Elite fund managers share their best stock ideas for 2013.
There’s nothing like having a local guide. Whether you’re a climber trying to scale the heights of Mount Everest or an investor exploring a stock, you can benefit from the insight of a person who spends endless hours learning a particular terrain. That’s why we’ve turned this year to sage investing guides who’ve honed their expertise in a dozen sectors and stock styles, delivering lengthy records of superior performance. Read on to discover their most promising stock picks for 2013. It’s always easier to find a path when someone who knows it is there to point it out for you.
Buffalo Discovery Ticker: ALGN Sector pick: Technology Clay Brethour, co-manager of the $430 million Buffalo Discovery Fund BUFTX — up 10.6% a year on average for the past 10 years, vs. 7.5% for its category, according to Morningstar — likes to think about innovation broadly rather than about technology per se. Case in point: Align Technology, the $550 million (in revenue) maker of Invisalign invisible braces, which have transformed orthodontics. The company’s clear aligner trays, which pop in and out like retainers, first became popular with adults as an alternative to the despised traditional metal braces. Now the company is making inroads in the teenage market, which represents three-quarters of the 2.6 million orthodontics cases begun each year. (Shares have fallen 28% since a quarterly decline in shipments to adults, but Brethour isn’t worried because of the potential he sees in the teen market.) He thinks the company, a top holding of his fund, can continue to increase revenue about 15% or so a year, and expand profits at an even faster rate, for the next five years. As Brethour puts it, “If you talk to orthodontists and dentists, this is the only product where patients come in and ask for it by brand.” –Amy Feldman
Ivy Science and Technology Ticker: PNR Sector pick: Technology Ivy Science and Technology WSTAX , with $1.5 billion in assets, has trounced the market over the past decade, returning an annualized 11.8%, vs. 7.5% for its category. Manager Zach Shafran has been mixing big tech companies with more contrarian plays since 2001. Pentair, which accounts for 2.2% of the fund’s assets, falls into the latter category. Shafran views it as “a story about water on a global basis.” Pentair makes filtration devices and pumping systems, and he gushes about markets in the U.S. (as homeowners, hotels, and spas become more efficient with water) and in the developing world (as growing economies fund needed infrastructure). Pentair, which had revenue of $3.5 billion in the latest 12 months, recently completed a $4.9 billion merger with the flow-control business of Tyco International. That will make the company more global and more than double sales. “They can expand their product line and reach,” Shafran says. At a recent $49, the stock trades at roughly 15 times next year’s estimated earnings and has a dividend yield of 1.8%. But Shafran is most excited by Pentair’s goal of a 50% increase in annual profits by 2015. Shafran thinks the company can exceed that figure. –A.F.
Neuberger Berman Real Estate Ticker: PSA Sector pick: Real Estate Brian Jones and Steve Shigekawa, managers of the $670 million Neuberger Berman Real Estate Fund NBRFX , own just 40 stocks, with the top 10 representing nearly half the fund’s assets. That strategy has served them well: The fund has landed an average annualized gain of 13.3% for the past 10 years, vs. 10.3% for the category, according to Morningstar. Jones’s favorite stock for 2013 is Public Storage, the largest self-storage company in the U.S., which represents more than 5% of the fund’s assets. The REIT has a lot going for it. As the largest player in a fragmented market — its 2,200 facilities are just 4% of the nation’s 50,000 — Public Storage has the financial strength and marketing clout that rivals lack. “They own more than twice as many self-storage facilities as their nearest competitor,” Jones says. The company boasts occupancy levels above 90%, which has helped Public Storage boost its rental rates. With the economics favoring big players and a dearth of financing for construction of storage spaces, the market is primed to consolidate, Jones says, and Public Storage should benefit. –A.F.
T. Rowe Price Health Sciences Ticker: GILD Sector pick: Health care Kris Jenner, a former doctor, has operated the white-hot T. Rowe Price Health Sciences Fund PRHSX since 2000. With $4.9 billion in assets, it has delivered an annualized 13.6% gain for the past decade, drubbing its peers’ 9.0%. Jenner’s prescription: shares of biotech giant Gilead Sciences, one of his fund’s largest positions. Gilead made its mark with a once-a-day HIV pill, and Jenner thinks it can repeat that success with a new treatment for hepatitis C. Known as sofosbuvir, it has a higher cure rate with less toxicity than interferon, the standard treatment, he says. The market is huge: More than 4 million people have hepatitis C in the U.S. “The hepatitis C market will be in excess of $10 billion,” says Jenner, “and we are at the dawn of that market.” He believes Gilead’s revenue could rise 16% a year through 2016, with earnings per share soaring 27% annually. At a recent $75, the shares aren’t cheap — they’re up 84% since the beginning of 2012 and trade at 20 times this year’s consensus forecast. Jenner advises waiting for a pullback before buying. But be patient. “In its peer group,” he says, “it’s going to be unrivaled in terms of its revenues and earnings growth.” –A.F.
