What companies are tomorrow's big winners? In our ongoing series, I'm chatting with Fool analysts and advisors to discover the stocks they're watching and the catalysts that would signal it's time to buy.
Today, Stock Advisor analyst Jim Mueller shares three companies on his watchlist and one that he's loading up on now. (For your convenience, you can now create your own version at MyWatchlist.com, your free customized hub to follow the performance and Fool coverage of the companies you care about.)
Jim is a devotee of expectations investing, the theory espoused by investing guru Michael Mauboussin that essentially reverses the traditional discounted cash flow analysis. In his "messed-up expectations" portfolio, Jim screens for stocks that the market expects little or no growth from and then digs in to find if those expectations are justified. Turning up on his most recent screen is Dr Pepper Snapple Group (NYSE: DPS ) , the No. 3 soda business in North America. Although the value-hunting Jim sticks to store-brand sodas, he believes Dr Pepper has more to offer than the market currently believes. Shares are priced as if the company isn't going to do anything for the foreseeable future, so he needs to dig in to find if there are valid reasons for the pessimism -- bad earnings, gloomy guidance, a drop in shipments, or other news. If his search comes up clean, this might be one to buy.
Similarly, Dean Foods (NYSE: DF ) has been left for dead by the market and showed up on Jim's most recent screen. A leading processor and distributor of milk and other dairy products ranging from Borden to Land O' Lakes to Silk soy milk, Dean Foods has seen its shares plunge nearly 60% so far this year. A big chunk of that drop came in early November in the wake of the company's third-quarter earnings report, in which Dean reported earnings per share down 61% from the previous year and well short of the number analysts were looking for. While revenue was up, much of that came from passing on higher input costs to customers. Oh, and the CFO resigned. Still, the market expects essentially no growth from this stock. Jim's going to investigate if the fears are overblown.
While the market isn't quite as pessimistic about the growth prospects for Microsoft (Nasdaq: MSFT ) , shares are priced as if its free cash flow is expected to maintain its uninspired performance of the past five years. The company today reminds him a bit of Coca-Cola (NYSE: KO ) a couple decades ago. In the late 1970s and early 1980s, the soda king experienced about eight years of nothingness. While it grew its earnings and sales, the share price remained flat. And then the stock took off on a run for the ages. The first part of the story looks the same for Microsoft, and while Jim isn't predicting the same magnitude explosion for Microsoft, he's a lot more optimistic than the expectations priced into shares.
And one he's buying ... twice
When he ran his screen in late October, Jim came across Transocean (NYSE: RIG ) , the company that operated the fateful Deepwater Horizon for BP. Shares took a hit for the company's role in the Gulf of Mexico disaster, and although they have recovered somewhat, the market's expectations remain dismal because of regulatory concerns, the possibility of losing leverage in the day rates it can charge, and legal liability. Jim gets that, but as he wrote when he made his first purchase in his Rising Star portfolio, "Transocean brought in just under $3 billion in free cash flow over the past four quarters. At a stock price of $63.36 and using a discount rate of 15%, that implies the company can grow that number by just 0.7% for each of the next five years, then by 0.4% for the following five years, followed by no more growth forever.
"Now consider the following," he continued. "Over the past five years, Transocean has grown free cash flow by an average of 41.7% per year. Over the past year, it managed 4.9% growth. Given the concerns above, yes, it might have a bit of a problem growing free cash flow for the next couple of years. But, a lot of that concern is going to be resolved over the next few years with the likelihood of higher expectations baked into the price, which means higher prices."
Today, shares trade at $70 per share, and Jim is going back for seconds. As he wrote, "Buffett reminds us that we pay a hefty price for a cheery consensus. There is definitely not one surrounding Transocean today, but waiting until the risks are resolved will not serve us well."
And that's why it pays to watch. You can make smarter investing decisions with your own version of My Watchlist, new and free from the Fool. Click below to start following one of the stocks mentioned above: