3 stocks for post-election and QE2

Dow companies with cash stockpiles offer safety amid political uncertainty and Fed manipulation.

By TheStreet Staff Nov 2, 2010 10:19AM

thestreetBy Jake Lynch, TheStreet

 

A Republican influx into the House and Senate would probably be cheered by investors hoping for political gridlock or a change in economic policy.

 

Stricter regulations in response to the subprime-mortgage crisis and the ensuing recession have painted Democratic leaders as anti-business. Further, ObamaCare and the threat of looming tax increases have aided a Republican resurgence. The GOP needs 39 seats to reclaim the House and oust Nancy Pelosi as speaker. Some analysts predict a 60-seat swing in Republicans' favor.

 

Jobs and the federal deficit are voters' top concerns, polls show. And fear of harsher regulations has made businesses hesitant to hire. Moody's (MCO) data indicate that S&P 500 ($INX) companies are sitting on $1 trillion in cash.

 

Liquidity hoarding and cost cutting have pushed profit margins near all-time highs and goosed the stock market despite the employment slump. So far, 259 of the 321 S&P 500 companies that have reported third-quarter earnings have exceeded consensus targets. Just 194 beat revenue forecasts, as sales growth appears to be tapering. Without stronger demand, companies won't invest in new jobs.

A self-reinforcing cycle has created a so-called jobless recovery. The unemployment rate is stuck at 9.6% and is predicted to hover at that level unless additional economic stimulus is provided. Assuming the consensus scenario of Republican wins and a stalemate in Congress, the likely form of stimulus is an extension of the Bush tax cuts and a second round of quantitative easing, expected to be announced by Federal Reserve Chairman Ben Bernanke on Wednesday.

 

Speculation has it that the Obama administration is considering extending tax cuts for all Americans, but extensions for the wealthy would be temporary, either for one or two years. Some analysts argue that quantitative easing, a process through which the Fed purchases Treasurys to boost asset prices, including those of stocks, has already been priced into markets. The dollar has depreciated sharply in recent weeks, and the S&P 500 posted an impressive 13% gain for September and October. Still, some observers see further upside in equities.

 

Barton Biggs, a former chief global strategist at Morgan Stanley (MS) and the current manager of hedge fund Traxis Partners, last week predicted a 10% stock rally upon announcement of QE2.

 

Bond fund manager Bill Gross of Pimco sees QE2 as the death knell for a 30-year bull market in fixed-income securities. Gross, though not predicting a sell-off in Treasurys, argues that yields have little room to decline without causing negative real returns for long-term holders. Thus the case for stocks is difficult to rebut. When the world's foremost fixed-income authority "calls" a top in bonds, it's time to embrace equities.

 

The most compelling, and arguably safest, stock investments are blue chips. Noted Fed critic and contrarian investor Jeremy Grantham of GMO Capital continues to stress the historic discount of high-quality U.S. companies, namely Dow stocks. Dow stocks offer some of the highest dividend yields in the market and represent tried-and-true U.S. businesses.

 

Below is a look at the three Dow stocks with the most net cash (cash minus debt). Excess liquidity likely signifies impending share buybacks, dividend increases or acquisitions, any and all of which translate to above-average gains for stock holders.

 

3. Intel (INTC) is the world's largest semiconductor company. During the past three years, Intel has grown its sales 4.6% annually, on average, and boosted its net income 19% a year, on average. Its third-quarter profit surged 59% to $3 billion, or 52 cents a share. Revenue increased 18%. Intel's operating margin expanded from 28% to 37%.

 

Intel exceeded analysts' consensus adjusted earnings estimate by 3.6%. It beat on the top-line by 0.9%. Currently, 31 analysts rate Intel's stock "buy", 19 rate it "hold" and three rank it "sell." A median price target of $23.45 suggests a 12-month return of 14%. Bullish forecaster RBC (RY) expects the stock to rise 27% to $26. Piper Jaffray (PJC) and Citigroup (C) both offer price targets of $25, suggesting an impending 12-month return of 22%.

 

Intel pays a quarterly dividend of 16 cents, translating to an annual yield of 3.1% with a safe payout ratio of 33%. It has a three-year dividend growth rate of 12% and a five-year growth rate of 17%. The stock trades at a trailing earnings multiple of 11, a forward earnings multiple of 10, a book value multiple of 2.3 and a sales multiple of 2.6, 41%, 25%, 28% and 19% discounts to peer averages. A PEG ratio of 0.1 signifies a 90% discount to estimated long-run growth.

