was back in 2008, when the economic outlook was considerably worse.

Furthermore, while many investors are focused on Caterpillars slowing machinery sales, they are actually missing out on the company's most lucrative division - it’s financing operations. After several years of good sales and low interest rates, Caterpillars finance division has grown rapidly and now contributes around 16% of the company's overall income. The good news is this income is recurring and not affected by slowing equipment orders.

Caterpillar is also currently trading at a PEG ratio of 0.8, indicating that the company offers growth at a reasonable price.

What about the others?

Meanwhile, Altria still looks attractive. Even after the company's recent gains, it still offers a 5% dividend yield, which is project to rise to around 5.3% next year. Additionally, the company is project to grow its earnings around 8% a year, for the next five years and dividend payouts should grow in-line with earnings. There are also some rumours floating around the market that, SABMiller, which Altria holds 28.7% of (worth $24 billion), could be the target of a takeover by peer AB Inbev. A buyout could put investor's inline for a huge payout.

Overall, Altria still looks cheap at these levels, with plenty of room for both capital gains and lots of income.

Elsewhere, after its impressive gains this year, Visa is starting to look a bit expensive. The company's shares are already up 20.5% since the beginning of the year and after these gains the company is now trading at historically high earnings multiples.

Visa is in line to earn $8.70 per share this year, putting the shares at a forward P/E ratio of 21 - slightly higher than its 5-YR 12 month forward P/E ratio of 20. Furthermore, at this ratio the stock is trading at a 68% premium to the average multiples of its four largest peers, American Express, Capital One Financial, Discover and MasterCard, which all trade at an average forward earnings multiple of 14.7.

Moreover, Visa is trading on a EV/EBITDA valuation of 12.6x - above its five year historic average of 11.7 x. The company is also trading at a PEG ratio of 4.5, indicating that despite the company rapid earnings growth that is predicted for this year, the stock is not priced for growth at a reasonable price.

Conclusion

So, at the half way point, the portfolio of stocks to buy and hold for 2013 is performing well, but is being held back by Caterpillar. Having said that, on a longer term basis, Caterpillar still looks like an attractive investment and so does Altria, as the tobacco giant’s earnings and dividend payouts continue to grow.

On the other hand, Visa looks a tad expensive at these levels, so investors that are considering purchasing at these levels should hold off and perhaps look at investing in one of the company’s close peers.


Fool contributor Rupert Hargreaves owns shares of Altria Group and Caterpillar. The Motley Fool recommends Visa. 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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