Akre Focus Ticker: MCO Sector pick: Finance “Moody’s is a company that is certainly not without its controversies,” admits Chuck Akre. That’s quite an understatement. The ratings agency was famously vilified during the financial crisis for awarding gilded AAA ratings to toxic debt. But Moody’s survived — and Akre thinks its future is bright. The money manager, whose $1.2 billion Akre Focus Fund AKREX has returned 15% a year since 2009, besting 84% of peers (after he averaged 12.6% a year for more than a decade at his previous fund), notes, “You can’t go to the debt market without one of their ratings, period.” As a result, Moody’s has “fabulous pricing power,” which is why it generates free-cash-flow margins of nearly 30%. The stock has been on a tear recently, but Akre thinks that at 16 times next year’s earnings — half its pre-crisis valuation — it remains a bargain because of the lingering damage to its reputation. Moody’s could actually benefit from the crisis in Europe, he says. As banks there stop lending, companies will have to issue bonds if they want to raise cash. Akre also likes Moody’s prospects in the U.S.: “The need for debt financing in this low-interest-rate environment is staggering.” –Mina Kimes
MFS Utilities Ticker: CMS Sector pick: Utilities As investors fret that taxes on dividends may rise, high-yielding utility stocks are taking a beating. Maura Shaughnessy, manager of the $4.6 billion MFS Utilities Fund MMUFX , thinks the market is overreacting. “Trying to invest in what the government is going to do is a loser’s game,” says Shaughnessy, whose fund has powered past 98% of utilities funds over the last decade, returning an average of 14.5% a year. She still likes dividend stocks, and one of her favorites is CMS Energy, a Michigan-based utility with a 4% yield. CMS is a regulated utility, which means a local board sets its rates. Shaughnessy says that Michigan regulators have become “extremely transparent and rational,” enabling CMS to earn a decent return. Shaughnessy expects CMS to boost earnings at a rate of 4% to 6% over the next five years, while most peers earn less. Despite its superior prospects, CMS is trading at a discount of about 10% to the group. Shaughnessy says that’s because the regulatory climate in Michigan used to be worse and because the company used to carry too much debt. CMS has improved its balance sheet, she says, making it likely to receive an investment-grade credit rating soon. –M.K.
Heartland Value Plus Ticker: AIN Small and large pick: Small-caps Brad Evans loves stocks that others hate. That approach has propelled Heartland Value Plus HRVIX to annualized 5.8% returns over the past five years, beating 95% of its competitors. Albany International is a classic Evans choice. The company used to be a mini-conglomerate, selling everything from industrial doors to fake down. Now it’s got two key units: a lucrative (but flat) business in fabrics and belts used to make paper, and a line that produces engineered composites, which are lightweight and save fuel, mostly for aerospace and defense. Already providing fan blades for the LEAP engine, used on new planes from Boeing and Airbus, this unit could take off, in Evans’s view. It represents only $60 million in sales, vs. nearly $700 million for the paper operations, but Evans argues that composites could be a $300 million to $500 million operation (with 20% operating margins) by 2020. The stock has a forward P/E of 13.5 and a yield of 2.6%. “The market is valuing the company as a no-growth paper machine clothing company, and it is very attractively valued on just that metric,” Evans says. Add in the composites business, he argues, and Albany is “misunderstood, underloved, and underfollowed.” –A.F.
