This article is part of our Rising Star Portfolios series.
Building a list of companies you'd like to own but don't yet for one reason or another is a key part of investing. Maybe the price isn't right, maybe you haven't looked into it deeply enough, whatever. Using a watchlist keeps these companies in front of you, so that you can invest in them when the time is right.
Three companies that came across my radar screen recently while looking for the next company to add to my Messed-Up Expectations (MUE) portfolio -- which invests in companies that the market is not expecting much from at all -- were Cephalon
This biotech company hit my radar because the market is expecting very little of it in terms of free cash flow growth -- the exact thing my MUE port is looking for -- where I believe the market is wrong, that is. But I don't think that's the case with Cephalon, unfortunately. Provigil, a treatment for narcolepsy, accounted for 41% of the company's $2.76 billion in net sales last year. However, it's going to see generic competition beginning next year. Not good. While it has several drugs in various stages of development, most are still in early clinical trials, with only two new ones in phase 3. I'm going to pass on this one, as replacing that much revenue is going to be a struggle, something Pfizer
- To follow the revenue story, add Cephalon to My Watchlist.
A watchlist doesn't have to come just from a screen of possibilities. It can also include companies you'd like to own, just not at today's price. One such for the MUE port is Medco, a pharmacy benefit manager. Medco handles prescription benefit plans and makes more money (and saves its customers money) by shipping generic drugs over brand-name drugs. It's been increasing its generic dispensing rate over the last few quarters and is moving into international markets. With the patent cliff facing companies like Cephalon and Pfizer, more generics is good news for Medco.
At last Friday's price of $62.63 per share, it has FCF expectations of 11.1% per year for five years, 5.5% for five more years, and 2.5% terminal priced in (discounting at my 15% hurdle rate). While those rates are significantly less than what the company has produced annually over the past three- and five-year periods, I'd really prefer to get an even better price. If the market can just drop expectations to about 8%, 4%, and 2.5%, respectively, that would translate to a $9 discount to Friday's price and would be a much better deal. We'll just have to see if I can get a lower price.
- To follow price developments, add MedcoHealth to My Watchlist.
Sometimes the best stock to buy is one you already own. I've purchased Transocean twice for the MUE port and the results have been very pleasing, with both positions up handsomely. The first time I bought, expectations were for FCF growth of less than 1% per year. The second time, the expectations had grown to a bit over 6% annually for five years, 3% for the next five, and nothing after that. At Friday's close, the market is expecting 9.2%, 4.6%, and 0%, respectively. The gradual rise in expectations has paralleled a rise in share price, and those two positions are up 29.5% and 17%, respectively.
I get these outsized returns as the market corrects its messed-up expectations, and right now, the expectations are not particularly messed up. Buying at the current price, I could probably do fairly well -- after all, the company's three-year annual growth rate in FCF is north of 14% -- but I prefer a slightly lower price. Plus, I need to dig further into last week's fourth-quarter earnings results and reread the conference call. On to the watchlist it goes.
- To see more news, add Transocean to My Watchlist.
Come join me over on the Messed-Up Expectations discussion board to talk over these and other companies hitting our radars.
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Pfizer is a Motley Fool Inside Value pick. MedcoHealth Solutions is a Stock Advisor selection. The Fool owns shares of Transocean. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.