A time-tested group of elite fund managers offer their best stock ideas for 2014.

By Jon Birger & Scott Medintz
December 5, 2013

The moment to be most fearful is when everybody else is blissfully unconcerned. That bit of investing wisdom comes courtesy of Warren Buffett, and by that standard, as stock indexes set new records and once-traumatized investors pile back into equities, we should be very, very cautious. The market is seemingly overdue for a breather (if not a full-fledged swoon), so it’s the perfect time to take advantage of insights from investors who have thrived in good times and bad. To that end, we’ve assembled stock ideas from an eclectic assortment of top mutual fund managers. They’ve chosen low-priced values and roaring fast-growers; small fry and behemoths; U.S. companies and distant players. The one commonality: the superior long-term records of the people selecting the stocks. Because nothing beats experience, especially when times are good.


Vitamin Shoppe

Frank Sustersic

Turner Emerging Growth

Ticker:
VSI

Category: Health & nutrition

Small can be sublime. So it is for the $260 million Turner Emerging Growth Fund TMCGX , run since 1998 by Frank Sustersic. During that time it has delivered 18.9% annualized returns, obliterating the 9.1% average for Morningstar’s small-growth category. His current favorite stock: Vitamin Shoppe, the national retail chain that sells supplements, vitamins, and weight-loss products. “I love to find stocks that are growing irrespective of what’s happening with the economy,” says Sustersic, who notes that many consumers are seeking holistic health approaches. Vitamin Shoppe’s stock has slipped 6% in 2013 because of slowing sales growth at existing stores and missing a target for a 10% increase in new-store openings. Sustersic thinks investors have overreacted. “The store count will still be up 8% or 9%,” he says. Sales at existing stores edged up 2.6% last quarter, below the company’s usual 6%-plus. Sustersic contends the quarterly comparisons were tough due to gangbuster 2012 sales of “metabolism boosters” promoted by TV’s Dr. Oz. “The quarterly comparisons become much easier going forward,” says Sustersic. “The reality is that most retailers would kill for 2.6% comps anyway.” –J.B.


Hain Celestial

Kimberly Scott

Waddell & Reed New Concepts

Ticker:
HAIN

Category: Health & nutrition

Burgeoning trends at a reasonable price. That’s Kimberly Scott’s philosophy. Her Waddell & Reed New Concepts Fund UNECX has averaged 11.5% returns over the past decade, better than 95% of its peers, and these days she favors Hain Celestial. The case starts with the exploding appeal of the kind of natural and organic foods the company sells. It ain’t just Whole Foods WFM either, she notes; traditional grocers are devoting more shelf space to the category. Plus, Scott says, Hain has been smart about adding innovative brands like the British baby-food maker Ella’s Kitchen, acquired in May, to its existing lineup. (Wal-Mart WMT began stocking Ella’s squeezable pouches at its 4,000 U.S. stores last month.) Hain’s earnings have been mounting at close to 40% for the past three years, and analysts project another three to five years of 15% EPS increases. What’s more, Scott says, Hain Celestial is the “rare” growth company with a focus on squeezing productivity and profits from its manufacturing operations and supply chain. The upshot: Her “conservative” projections have the stock, currently trading around $85, reaching $135 in the next four years. –S.M.


PepsiCo

Don Yacktman

Yacktman/Yacktman Focused

Ticker:
PEP

Category: Consumer

Slow and steady has always been the recipe for Don Yacktman’s world-beating results. (His $13.5 billion namesake YACKX and $11.7 billion Focused Fund YAFFX have both returned about 11% a year for a decade, crushing the S&P SPX by 3.2 percentage points a year.) His strategy: Buy great companies when they’re out of favor and hold them, more or less forever. With the market regularly hitting new highs, Yacktman and son and co-manager Stephen are craving comfort food. “We’re focused on defense more than offense,” Stephen says, and PepsiCo promises just about the best “risk-adjusted” returns out there. Between dividends and stock buybacks, the company is paying shareholders 4.5% to 5% in cash. Add in anticipated growth from price increases and 2% to 3% unit volume increases and you can expect to earn 9% to 10%, Stephen argues. Given Pepsi’s stranglehold on the snack-food aisle and its forward thinking about healthy alternatives, that return won’t be nibbled away over time. “Think of it like buying an undervalued triple-A bond,” says Don. “It’s not very exciting, but that’s the point: You sleep at night when the wind blows.” –S.M.


