Our 10 Favorite Stocks for 2015
Even with the Dow at an all-time high, some shares still look tempting. GM, Google, Macy’s, Gilead could climb.
With the Dow topping 18,000, the U.S. stock market isn’t brimming with bargains. But our 10 top picks for 2015, mostly household names, could deliver 20% to 50% returns over the next year.
Last year’s Top 10 beat the market, gaining an average of 18.1%, compared with 15.7% for the Standard & Poor’s 500 index. US Airways, now part of American Airlines Group (ticker: AAL), and Intel (INTC) led the pack, returning 133% and 51%, respectively. The worst performer was Barrick Gold (ABX), which lost 31%.
Two themes to watch next year are how consumers will respond to low gasoline prices and how investors will fare if the Federal Reserve raises interest rates. But these play only peripheral roles in our picks, because we’re more interested in good stocks than good themes.
Don’t expect stock gains to come easy in 2015. In three years, the S&P 500 has risen from a humble 11.7 times next-four-quarter earnings estimates to an ambitious 16.5 times. Shares look likely to rise in tandem with earnings from here, and the estimate for earnings growth next year stands at 8%, according to FactSet.
If there are any themes to our list, they are hidden strength, overblown fears, and underappreciated growth potential.
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General Motors (GM) and Bank of America (BAC) are doing much better than their decimated 2014 profit statements suggest, and most of this year’s bad news won’t repeat in 2015, sending earnings soaring with or without growth (likely with). David Copperfield once made a jumbo jet disappear, but Boeing ’s (BA) magic trick starting next year will be to collect billions more in free cash than it reports in earnings. Speaking of magic, American Airlines Group (AAL) shares have doubled in 2014, but the carrier’s valuation has shrunk. American and Micron Technology (MU) aren’t getting nearly enough credit for profound improvements in their industries.
Google (GOOGL) and Royal Caribbean Cruises (RCL), meanwhile, have more growth potential than investors have priced in. Fluor (FLR) can soar if oil rebounds—and do just fine if it doesn’t. Macy’s (M) is an e-commerce whiz disguised as a 156-year-old department store. Gilead Sciences (GILD) is, well, complicated. But its shares look cheap relative to even bearish assumptions—a setup we like.
General Motors: GM could double its earnings per share over the next three years, and its shares sell for a deep discount to the S&P 500. That’s a combination we like enough to keep it as a holdover from last year’s Top 10 picks—even though the stock has run over our toes on the way from $39 to $34 since that story was published.
For General Motors, 2014 was dominated by massive recalls of vehicles with faulty ignition switches that have been linked to dozens of deaths. The fiasco has cost billions of dollars in outlays for repairs and victim compensation. The company lost hundreds of millions more to a currency devaluation in Venezuela and the cost of shuttering a German plant. In 2015, these costs fade. That’s one reason Wall Street predicts that GM’s profit will rise 60%, to $7.27 billion.
There are other reasons. U.S. sales are booming; China is becoming a meaningful profit contributor; and, thanks to restructurings, GM is approaching break-even in Europe. By paying off costly preferred stock this year, it will save on interest next year. General Motors is also likely to be a key beneficiary of lower gas prices, thanks to its more than 70% share of the lucrative U.S. market for large sport-utility vehicles. In November, pickup and SUV sales for GM jumped 32% year over year.
GM could reach $5 a share in earnings as soon as 2016. As that number comes into view over the next year, its shares could rise nearly 50%, to $50. A 3.6% dividend yield adds allure, and payments are likely to grow.
Bank of America: BofA is a lot like General Motors, with depressed financial results this year that should give way to much better numbers in 2015. Massive legal charges related to mortgage securities and, to a lesser extent, currency trading, will result in 2014 earnings per share falling by half, to an estimated 44 cents. But look for the charges to quickly shrink in coming quarters. In 2015, earnings per share are expected to more than triple, to $1.48. The stock trades at 12 times that figure.
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Wall Street expects BofA to reach about $2 in earnings-per-share power by 2017. Like many banks, it has seen lending spreads shrink with interest rates this low and will benefit if rates rise. Management reckons that each percentage point increase in rates from here is worth $3 billion in pretax profits—equal to 12% of next year’s estimated haul. BofA, which traded last week at $18, has lagged behind many of its peers in restoring its dividend since the financial crisis. The shares yield just 1.1%, but the payment could double in two years. Look for BofA to return 20% over the next year, as investors see cleaner earnings reports and healthy growth, and the financial-crisis hangover fades.