 

The quarterly cash balance soared 60% from the year-earlier tally to $21 billion. Long-term debt grew marginally to $2.3 billion. Intel has a net liquidity position of more than $18 billion and a lofty quick ratio of 2.7. Management recently announced a $6 to $8 billion investment in domestic manufacturing, including a new development fab in Oregon and upgrades to four existing fab sites in order to accommodate a new 22 nano-meter process technology.

 

Intel has announced 10 acquisitions and strategic investments in 2010, including a high-profile purchase of technology security company McAfee for nearly $7.7 billion. Another notable investment is Intel's $50 million stake purchase in 4G pure-play Clearwire (CLWR). Intel now owns roughly 15% of Clearwire's float, rendering it the largest shareholder.

 

2. Microsoft (MSFT) designs and sells software, including the Windows operating system and the Office product suite. During the past three years, Microsoft has increased revenue 6.7% annually, on average, and expanded net income 11% a year, on average. Fiscal first-quarter profit jumped 51% to $5.4 billion, or 62 cents a share, as revenue grew 25%. The operating margin stretched from 35% to 44%. Return on equity rose from 33% to 44%. (Microsoft owns and publishes MSN Money.)

 

Microsoft, the largest software company in the world, exceeded its consensus earnings target by 13%. It beat on the top-line by 2.6%. Currently, 30 researchers advise purchasing Microsoft's shares while 12 recommend holding them. None advocate selling. A median target of $32.71 implies an impending one-year return of 21%. Stifel Financial (SF) forecasts that Microsoft's stock will appreciate 48% to $40. Credit Suisse (CS) offers a target of $35. UBS (UBS) predicts that the stock will hit $35.

 

Microsoft pays a quarterly dividend of 13 cents, equaling a yield of 2.4% with a payout ratio of 22%. Microsoft has a three-year dividend growth rate of 9.1%. The stock sells for a trailing earnings multiple of 11, a forward earnings multiple of 10, a book value multiple of 4.9, a sales multiple of 3.5 and a cash flow multiple of 8.8, 64%, 63%, 10%, 85% and 66% discounts to software averages. A PEG ratio of 0.3 signifies a 70% discount to estimated fair value.

 

The quarterly cash balance expanded 20% from the year-earlier balance to $44 billion. Debt nearly doubled to $11 billion. Still, Microsoft boasts a net liquidity position of nearly $34 billion. The company is expected to boost its dividend to 16 cents in the next quarter. Researchers also expect a new buyback program. Shares outstanding decreased from 8.9 million to 8.6 million in the latest reporting period, amplifying per share earnings growth.

 

Microsoft has announced three acquisitions in 2010, two of which have been completed. Yesterday, news broke that Microsoft plans to purchase Canesta, a leader in 3D sensing technology, for an undisclosed amount by year-end. Canesta has several patented sensing technologies, which Microsoft is after. The patents will have important applications in consumer, industrial and medical markets. Microsoft Kinect, a controller-free technology compatible with the Xbox 360 gaming console, is due out this holiday season.

 

1. Cisco Systems (CSCO) is the largest seller of networking equipment. During the past three years, it has grown sales 4.7% annually, on average, and boosted net income 1.9% a year, on average. Fiscal fourth-quarter profit surged 79% to $1.9 billion, or 33 cents a share, as revenue gained 27% to $11 billion. The operating margin extended from 18% to 22%. Return on equity rose from 16% to 18%, exceeding the industry average of 17% and the S&P 500 average of 13%.

 

Cisco exceeded analysts' consensus adjusted earnings target by 3.1%. It missed on the top-line by 0.8%. Currently, 38 researchers advise purchasing Cisco's shares, 10 recommend holding them and one says to sell. A median target of $27.54 implies a 12-month gain of 20%. Credit Suisse predicts that the shares will appreciate 40% to $32. Sanford Bernstein expects Cisco's stock to rally 35% to $31. Citigroup values the shares at $29.

 

Cisco doesn't pay dividends, but CEO John Chambers announced that the company will commence a payout in 2011, targeting a yield between 1% and 2%. The stock sells for a trailing earnings multiple of 17, a forward earnings multiple of 11, a book value multiple of 2.9 and a cash flow multiple of 13, 45%, 51%, 6% and 19% discounts to communications equipment industry averages. A PEG ratio of 0.6 reflects a 40% discount to estimated fair value.

 

The quarterly cash balance advanced 14% to $40 billion, converting to a quick ratio of 2.4. Long-term debt increased by 48% to $15 billion. Cisco has a net liquidity position of nearly $25 billion. Shares outstanding dropped by 130,000 from the year-earlier tally. Cisco will report fiscal first-quarter results on Nov. 10. It has completed 10 acquisitions or strategic external investments so far in 2010, deploying cash in order to grow its business inorganically.

 

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