Target

Meggan Walsh

Invesco Diversified

Ticker:
TGT

Category: Retail

By many accounts, Target botched its 2013 incursion into Canada. When the first of the retailer’s planned 124 Canadian stores opened in March, it was hampered by high prices and limited supplies. That’s one reason Target’s shares have underperformed the S&P by 50% this year. But Meggan Walsh, who runs the $8.7 billion Invesco Diversified Dividend Fund LCEAX , thinks the episode has been blown out of proportion. Her fund, which has averaged 8.7% annualized returns over a decade, vs. 7.8% for the S&P, looks for undervalued dividend-payers. “The problems have been identified, and we’re at the point where shareholders will begin to benefit from the investments,” she says. With the Canadian push behind it, she adds, Target will reduce capital expenditures by $1 billion next year and is likely to pass the extra cash to shareholders. And because Target’s customers have higher average incomes and do more discretionary spending than the competition’s, Walsh expects better same-store sales. That, she argues, will help nudge its forward P/E ratio from 14 back toward its 10-year average of 15.5. –S.M.


Expedia

Steven Pollack

John Hancock Disciplined Value Mid Cap

Ticker:
EXPE

Category: Travel

Steven Pollack has three criteria when selecting a stock. The valuation should be enticing; it should be a quality business with attractive free cash flow and return on capital; and there should be a reason to buy the stock now, such as positive momentum or a catalyst to push the stock price higher. Expedia, the online travel firm, “fits all three,” says Pollack, whose John Hancock Disciplined Value Mid Cap Fund JVMAX has a 28.8% average annual return over five years, vs. 27.3% for the S&P’s Midcap 400 index. Expedia trades at 16 times projected 2014 earnings, well below archrival Priceline’s P/E ratio of 22. Expedia reported $740 million in free cash flow during the first nine months of 2013, and revenues are growing at a 15% annual clip. Beyond that, Pollack likes the fact that Expedia and Priceline PCLN are becoming an oligopoly, which will discourage new competition. Pollack also sees potential catalysts. Expedia holds controlling stakes in Trivago and eLong, popular travel sites in Europe and China, respectively. “Both Trivago and eLong have significant growth opportunities,” Pollack says, “and both could potentially be spun out.” –J.B.


Technip

Sarah Ketterer

Causeway International Value

Ticker:
TKPPY

Category: France

Sarah Ketterer, manager of the $4.5 billion Causeway International Value Fund CIVVX , is a fan of energy stocks these days, in part because they’ve lagged. Ketterer, whose fund has averaged 21.2% annual returns over the past five years, vs. 16.3% for its category, blames exaggerated concerns about China for the anemic stock performance: “China is slowing down, but its demand for energy is still very high.” Her favorite stock today is Technip, which lays deepwater oil and gas pipelines. The stock trades at a mere 13 times expected 2014 earnings, which analysts project to gush 27%; Technip also offers a 2.1% dividend yield. The stock has slumped 15% since October, and Ketterer blames guilt by association, as two Technip rivals suffered big earnings disappointments. Deepwater pipe-laying is Technip’s core business, but Ketterer thinks another specialty will provide long-term windfalls. Given the shale gas boom in the U.S., she expects the country will eventually ship liquefied natural gas to Europe. Technip builds plants that convert natural gas to LNG and LNG back to gas. “They’re the best at it in the world,” says Ketterer. –J.B.


