Warren Buffett recently said that unless you're willing to spend six to eight hours a week researching stocks, you should invest in index funds. Research is key to producing good results, but many people do not have the time or inclination to properly research their stock picks. I recommend one approach that can reduce research time: Choose a category and then look at the best-performing mutual funds in that category as a source for great stock picks. This approach uses the expertise of professional fund-managers to help narrow down the universe of stocks to those that fit an investor's investment style and have performed well. Investors can easily find out the top-performing funds and their holdings.
The first step is to choose a high-performing mutual fund in a specific category. Mutual funds are ranked by Morningstar, U.S. News, Forbes, and other sources by size, industry, and investment style so that investors can determine the best-performing funds in a category that interests them. After a fund has been selected, the research on individual stocks begins. The typical stock fund holds 50 to 100 stocks, which is too many to research. I prefer to look at the fund's top five holdings -- the stocks the fund managers have put the most money on. The top five holdings are found in the prospectus and in fund summaries provided by Morningstar and others.
One of my favorite stock funds is Janus Global Life Sciences (JNGLX 1.36%), a large health-care growth fund with total assets of $1.8 billion. In 2013 Janus Global Life Sciences was one of the best-performing funds in the health care sector with a return of 56%. It has performed well in down markets, too, losing only 29% during the bear market of 2008 versus a loss of 37% for the S&P 500. I also like that the manager has run the fund since 2007 and worked at Janus since 1999.
Here are Janus Global Life Sciences' top five holdings:
| Company | Percentage of Fund | 1-Year Return |
|---|---|---|
| Gilead Sciences | 4.8% | 76.6% |
| Express Scripts | 3% | 33.7% |
| Aetna | 2.8% | 46.5% |
| Celgene | 2.6% | 42.3% |
| Biogen Idec | 2.6% | 96.1% |
Source: Janus. Holdings current as of Jan. 31, 2014.
All five top holdings easily beat the S&P 500 return of about 21%. In my research, two stocks stood out: Gilead Sciences (GILD 0.07%) and Aetna (AET).
Gilead Science is a biopharm company with $11 billion in sales. It has products for the treatment of HIV (including the upcoming Stribild), AIDs, hepatitis (Sovaldi), chronic angina, and the flu (Tamiflu). Gilead has a market cap of $122 billion, which suggests that the stock's growth will taper unless it continues to find innovative products. Analysts, however, estimate that its revenue will increase by 46% this year and 29% in 2015. Gilead's most promising new product is hepatitis C treatment Sovaldi. Sovaldi only launched in December, and despite its high price, the analyst consensus is that it will remain popular and achieve 2014 sales of more than $3 billion because it successfully cures patients of hepatitis. Gilead's recent P/E is 44, but due to Sovaldi and other high-margin products, its forward P/E is estimated at only 14.
Aetna operates in three segments: health care services, group insurance, and pensions. Aetna acquired Coventry Health in May 2013, which has helped Aetna's Medicaid members grow from 1.2 million to 2 million. Membership has increased to 22 million medical and 14 million dental members. Revenue has increased steadily from $27.6 billion in 2007 to $47.3 billion for 2013.
The concern for Aetna and other health care companies participating in the new federal exchanges is that the new members will increase operating costs and reduce margins. On the other hand, as Obamacare widens the pool of insured Americans, it will provide greater economies of scale and allow health care companies to negotiate lower rates with health care providers. This is what Aetna experienced. While fourth-quarter medicare costs were higher than expected by more than 2% and overall operating margins dropped, Aetna's fourth-quarter earnings still almost doubled to $368.9 million from a year earlier.
There is no stock picking strategy that will work all the time, but by using the research of the best-performing funds' analysts as a starting point and then doing your own research to fit your individual investment style, you can save time and achieve superior results.
