Investing in America’s Triple-A Club
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It was just under one year ago when Standard & Poor’s, the most iconic of the Big Three rating agencies, downgraded its credit rating on U.S. federal government debt from AAA to AA+, amid widespread media panic and market turmoil. While Moody’s and Fitch Ratings did not follow suit, each changed their respective outlooks on U.S. debt to negative, citing the maladroitness plaguing Washington, mounting national debt, and risks of a double-dip recession. Interestingly, S&P’s decision has given four U.S. companies the unique distinction of exhibiting a higher credit rating than Uncle Sam. Now, this circumstance is not as atypical in countries like Spain or France, where sovereigns have experienced a severe wave of debt downgrades; to learn how to profit from this situation, continue reading here.
In the U.S., however, this condition is much more rare. While stock-centric investors typically do not pay much attention to bond ratings, the sheer exclusivity of this group warrants the consideration of these companies as solid equity investments. To gauge the creditworthiness of any organization, rating agencies use ‘ability to pay’ as their primary measuring stick, which is undoubtedly a factor of: (1) management quality, (2) future growth prospects, and (3) financial stability. Below are the last four members of the American Triple-A club; they exhibit these characteristics to the nth degree.
Founded in the days of greasers and beatniks – 1949 to be exact – Automatic Data Processing (NASDAQ: ADP) has grown into a $26 billion behemoth, and the outright leader in the human resources services industry. Payroll management, benefits oversight, and other miscellaneous HR tasks have become staples of ADP’s business model; expensive switching costs and brand recognition have garnered the company an extraordinarily high economic moat. In 2008, when the Dow Jones Industrial Average lost 30.8 percent, shares of ADP finished the year in positive territory; in the three years since the recession, the stock has returned almost 60 percent.
The company offers a modest dividend yield of 2.9 percent, and has raised its dividend for 37 consecutive years – an achievement incomparable to any accolade. ADP currently trades at P/E (19.7X) and P/CF (14.3X) metrics that are below industry averages, despite sporting solid annual earnings (4.6 percent) and free cash flow growth rates (7.7 percent) over the past three years. Going forward, analysts are expecting the company to finish 2012 with earnings of $2.74 a share, which would be an 8.7 percent jump from last year.
As one of the largest companies in the world, Exxon Mobile (NYSE: XOM) is an integrated oil and gas giant, trading at a market capitalization of nearly $400 billion. Since last summer, shares of have risen 6.9 percent, though this may be just the start of more bullish action to come. It goes without saying that shares of XOM have been negatively affected by the decline in oil prices, which have dropped below $80 a barrel in recent weeks, though the long term sentiment surrounding ‘black gold’ is inherently bright. For a more detailed look at the future prospects of this industry, continue reading here.
Currently, XOM is trading at P/E (9.9X) and P/CF (6.8X) ratios significantly below its 5-year historical averages, even though the company achieved double-digit EPS and FCF growth last year. In fact, XOM’s earnings have historically traded at a 19 percent discount in relation to the Dow Jones’ average over the past half-decade. This year, they appear cheaper, as they are trading at a 29 percent discount. Assuming that Exxon hits its year-end earnings target of $8.01 a share, fairly valued shares should rise above $97. The stock currently trades in the $81 range.
Johnson & Johnson (NYSE: JNJ) is the world’s largest healthcare company, selling consumer, pharmaceutical, and medical equipment products to over 175 countries. Over the past few years, the company has been plagued with stagnant revenues and shrinking earnings, and investors are unenthusiastic about its drug pipeline. Earlier this month, JNJ acquired the Swiss Synthes in an effort to shore up its medical device business. It is expected that this acquisition will add to the company’s bottom line, which is already predicted to rise by 3 percent to $5.14 a share by year’s end. Interestingly, JNJ is trading at earnings (18.3X) and cash flow (12.5X) multiples above industry and historical averages, and competitors like Merck & Co, GlaxoSmithKline, and Eli Lilly and Company. JNJ does offer a rock-solid dividend yield of 3.7 percent, though this stock looks like a hold at its current valuation.
Last but certainly not least, Microsoft (NASDAQ: MSFT) is the only tech company to hold the coveted AAA rating, which is based on the company’s strong leadership, earnings stability, and superior cash flow generation. It appears that Apple might also be a good candidate to join this club, though it does not hold any long-term debt. To learn more about the surprising prospects of MSFT’s main competitor, check this out. Now, Microsoft has been in the news lately with its announcement of the new Surface tablet, and this may provide an additional boost to a bottom line that has been growing (12.9 percent) faster than industry averages (12.1 percent) since the recession. From a valuation standpoint, shares of MSFT look to be under-appreciated by the markets, as they are trading at P/E (11.2X) and P/CF (8.7X) ratios below 5-year historical averages. Analysts are expecting the company to earn $3.08 a share by the end of 2013, which would mark a near 15 percent increase from current EPS levels. If this consensus holds, a fairly valued MSFT should rise above $42 a share by next year. Heck, even if the stock stays at its current valuation, it will eclipse $35; MSFT currently trades in the $29 range.
To recap, it looks as though Microsoft, Exxon, and Automatic Data Processing are the best equity investments in America’s Triple-A club. Each stock exhibits strong bottom line prospects while trading at undervalued price multiples. Going forward, it would be wise for investors to continually monitor the status of these three companies; WealthLift’s Sentiment Index is a good place to start.
Fool blogger Jake Mann does not own shares in any of the companies mentioned above. The Motley Fool owns shares of Johnson & Johnson, Microsoft, and ExxonMobil. Motley Fool newsletter services recommend Automatic Data Processing, Johnson & Johnson, and 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.If you have questions about this post or the Fool’s blog network, click here for information.