8 'Beat the Market' Stocks to Buy

By Brian Nichols, InvestorPlace Contributor

There’s a problem with tracking the entire S&P 500 with index investing — you get to own the gems, but you also have to hold the deadweight.

While most investors like to be diversified and consider exchange-traded funds that track entire sectors, industries or major indices to be safe, the truth is that laggards within those ETFs weigh down the performance of blue-chip value investments.

As a result, I typically refer to this famous Warren Buffet quote as a lesson for how to diversify my portfolio: “Wide diversification is only required when investors do not understand what they are doing.”

Instead of owning these ETFs that track everything, why not pick something great from each sector?

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This strategy gives investors exposure in each sector, but by picking the best of the best, this strategy should yield larger returns than an investment in SPDR S&P 500 ETF Trust (SPY). While “best of best” is subjective, let’s look at eight stocks to buy in eight different sectors to outperform the S&P 500.

Apple (AAPL)

Apple (AAPL) may seem like a cop out choice in the technology sector that lacks imagination, but when you really look at the metrics and outlook associated with AAPL, there really is no better choice.

This is a company that is poised for long-term success in so many areas. China now accounts for nearly 25% of AAPL’s revenue while growing nearly 100% year-over-year. Furthermore, AAPL’s average selling price for iPhones continue to rise, thereby driving revenue and profit growth.As you can see, AAPL is cheaper and pays a better dividend than the technology sector, but if you remove Apple’s $200 billion-plus cash pile from the equation, then it looks really cheap at just 10.5 times earnings.

Lastly, the Internet of Things is the biggest movement in technology over the next five years, and with AAPL being a top consumer electronics company, and also being a leader in enterprise with $25 billion in annual revenue, the company is well positioned to thrive during this new IoT era. Collectively, there’s no better and safer choice than AAPL in technology.

AT&T (T)

AT&T (T) has something that no other large U.S. wireless company has, and that’s growth initiatives beyond the U.S.

With its acquisition of DirecTV and two wireless acquisitions in Mexico, AT&T’s wireless network reaches 400 million people along with broadband, wireless, and video opportunities in Latin America.

The end result of these initiatives is expected growth of 12% this year and 14% in 2016, along with significant margin and free cash flow growth.

While AT&T looks expensive at 35 times earnings, investors must remember that this multiple takes into account all those one-time items from completing several acquisitions over the last year. However, if we look at free cash flow, which is operating income minus capital expenditures, then AT&T trades at less than 15 times FCF.

That said, AT&T may not trade at too deep of a discount to the rest of telecom, but its growth and dividend make a slight valuation premium appropriate.

Kroger (KR)

The consumer staples and consumer discretionary sectors are where dividend and income investors feel most at home, as it consists of companies that operate in businesses that are usually stable regardless of the economy.

However, the last year has unveiled a threat of sorts for these stocks, forex and currency exchange issues for companies that have heavy exposure overseas. Kroger’s (KR) exclusive presence here in the U.S. is one reason it is my top choice in this sector.

Kroger has achieved 47 consecutive quarters of identical same-store sales growth; and in its most recent quarter grew 5.3%, excluding fuel. This is remarkable growth for a grocery retailer that has nearly $110 billion in 12-month revenue.

This growth and its increased market share is why I’m willing to pay a premium for KR, and don’t really care about its yield.

Phillips 66 (PSX)

Most of the revenue, profit and stock losses we’ve seen in the energy sector are appropriate given the decline in oil prices.

Currently, oil prices are a huge drag on this sector, and no one knows how long prices will stay down, or if this is permanent. That’s why I want to own a company that’s not really as vulnerable to oil prices, like Phillips 66 (PSX).

The bulk of PSX’s business comes from downstream operations, which is the processing and purification, along with marketing and distribution of oil and gas. This business is not as exposed to the fluctuations in oil prices. This fact along with the company’s goal for 30% EBITDA growth between 2014 and 2018 make it superior in a very volatile, unpredictable sector.

Lastly, the fact that PSX is cheaper and pays a higher dividend than the sector average doesn’t hurt its appeal either.

Bank of America (BAC)

Sooner or later, interest rates are going to rise, and all of the fear and uncertainty it brings will help banks thrive. Bank of America (BAC) is my favorite in this arena because it has seen such vast improvements.

Not only have noninterest expenses declined, but BAC’s efficiency rating in consumer banking and global markets has started to improve, which is good in a higher rate environment.

All things considered, BAC is the ultimate value investment, a company that’s large enough to absolutely thrive as interest rates start to rise. While it’s clearly cheap compared to the financial sector, BAC’s multiples don’t tell the whole story.

BAC continues to trade at the deepest discount to its book value per share of any other large financial institution. Its current stock price of $17.3 is well shy of its $22.4 book value per share. This along with its improvements is why BAC is the best opportunity in finance.

Walgreens (WBA)

Walgreens (WBA) is not considered a healthcare company, but with the majority of its revenue coming from drug sales and drug wholesales, and its growing pharmacy benefit management, I consider WBA the ultimate play on the healthcare industry.

It benefits from a rise in healthcare coverage, higher drug prices and an increase in FDA drug approvals. Not to mention, WBA acquisition of Boots was a game changer and it is getting Rite Aid (RAD) at a significant discount.

To top it all off, WBA is very cheap.

Currently, WBA is trading 15% off its 52-week high, thereby presenting a good entry point for investors.

Boeing (BA)

The industrial space is risky business, as production and manufacturing can go up and down depending on macro conditions both globally and domestically. This means that for industrial stocks to perform well, the global economy needs to be in great shape.

However, there are a few exceptions to the rule, such as companies that already have the next 10 years worth of work already lined up. I’m talking about Boeing (BA).

Boeing has a backlog of 5,640 planes that are unfilled at the moment, planes that are ordered but not built, revenue not yet realized. Nearly 75% of these orders are 737 planes, in which BA has the capabilities to produce just 42 per month. In other words, BA is rather busy for the next decade.

While BA is a bit more expensive than other industrial stocks, I think it is worth the premium because investors don’t have to worry about BA from year-to-year. That’s a safety net that not many companies can offer shareholders. With a solid yield to serve as downside protection, and BA hiking production to thereby boost top and bottom line growth, Boeing looks like the best investment in this space.

Dow Chemical Co. (DOW)

The materials sector is one of those areas that you almost want to avoid in a portfolio. It is a sector that has not performed well in recent memory, but also one that is very cheap with lots of value at a good price. One of the best is Dow Chemical (DOW).

What I like most about DOW is that management has correctly identified areas in its business that are low margin and underperforming, and has then chosen to divest those businesses to prioritize high-margin opportunities. These include building and construction, electronics and plastic materials businesses.

Dow’s Performance Plastics business saw margins rise 700 basis points during its last quarter alone, with Consumer Solutions and Materials & Chemicals up 216 and 187 basis points, respectively.

While DOW is not a revenue growth story due to heavy forex exposure, it is a margin story, and with bigger profits come bigger dividends and buybacks for shareholders. At just 13.7 times earnings, DOW’s P/E ratio is consistent with the industry, and its dividend far superior. Collectively, these things make it a bright star in an otherwise dull group of stocks.

As of this writing, Brian Nichols was long AAPL, T, RAD and BAC.

This article was originally published on InvestorPlace Media.


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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