Which companies are tomorrow's big winners? In our ongoing series, I'm chatting with Fool analysts and advisors to find out the stocks on their watchlists and the catalysts that would induce them to buy. By the end of today's article, you'll get three companies that the man in charge of training our analysts thinks you should be watching and three that he recently bought for his personal portfolio.
Large caps on sale
Buck Hartzell has been investing for decades and can't recall a time when large caps have been quite as cheap. A numbers-focused guy (his 100-point rating system for interview candidates is the stuff of Foolish lore), he decided to dig in on key multiples of six companies on his watchlist that share some commonalities:
- Strong and growing businesses.
- Very low multiples.
- Unparalleled balance sheets.
- Trend of buying back more of their shares.
- A dividend that now or soon will outpace inflation.
After a thorough exploration, he found that three of them were worth watching a bit longer, and three he decided to buy.
Three to keep watching
Shares of Hewlett-Packard (NYSE: HPQ ) took a hit when Mark Hurd left the CEO spot, but the business hasn't changed since his departure. The company's got an enterprise value/free-cash-flow ratio (Buck's proxy for price-to-earnings ratio) of 14.2, and it sports a compound annual revenue growth rate of almost 9 % for the past five years while its earnings per share have soared at a 35% annual clip. Today, it sits with gross margins of 24%. At the moment, its dividend yield is a modest 0.7%, which leaves something to be desired.
And Buck has concerns about upcoming regulations that will require printer makers to let us know how many pages we can actually print with each toner cartridge (a shocking concept), so he's keeping this one on his watchlist for now.
Joining HP is Intel (Nasdaq: INTC ) , the chip maker with the huge moat and the healthy yield. The company's EV/FCF ratio is a historically cheap 10.0 and it pays a 3% dividend yield. Digging in, however, Buck felt hesitation about the capital-intensive nature of the business and Intel's lack of growth -- revenue has grown only 2% annually over the past five years. Granted, his numbers are quite conservative (they include the biggest market downturn in decades), but so is Buck. And so Intel remains a company to watch.
Earlier this month, Automatic Data Processing (Nasdaq: ADP ) extended its streak to 36 years of raising its quarterly dividend, and the yield is now 3.1%. The company's EV/FCF ratio is fairly high at 13.8, but ADP has shown strong five-year growth of 7.2% annually to earnings per share. Buck ruled this one out for portfolio reasons (he already owns companies in this area) and because the company is already paying out 44% of its free cash flow, meaning the dividend doesn't have as much room to grow as the companies below.
If you want to keep an eye on these stocks, click over to MyWatchlist.com, the Fool's free customized hub to follow the performance and Foolish coverage of the companies you're watching.
Three that Buck bought
Once he started investigating his watchlist, Buck was hit by three great companies that were simply too cheap to let go. He purchased all three of the following stocks, and is convinced that the last one represents a buying opportunity that shouldn't be missed by any investor.
Johnson & Johnson (NYSE: JNJ ) has been here before. It's seen its share price dip after a recent Tylenol product recall, but the business's fundamentals remain incredibly strong and it has exhibited amazing resilience over the years. Its EV/FCF ratio is stunningly low (10.7), and the company's five-year CAGR is 3%. Even better, its bottom line grew 8% annually over the same period, meaning it's making better use of its money. Today, J&J enjoys gross margins of 70%. The company reduced its share count at the average cost of $79 per share (Buck determines this figure by taking stock repurchases and adding back in the amount received from stock option exercises to get an adjusted cost for share count reduction), so there's optimism in the building. Buck thinks that optimism is well-placed, and coupled with J&J's 3.4% dividend yield, it's too appealing not to buy.
The reasons behind the drop in Cisco's (Nasdaq: CSCO ) stock are a bit fuzzier. In its most recent quarter, the company reported 19% revenue growth and was rewarded with a hit to its stock on weakness in its government business. Now down 20% since Nov. 10 in a relatively flat market, Cisco has an EV/FCF of less than 10 despite growth across the board and gross margins of 64%. The kicker that got Buck to buy here was the company's decision to start returning cash to shareholders -- it will pay its first dividend by next July, the end of its current fiscal year.
Buck's biggest winner
In this environment where once again capital is precious, Buck loves strong, stable companies that lead their industries. If you believe the hype and the headlines, Microsoft (Nasdaq: MSFT ) no longer fits that bill as it's being eaten alive by its trendier rivals, its dominance being eroded more every day. The numbers paint a dramatically different picture.
The behemoth has stable gross margins (at a stunning 80%) and its top and bottom lines have grown at a strong rate of 10% and 8%, respectively. The company's buying back its shares, using its massive cash hoard to reward investors. And Microsoft has just begun. With a bucketful of cash on hand (over $5 per share, versus debt of just over $1 per share), Buck expects CEO Steve Ballmer to increase the company's current 2.5% dividend yield, meaning huge returns for investors at today's prices. Microsoft could increase its dividend to almost 7% and still be paying out an acceptable 75% of its earnings. That's why Buck bought (and I'm doing the same as soon as our trading guidelines allow).
Buck's not the only one bullish on Microsoft. In the Fool's recent report on 13 high-yield companies, analyst Jim Royal calls Microsoft the "dividend play of a lifetime." To get instant access to this report and another dozen outstanding dividend payers, click here – it's free.