Delaware Select Growth Ticker: PAY Small and large pick: Large-caps Van Tran focuses on transformation: Companies whose products or industries are in the midst of major change, which tends to depress stock prices. She aims to predict the long-term winner — she calls it “time arbitrage.” That strategy has helped the Delaware Select Growth Fund DVEAX , which Tran began co-managing in 2010, produce 9.1% annual returns over 10 years, vs. 6.2% for the S&P. Tran is betting that when the shakeup is complete among companies that handle point-of-sale payments, VeriFone will emerge triumphant. The ongoing shift from cash to plastic and now phones, combined with the entry of new mobile-payment players like Square, PayPal, and Google, has shaken the industry and helped push VeriFone shares down 20% over two years even as the company expects 11% sales growth in 2013. Tran is skeptical that newbies like Square can swing the massive investment needed to scale up. VeriFone, with its software and high market share in point-of-sale terminals — 60% in the U.S. — is “not betting their business on any given payment technology,” she says. “It’s more about working within the existing ecosystem and enabling what might come.” –Ryan Derousseau
BBH Core Select Ticker: USB Small and large pick: Large-caps Most banks are complicated. U.S. Bancorp has thrived by keeping it simple. Tim Hartch, whose $3.5 billion BBH Core Select fund BBTEX has returned 6.4% a year since 2007, easily besting the S&P 500’s 1.4% annual return, is impressed by U.S. Bancorp’s straightforward business model. Instead of relying on trading and investment banking, he says, it makes money the old-fashioned way: collecting deposits, issuing loans, and managing people’s wealth. “If the regulators could have their wish,” he says, “all banks would look like U.S. Bancorp.” The country’s fifth-largest bank isn’t immune to its sector’s challenges: new regulations and record-low interest rates (which compress profits, since banks can’t charge much for loans). But it is insulated by its sizable payment-processing business, which helps retailers handle electronic transactions. “It’s a nice earnings stream that doesn’t require a significant amount of capital,” says Hartch. Of all the big commercial banks in the country, he adds, U.S. Bancorp reaps the highest return on equity and the highest return on assets. Yet with a P/E of 11.8 times trailing earnings, it trades below the (already low) sector P/E of 12.6. –M.K.
Oppenheimer Equity Income Ticker: F Small and large pick: Dividends Michael Levine says the American auto comeback isn’t over. The industry is set to sell about 14 million cars this year — a dramatic improvement from the lows of 2009 but still well below the peak of 17 million in 2000. “I think there’s a lot of pent-up demand,” says Levine, who has driven the $3.4 billion Oppenheimer Equity Income OAEIX Fund to 8.2% annual returns over the past decade. “The age of the fleet is at an all-time high; there are a lot of older cars out there that need to be replaced.” On top of that, Levine thinks automakers will benefit as housing construction rebounds and contractors need to buy more pickup trucks. Levine sees promise in the whole sector but says that Ford, which survived the recession without a bailout, is especially compelling. Its stock is trading at just eight times next year’s earnings. Ford’s shares have suffered because of skidding sales in Europe, but Levine thinks its results will improve as it shrinks its manufacturing capacity in the region. In the meantime the company offers a 1.7% dividend yield. Because it has a rock-solid balance sheet, he says, Ford has the wherewithal to bulk up its payout by at least 50% over the next year. –M.K.
TIAA-CREF Growth & Income Ticker: CMCSA Small and large pick: Dividends Not much has changed in Susan Kempler’s strategy since she took the helm of TIAA-CREF’s $3 billion Growth and Income Fund TIIRX in 2005. She has always sought high-quality companies with rising earnings and cash flow, delivering 7.7% annualized returns over 10 years, vs. 6.4% for the S&P. Comcast is undergoing a transition that offers the growth Kempler likes. The cable giant’s 51% stake in NBCUniversal, which it purchased in 2011, has brought a new source of revenue, which boomed 32% in the third quarter compared with the year-earlier quarter because of strong ad spending for the Olympics and political campaigns, and improving ratings for its once-moribund network lineup. Comcast will continue to up its stake until it owns 100% of NBCUniversal in 2017. Meanwhile its cable business, which accounts for 63% of revenue, has pared infrastructure spending, leaving cash for $6 billion worth of dividends, buybacks, and R&D. “The business isn’t just collecting monthly cable bills anymore,” says Kempler. “They’re powered by [cable and Internet] technology that makes it better than its peers.” –R.D.