Green REIT

Edwin Lugo

Franklin International Small Cap Growth

Category: Ireland

Green REIT, Ireland’s first-ever real estate investment trust, is a good story. It’s also a brand-new stock with no history, so it helps that the storyteller is a premier manager: Edwin Lugo, whose $1.5 billion Franklin International Small Cap Growth Fund FINAX has returned 25.7% a year over the past five years (see chart above), putting it in the top 2% of its foreign stock-fund category. Green REIT is essentially a vulture fund for Irish real estate. Commercial property prices fell 65% during the financial crisis. As a result, the Irish government and various banks ended up holding €76 billion in foreclosed properties and loans. To speed the recovery, Ireland passed a law permitting REITs; in July, Green became the first to launch there. “Banks are not in the business of managing property,” says Lugo, so they’re willing to sell “at a huge discount.” The timing looks excellent. Irish commercial property prices rose in October for the first time since 2007, just as Green made its first purchases at big discounts to U.S. properties. “It’s rare you get a chance to buy real estate at the bottom,” says Lugo, who notes that “the Irish economy is already turning around.” –J.B.


Volkswagen

Jim Moffett

Scout International

Ticker:
VLKAF

Category: Germany

Jim Moffett gravitates to out-of-favor stocks, an approach that has delivered an annualized 9.3% for a decade UMBWX , outperforming the foreign stock index by 1.6 percentage points a year. Lately Moffett’s thinking has driven him to the auto industry. He’s especially optimistic about Volkswagen because the German automaker has been “lagging the pack” while laying the groundwork for a resurgence. The automaker’s recent stall, he says, is partly a reflection of Europe’s woeful economy and partly a result of being “out of sync” with the industry. In particular, he says, VW has lacked broadly appealing high-end offerings in the U.S. Now, though, the European economy is showing hints of improvement, and VW plans to roll out new products next year. Meanwhile, he says, the company is reducing costs with its modularized manufacturing strategy, which he expects to show results in the next year. The upshot, Moffett says: The market will eventually perceive the improvement, and VW’s stock, currently trading at nine times 2013 expected earnings, will catch up to BMW and Daimler, which have P/Es of 10.5 and 11.5, respectively. –S.M.


Ezion Holdings

David Semple

Van Eck Emerging Markets

Ticker:
EZIDF

Category: Singapore

David Semple, manager of the $190 million Van Eck Emerging Markets Fund GBFAX , enjoys an edge when it comes to energy stocks. His fund family includes two commodity funds, and it employs a team of oil and gas experts whom Semple can tap. That has helped his energy-heavy fund tally a 29.1% average annual return over the past five years, putting it in the top 1% of its category. Semple’s current favorite: Ezion Holdings, an oil-services company based in Singapore (but available to U.S. investors through the likes of Fidelity and E*Trade). Semple is betting on rising oil demand in Southeast Asia, and Ezion’s earnings growth (up 95% in the first half of 2013), modest valuation (a forward P/E of 8), and unique niche appeal to him. Says Semple: “Oil demand from this region is clearly very strong, and this company seems to be at the center of it.” Ezion owns and operates one of the world’s largest fleets of “liftboats” — vessels used to service and repair shallow-water, offshore oil platforms. According to Semple, the Asian market is underserved, with one-seventh the ratio of liftboats to oil platforms compared with the Gulf of Mexico. –J.B.


China Mobile

Brian McMahon

Thornburg Investment Income Builder

Ticker:
CHL

Category: China

Long viewed as frumpy, dividend stocks enjoyed a vogue in recent years. The category has waxed and waned, but one thing has remained constant: Brian McMahon’s outperformance. His $16 billion fund TIBAX has turned in annualized 10% returns for 10 years, more than two percentage points above results for the S&P 500 and his “world allocation” peers. China Mobile, the world’s largest telecom, follows his template. The stock’s dividend yields 4.3%, and it has grown at 6% annually for the past five years. But there’s more upside. McMahon says investors have punished the stock (which trades as an ADR in the U.S.) because the Chinese government has forced the company to adopt — and invest heavily in — the country’s homegrown 4G technology before it was widely used by the telecom industry. The good news, he says: The technology looks promising and is about to launch. “Soon they’ll have the most spectrum, the most base stations, and the first shot at this great new technology.” The result? He expects the stock, trading at 3.5 times Ebitda, to leap to 4.5 by 2015. That could propel the share price by 40% or more. –S.M.


