When Go-Nowhere Companies Go Somewhere Big

When Microsoft (MSFT -1.27%) was originally picked for the real-money Inflation-Protected Income Growth portfolio last December, its shares traded as though the company would never grow again. Since then, Microsoft's stock is up about 39%, making it one of the top-performing companies in the portfolio. In addition, Microsoft was the top-performing iPIG pick since last week's update.

Two key items drove Microsoft's gains for the week. The first was news that its Windows Phones were gaining market share internationally. The second was that its CEO search committee was making progress toward finding a new boss. While that news helped on the week, the larger, longer-term gains that the iPIG portfolio has seen from Microsoft's stock have been driven by the simple truth that the company is doing better than "go nowhere."

Expectations rule the market
In its most recently reported quarter, for instance, Microsoft booked $18.5 billion in revenue, which is up substantially from the $16 billion it booked during the same quarter last year. Growth at that rate (a touch more than 15%) is probably not sustainable for Microsoft, but it does seriously challenge the belief that the company is too big to grow at all.

And with that challenged assumption, Microsoft's shares are up over the past year in part because the market's expectations for its future have improved. It's still a slow-growth behemoth, but when it comes to valuation, "slow growth" earns a higher price than "no growth."

Indeed, improving expectations are behind all of the top performing companies in the iPIG portfolio.

Overall top performer Walgreen (WBA 3.69%) was originally purchased for the iPIG portfolio as it wrapped up a battle with Express Scripts (NASDAQ: ESRX) over reimbursement rates. The fear priced into Walgreen's stock at the time came from concern that the pharmacy giant would permanently lose the customers who had moved elsewhere during the battle. As Walgreen demonstrated the ability to bring back customers, the market's expectations improved -- taking its shares up with it.

Likewise, No. 2 performer Raytheon (RTN) was selected for the iPIG portfolio as fears of reductions from Defense Department budget sequestration sent shares tumbling. In spite of those fears, Raytheon continued to post respectable numbers, including this most recent quarter when it posted essentially flat net income per share versus last year.

Raytheon took the Pentagon sequester, did what was necessary to streamline costs, bought back some shares, but basically kept on going. The company's ability to survive, and in some sense thrive, in spite of the cuts from its key customer showcased its adaptability. And that adaptability helped the market adjust upward its expectations for Raytheon's future, lifting the company's stock price.

Then there's Hasbro (HAS 0.60%), the third-best overall performer in the iPIG portfolio. Shortly after Hasbro was selected for the portfolio, it announced that it missed expectations for the all-important 2012 holiday shopping quarter. Yet after cost-cutting and an improvement to its business in the first part of 2013, the market's expectations for the toy maker are now higher, lifting its stock price accordingly.

Only the ticking of the clock and the turning of the calendar pages will tell whether Hasbro will successfully reach those loftier expectations. But it's those expectations that have driven the company's stock price higher, and after this holiday season gets reported, it'll be the expectations for next year that will drive the company's price going forward.

Expectations, meet reality
While the market's expectations for the future drive a company's stock price, what the company actually delivers every quarter helps influence the Street's perspective of things to come. After all, a strong company that is generating a lot of cash has more resources to plow into future growth opportunities than a company struggling to post profits. So while the past is no guarantee of the future, it is a useful guidepost of what may very well come.

Put together a group of companies, each with their own histories behind them and expectations for their futures priced into them, and you have some key foundations for a portfolio. For the Inflation-Protected Income Growth portfolio, the key expectation of each company is that it can continue increasing its dividends on a regular basis.

Those dividends, to be sustainable, have to come from cash the companies generate from their operations. To increase those dividends, the companies themselves have to grow -- maybe not every year, but fairly consistently over time. Nobody can accurately predict the future or guarantee that the companies will live up to those expectations, but we all can watch and see how they perform over time.

The table below has a snapshot of how the iPIG portfolio has performed:

Data from the iPIG portfolio's brokerage account, as of Nov. 8, 2013.

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