BlackRock Global Dividend Income Ticker: UL Around the globe pick: Europe Unilever may be headquartered in Europe, but it’s thriving in emerging markets. The purveyor of packaged foods and consumer products does more than 50% of its sales in the developing world, and those sales have risen 12% this year, excluding the effect of acquisitions. Stuart Reeve, manager of the $1.2 billion BlackRock Global Dividend Income Fund BABDX , says the company has a strong advantage overseas. “Unilever has been in India for well over 70 years,” says Reeve, whose fund has returned 9.4% a year over the past three years, topping 83% of world stock funds. While other businesses are just setting up sales networks and supply chains in emerging markets, he says, Unilever is already up and running. “They’re well positioned to get their products in front of consumers without employing extra costs.” That’s one reason Unilever boasts a healthy 14% operating margin and why it’s able to return 50% of its free cash flow to shareholders. Over the past few years, Reeve says, it has consistently raised its dividend at a rate of 6% to 8% per year. He expects Unilever’s payout — the stock currently yields 3.3% — to continue its ascent over the next few years. –M.K.
Fresenius Medical Care
Harding Loevner International Equity Ticker: FMS Around the globe pick: Europe Fresenius Medical Care runs dialysis centers, providing an indispensable service to patients whose kidneys are failing. With an aging population, that market is burgeoning: Researchers expect the number of Americans with end-stage renal disease to reach 785,000 in 2020. That’s up 60% from 2005 levels. Fresenius, which is based in Germany but operates primarily in the U.S., commands some 30% of the market, according to Alec Walsh, co-head of the $2.2 billion Harding Loevner International Equity Fund HLMNX . Fresenius’s edge: It can leverage its size to tamp costs down, he says, making it more profitable than tinier rivals. Since 2007 the company has boosted its net profit margin by more than 20%. Fresenius recently reported earnings that lagged analysts’ projections, nicking its shares. But Walsh, whose fund has returned 9.1% a year over the past decade, sees that as an opportunity. He blames one-time operational issues. And analysts expect 11% annual earnings increases for the next five years. One promising target: emerging markets. Walsh notes that the number of dialysis patients in Asia is increasing by 10% a year. –M.K.
Perusahaan Gas Negara (Persero)
Shuxin (Steve) Cao
Invesco Asia Pacific Growth Ticker: N/A Around the globe pick: Asia A few years ago, finding a winning Asian stock was a no-brainer. But with growth in China and India less certain lately, it’s a lot tougher. Steve Cao, who has run the $640 million Invesco Asia Pacific Growth Fund ASIAX since 1999, has returned an annualized 17.2% for the past decade, vs. 13.3% for his peers, according to Morningstar. These days Cao is betting on utilities. “We like the predictable earnings and the long-term cash-flow-generation capability of these companies,” he says. His choice, Perusahaan Gas Negara, fits that mold. It owns and operates a natural-gas pipeline in Indonesia, where it has 90% market share. Its dominance has allowed it to maintain return on equity of 40%. The stock (which trades on the Jakarta exchange and is available through brokerages such as Schwab and E*Trade) has a forward P/E of 13, a relatively modest valuation for a company with strong prospects, Cao notes. Profits in 2013 are expected to be 16% above those for 2012, and Cao thinks they’ll keep advancing in the high single digits after that. An added plus: a dividend yield of 3%. Says Cao: “What we like is the quality of the growth — how long it can grow and the sustainability of that growth.” –A.F.
Grupo Financiero Santander Mexico
Virtus Emerging Markets Opportunities Ticker: N/A Around the globe pick: Latin America Investors focus so much on the BRIC countries (Brazil, Russia, India, and China) that they forget Mexico, says Rajiv Jain, whose $6.1 billion Virtus Emerging Markets Opportunities fund HEMZX has averaged a blistering 17% a year since 2002. He thinks that’s a mistake. “Mexico has been outgrowing Brazil for about two years,” he says. “It’s a wonderful market to be in.” When the Spanish financial giant Banco Santander began selling shares of its Mexican division this fall, Jain jumped at the chance to buy the stock, which he says has a forward P/E of 12. “It really is a jewel,” he says. Jain points out that the Mexican bank has a “huge” 2.5% return on assets, and its tier-one capital ratio is 14%. “They’re a massively well-capitalized bank compared with what you see in the U.S. or Europe,” he says. The market for financial services in Mexico is relatively nascent. The private debt-to-GDP ratio is about 50% lower than it is in Brazil, he notes, and many Mexicans still lack mortgages. As a result, Jain thinks Santander Mexico can lift its earnings by more than 12% a year over the next few years. And it’s one of five big banks that control three-quarters of the market, Jain says, which should prevent competitors from nipping at its heels. –M.K.