Credit Suisse

David Herro

Oakmark International

Ticker:
CS

Category: Switzerland

Even as investors fled Europe during its sovereign debt crisis, David Herro placed one of the most audacious contrarian bets in recent history, going all-in on beleaguered French, Spanish, and Italian financials. The result: nearly 40% returns over the past 12 months. (The fund’s OAKIX extended record is also superb: 11.3% annualized returns over the past 15 years, vs. 5.0% for MSCI’s EAFE index.) With Europe seemingly off the ledge, Herro now reserves his strongest conviction for Swiss banking giant Credit Suisse, which, he says, is at an “inflection point.” Low interest rates and a strong Swiss currency have pushed it to the bottom of its earnings cycle, and the bank has been building reserves to comply with higher post-crisis capital requirements. But those impediments, Herro says, have run their course. The result will be double-digit earnings increases, he says: “Over the coming years it should be able to generate $8 billion in annual operating profits” — four times the current level. To Herro, that makes the company’s forward P/E of 8.8 and price-to-book ratio of 1 look unjustly low. –S.M.


Agco

Thyra Zerhusen

Aston/Fairpointe Mid Cap

Ticker:
AGCO

Category: Agriculture

Thyra Zerhusen likes rummaging through the bargain bin. A year ago two of her biggest holdings were unpopular: medical-device maker Boston Scientific BSX and newspaper publisher New York Times Co. NYT The duo have returned 108% and 57%, respectively, so far in 2013. That’s one reason Zerhusen, who has led the fund CHTTX for 14 years, has racked up 12.1% annualized returns over 10 years, compared with 7.8% for the category. Her latest contrarian choice is agricultural equipment maker Agco. The stock sank 9% in October after quarterly earnings fell a penny short of analysts’ expectations. Never mind that per-share profits were up 32% (which is typical for Agco). With shares trading at just 10 times estimated 2014 earnings, Zerhusen sees much more upside than risk. “Between population growth and expanding farm income, there’s more incentive to be efficient in agricultural production,” she says. Management has been boosting profit margins (up two percentage points in the third quarter) through cost cutting, and Zerhusen expects the margins eventually to rise from 9% today to 15%. –J.B.


Ultimate Software

Sudhir Nanda

T. Rowe Price Diversified Small Cap Growth

Ticker:
ULTI

Category: Software

Ultimate Software Group isn’t a stock for bargain hunters. A developer of payroll and other human resources software for small and midsize businesses, it has seen its shares soar 1,100% over the past five years; they trade at a lofty 85 times projected 2014 earnings. Of course, as a growth investor, Sudhir Nanda isn’t looking for cheap stocks. He believes Ultimate’s potential is enormous, which is why it’s a top-five holding in his T. Rowe Price Diversified Small Cap Growth Fund PRDSX . Nanda has shown a knack for picking winners before: His $709 million fund has generated 29.8% annual returns over the past five years, vs. 26.6% for the average small-cap fund. Ultimate boasts gaudy 45% annual earnings improvement over the past five years, and Nanda loves the stickiness of its cloud-based services, which he considers better than those of rivals. Penetration for such HR offerings is only 30%, which means plenty of potential new customers. “The company can grow revenue greater than 20% for the foreseeable future,” Nanda says. “Earnings will grow even faster as you scale up and get margin improvement.” –J.B.


