While history's greatest investors have come in a variety of
shapes and sizes, one quality that the vast majority have had in
common is that they are contrarian thinkers. They don't follow the
crowd, they don't listen to the pundits, and they don't let the
headlines of the day drive their investment decisions.
Right now, the headlines and the pundits and the crowd seem to
have one thing on their minds: the "fiscal cliff". And the
conventional wisdom seems to be that, if the U.S. does go off the
cliff (which will trigger a number of significant tax hikes and
budget cuts in 2013), stocks will get hit hard -- particularly
certain types of stocks, like dividend plays and defense companies.
Be cautious, the thinking goes -- very cautious.
But what if we don't go off the cliff, or we do, but the impact
on the stock market isn't as severe as expected. Despite what you
may have heard, those are both legitimately possible scenarios. And
if they do play out, the stocks that are supposed to get hit hard
could instead take off.
If you're willing to take on some macroeconomic risk in your
portfolio, you might want to take a look at some of these types of
stocks. Recently I used my Guru Strategies, each of which is based
on the approach of a different investing great, to find some of the
most fundamentally and financially sound stocks in
"Cliff-sensitive" areas of the market, like the defense sector,
dividend stocks, and small caps. Again, keep in mind that these
stocks come with a good amount of macroeconomic risk in the short
term. But also keep in mind that that risk has been known for some
time, and may well be baked into prices already. If you have a
long-term horizon, picks like these could provide some nice upside
within a well diversified portfolio.
General Dynamics (
Virginia-based GD ($24 billion market cap) is one of the U.S.'s
largest aerospace & defense firms, making everything from
battle tanks and battleships to armaments and munitions to nuclear
submarines and military information technology systems.
Defense companies could be hit hard if the U.S. goes off the
fiscal cliff, which calls for drastic reductions in defense
spending. But General Dynamics has a long history of strong
performance, and its size would give it a big advantage over
smaller firms even if those drastic defense cuts did go into
effect. In addition, the fiscal cliff fears have made it quite
cheap -- it trades for just 9.6 times projected 12-month earnings,
which is based on projections of only minor growth next year.
Two of my models are quite high on GD. My Peter Lynch-based
strategy considers it a "slow grower", because of its 7.4%
long-term earnings per share growth rate. (I use an average of the
three-, four-, and five-year growth rates to determine a long-term
rate.) Lynch primarily invested in slow growers for their dividend
yields, and, at 3.1%, GD offers a pretty solid yield. Lynch also
pioneered the P/E-to-growth ratio, which divides stock's P/E ratio
by its long-term growth rate to assess value. (For slow and
moderate growers, Lynch added dividend yield to the growth rate).
General Dynamics has a yield-adjusted PEG of 0.95, which comes in
under this model's 1.0 upper limit, a sign that it's a good
My Joel Greenblatt-based model is also high on GD. Greenblatt
used a remarkably simple, two-variable strategy that looked at
earnings yield and return on capital. With an earnings yield of
nearly 15% and a return on capital of nearly 50%, GD rates quite
Intel Corporation (
This California-based computer-chip giant is paying a very healthy
4.5% dividend yield. But if legislators don't address the fiscal
cliff, dividend taxes will jump significantly, which has led to
speculation that dividend stocks' shares will get hit hard. The
reality may be far different, however. A recent study by
O'Shaughnessy Asset Management found that, historically,
high-dividend stocks have actually done best when dividend taxes
were highest, believe it or not.
Plus, Intel has more than just that dividend going for it. It
has a long-term growth rate of more than 26% and trades for just
8.7 times trailing 12-month EPS; that makes for a stellar 0.32 PEG,
one reason my Lynch-based model likes it. The model I base on the
writings of OSAM's James O'Shaughnessy, meanwhile, likes Intel's
size ($99 billion market cap), solid $3.82 in cash flow per share,
and that 4.5% dividend yield.
Northrop Grumman Corporation (
Like General Dynamics, Grumman is a large ($16 billion market cap),
well diversified aerospace and defense firm. In the past year, it
has taken in more than $25 billion in sales.
Grumman shares are cheap, trading for 8.6 times trailing
) earnings, and nine times projected 12-month earnings. My
Lynch-based model likes Grumman's 18.6% long-term growth rate, 3.3%
dividend yield, and that 8.6 TTM P/E, all of which make for a
strong yield-adjusted PEG of 0.39.
My Greenblatt-based model also likes Grumman, thanks to its 18%
earnings yield and 43.1% return on capital. And my Kenneth
Fisher-inspired strategy is high on the stock as well. Fisher
pioneered the price/sales ratio (
) as a way to gauge value, and Grumman's PSR of 0.65 comes in under
this models 0.75 upper limit, a good sign. The strategy also likes
Grumman's $3.85 in free cash per share and 7.1% three-year average
net profit margins.
Houston-based Conoco is an integrated oil and gas firm that has
operations in more than two dozen countries. The
$69-billion-market-cap firm has taken in more than $60 billion in
sales over the past year. It's another high-dividend play (4.6%),
but it's cheap, trading for just 10.3 times TTM EPS.
My O'Shaughnessy-based model thinks Conoco is worth a long look.
It likes the firm's size, its impressive $11.35 in cash flow per
share (about eight times the market mean), and that stellar
Main Street Capital Corporation (MAIN):
This Houston-based investment firm offers long-term debt and equity
capital to lower middle-market companies and debt capital to
middle-market firms. Main Street has three things going against it
in terms of the "cliff" fears: It's a small-cap ($950 million);
it's a financial; and it's a big dividend stock (6% yield).
But Main Street has even more going for it. My Motley Fool
growth model (based on a strategy outlined by Fool co-creators Tom
and David Gardner) gives it very high marks, in part because of its
impressive growth. The firm upped EPS nearly 63% and revenue 34%
last quarter (vs. the year-ago quarter). It also has tremendous
profit margins, which have been rising (95% this year). And it's
cheap -- Main Street's "Fool Ratio" (the same as Lynch's PEG ratio)
is just 0.22.
My Lynch-based model also likes Main Street, thanks to its 38.8%
long-term growth rate, that 0.22 PEG, and its 63% return on assets
I'm long NOC, GD, MAIN, INTC, and COP.