Kirby

David Daglio

Dreyfus Opportunistic Mid Cap Value

Ticker:
KEX

Category: Energy services

David Daglio has run the Dreyfus Opportunistic Mid Cap Value Fund DMCVX for a decade, during which it has churned out 9.7% annualized returns, vs. 8.8% for its Morningstar category. He believes the U.S. is entering a manufacturing boom — one fueled by cheap and plentiful natural gas and other chemical feedstocks. Daglio’s current favorite holding, Kirby, fits squarely in that thesis. It has already been a big winner in 2013, but Daglio thinks its ascent is far from complete. Kirby is the largest tank barge operator in the U.S., using the Mississippi River and connecting waterways to transport chemicals, crude oil, gasoline, and more to refineries and chemical plants. Kirby has benefited from the North Dakota oil and gas boom, and its barges also move Canadian crude to Gulf Coast refineries. Last quarter Kirby’s earnings rose 27% — very good for a stock trading at 19 times estimated 2014 earnings. Analysts expect 12% a year earnings growth over the next five years. “As we look at the landscape, it’s clear that we’re going to have more oil, natural gas, and natural-gas liquids, and that the people who reduce bottlenecks are going to make a king’s ransom,” says Daglio. “So for us Kirby is a pretty simple supply-and-demand story.” –J.B.


Jones Lang LaSalle

John Rogers

Ariel Investor

Ticker:
JLL

Category: Real estate

There’s a certain symmetry between John Rogers’s $2.3 billion Ariel Investor Fund ARGFX and his pick, Jones Lang LaSalle, a global real estate giant that runs commercial properties, brokers financing, and manages property portfolios for investors. A longtime holding for Rogers, the stock soared from $13 a share in 2000 to $117 in 2007, then cratered to $20 before roaring back to $95. After some bumpy years of his own, Rogers has been on a roll, with a five-year average return of 31.2%, vs. 21.5% for the S&P. Rogers thinks we’re in “the fourth or fifth inning” of a global commercial real estate recovery. He’s especially optimistic about JLL’s asset-management arm, which, he says, is benefiting as institutional investors diversify from equities and bonds and into real estate. The stock is trading at 14 times expected 2014 profits, but Rogers thinks the company’s accelerating profit growth merits a P/E closer to 20, which could lift the stock to $140. “People perceive this business as riskier and more volatile than it really is in 2013,” Rogers says. “They’ve diversified geographically — they’ve got huge businesses in Asia — and they’ve expanded their product offerings. We think there’s enormous upside.” –J.B.


U.S. Bancorp

Mark Henneman

Mairs & Power Growth

Ticker:
USB

Category: Retail banking

It’s not just shared heartland values that draw Mark Henneman to companies based in the Midwest, near his firm’s St. Paul headquarters. Henneman, who has co-managed Mairs & Power Growth MPGFX with William Frels since 2006 and took the helm this year, likes easy access to his portfolio companies. That approach earned an average of 9.5% for 10 years, vs. 7.7% for the S&P 500. In the case of Minneapolis-based U.S. Bancorp, he got an intimate look at how its refusal to chase hot ideas — think mortgage-backed securities — made it “the best-performing large bank in America” through the crisis. These days, he argues, size gives U.S. Bank a leg up: With $350 billion in assets, it’s big enough to benefit from efficiencies of scale, yet small enough to elude capital requirements imposed on the biggest institutions. Henneman admits a P/E of 12 doesn’t look cheap for a financial stock, but he argues that U.S. Bank’s conservative approach to reserving for underperforming loans means its earnings are effectively understated. Even before figuring in projected earnings growth of 8%, he thinks U.S. Bank’s current performance justifies an 18% stock bump. –S.M.


Bank of New York Mellon

Chris Davis

Davis New York Venture

Ticker:
BK

Category: Custody banking

Chris Davis is thoughtful and risk-averse — his $21 billion Davis New York Venture Fund NYVTX has averaged 6% annual returns over the past 15 years, vs. 4.8% for the S&P 500 — and he’ll always favor the reliable over the audacious. Davis’s choice: Bank of New York Mellon. A “custody” bank, it holds assets for institutional investors, such as mutual funds, and collects and distributes dividends and coupon payments for issuers of stocks and bonds. The economies of scale are so vast — with $26 trillion in custody — that it would be nearly impossible for a newcomer to make inroads into its market. BNY Mellon trades at 13 times projected 2014 earnings, pays a 1.8% dividend yield, and is projected to have 12% earnings growth in 2013. He also sees a scenario in which earnings could accelerate. “We expect interest rates to be significantly higher in the future,” says Davis, who asserts that a two-percentage-point increase in interest rates could increase BNY Mellon’s earnings per share by nearly 50%, given its massive assets in custody. “It’s a boring, boring business … but I don’t really see the scenarios where the earnings power is diminished,” Davis says. “That’s the sort of risk/reward that I like.” –J.B.


Morgan Stanley

Patrick Kelly

Alger Spectra

Ticker:
MS

Category: Investment banking

For the past decade, Alger Spectra SPECX has racked up returns of 12.3% a year, better than 99% of large-cap growth funds. Patrick Kelly, who has led the fund for nine years, says he looks for companies undergoing “positive dynamic change” that can propel earnings and stock prices. In the case of Morgan Stanley, Kelly says, the change has two components. First, through revenue growth and cost cutting, the company is boosting the margins of its wealth management division — from 9% in 2009 to a projected 20% in 2015. Second, it’s shrinking its less profitable fixed-income business, reducing the assets associated with it from $390 billion in 2011 to a projected $180 billion in 2016, freeing capital that can be returned to shareholders. As a result, he expects that wealth management will account for 50% of Morgan Stanley’s pretax income by 2015, up from 18% in 2010. When the market takes note, Kelly says, shareholders will benefit because wealth management trades at a higher multiple than does Morgan Stanley’s traditional institutional business. The stock has already surged from $19 at the start of 2013 to around $30 now, but earnings have advanced even faster, preserving the forward P/E at 12. –S.M.


Western Union

James Kieffer

Artisan Mid Cap Value

Ticker:
WU

Category: Money transfer

Underdogs abound at Artisan Mid Cap Value ARTQX , which has averaged 12.7% returns for a decade, vs. 10.5% for the S&P Midcap 400 Index. Sure enough, co-manager James Kieffer (at the fund since 2001) endorses a straggler: Western Union, whose shares have slid 8.5% over the past three months even as midcaps jumped 8.8%. The company warned of flat 2014 earnings, prompting some investors to bail out. Kieffer thinks that’s shortsighted. Globalization has led to greater labor migration, which has increased demand for wire transfers, since workers often support families back home. But the rise in transfers has also brought increased scrutiny by regulators looking for money laundering or other illegal activity. That means higher short-term compliance costs. Kieffer sees a silver lining. As the industry leader, Western Union is positioned to absorb those costs better than smaller rivals. In addition, he views Western Union’s decision to cut fees, which alienated investors, as the first volley in a price war to tighten the screws on competitors. “It’s a stock trading at 12 times earnings that historically had traded in the high teens,” he says. “They’re also paying you a 2.9% dividend yield. To me, that’s a lot of bang for your buck.” –J.B.


MarketAxess

Thomas Ognar

Wells Fargo Advantage Growth

Ticker:
MKTX

Category: Trading

It happened years ago for stocks, and Thomas Ognar believes it’s going to happen for bonds: a shift from dominance by a handful of Wall Street broker-dealers to electronic marketplaces. That means opportunity for MarketAxess Holdings, an electronic trading system for bonds. Despite lower costs, such platforms have made less headway with bonds than with stocks, in part because bonds are traded less frequently than stocks. But Ognar, whose $12.4 billion fund SGROX has a five-year average annual return of 29.2%, vs. 21.5% for the S&P, thinks that’s changing. Faced with tougher capital requirements and tighter regulations on proprietary trading, big Wall Street firms can no longer afford to maintain large inventories in the bonds for which they serve as dealers. Meanwhile, Ognar notes, reduced interest rates have made clients more price-sensitive than in the past. Trading volumes for MarketAxess, the leader in its niche, have increased 50% since 2011. The stock isn’t cheap, trading at 32 times estimated 2014 earnings, but Ognar thinks those projections are too conservative: “The trajectory of their ability to grow earnings is a lot higher than what analysts are looking for.” –J.B.

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