Boeing: Last December, Boeing shareholders got a dividend raise of just over 50%. This year, the company tacked on another 25%. The new annual payment of $3.64, paid quarterly, gives the shares, recently at $132, a yield of 2.8%. It also speaks to management’s confidence in future cash flow.
In 2014, Boeing shares have lost 4%, even though earnings per share are expected to be up 19%, to $8.38. Investors might fear that lower fuel prices will reduce the financial incentive for carriers to upgrade older planes. Not so far: Last quarter, Boeing’s backlog of orders swelled to $490 billion from $440 billion. That represents more than five years’ worth of revenue.
Lower fuel prices could actually give Boeing a boost. Carriers buy planes to use for decades. About half of Boeing’s orders are replacements, and half are for expansion. Cheap jet fuel allows consumers to spend more on travel, including flights. Earlier this month, the International Air Transport Association predicted that revenue passenger miles, a measure of air traffic, will jump 7% in 2015, up from 5.7% this year, on a boost from cheap fuel.
Watch Boeing’s free cash flow, which is likely to eclipse earnings starting in 2015. That’s because the company’s jumbo-jet accounting smooths earnings over the life of a plane, while in reality, the 787 Dreamliner has run steep losses so far, and is expected to break even sometime next year and gush cash thereafter. Looking at 2016 estimates, for example, Boeing trades at 14.2 times earnings—a good deal. But it trades at just 10.1 times estimated free cash. The shares could return 20%, including dividends.
American Airlines: Shares of American Airlines have doubled in 2014, to $52. Remarkably, the valuation has only improved. At the end of last year, the stock went for 7.5 times projected earnings for the following four quarters. Now, it fetches just 6.2 times. That’s because earnings estimates for future quarters have risen even faster than the shares.
A key reason: America’s big air carriers were so financially dysfunctional for so long that investors don’t quite believe in the latest turnaround. They should. The industry has undergone rapid consolidation, with Delta Air Lines (DAL) buying Northwest in 2008, United and Continental marrying in 2010, Southwest Airlines (LUV) gobbling AirTran Airways in 2011, and American merging with US Airways last year. These four carriers now control 85% of the U.S. market. In 2000, nine companies split that share, according to Morningstar.
A result is that prices have been steadily rising. Combine that with growing demand for air travel, and the outlook for the group is bright. American’s shares, which were punished during the recent Ebola outbreak, will likely make up for lost time in coming quarters. They could rise more than 40% next year, to $75, and still look reasonably priced.
Google: In a little over a year, Google has made two round trips north of $600 and back again to below $530. It recently fetched $542, or 17.8 times projected earnings for next year, not including stock compensation expenses. Investors seem torn between whether Google remains a go-go growth company deserving of a dot-com premium, or a mature tech titan that’s ready for a Microsoft multiple—recently 16.5 times calendar-2015 earnings estimates. It doesn’t help that last quarter paid ad clicks on Google’s sites, the company’s bread and butter, grew just 17%, down from 25% the quarter before.
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Google has plenty of growth ahead, however. Slowing click gains appears to be part of an effort to reduce inadvertent or low-quality clicks on mobile devices, which have plagued the industry for years and have driven down click pricing. It’s working; click prices fell 2% last quarter year over year, versus 6% the quarter before, and some analysts expect them to be flat in the fourth quarter. Meanwhile, Google’s YouTube video site is reeling in major advertisers, and its Play Store for apps is riding the popularity of Google’s free Android operating system for phones. Those fast-growing businesses might together already bring in 20% of revenue.
Google can grow earnings by 15% to 20% annually over the next five years. Its shares could climb 20% in a year and still be reasonably priced at 18 times the 2016 earnings projection. And the tech giant sits on cash equal to 16% of its stock market value.
Micron Technology: Shares of memory maker Micron have gained 61% in 2014. They should be up more. At a recent $35 and change, they sell for just nine times next-four-quarter earnings estimates. This suggests that investors, having watched the price for DRAM, the main working memory for computers, double in two years, expect the industry to succumb to overproduction, triggering another slump. But the industry’s boom-and-bust past has shaken out weaker players. Today, DRAM has only three main suppliers: Micron, SK Hynix (0660.Korea), and Samsung Electronics (5930.Korea). NAND, for long-term storage with speedy access, has five, including Toshiba (6502.Japan) and SanDisk (SNDK).
With so few remaining rivals, and the cost of squeezing better performance out of chips rising, expect disciplined production for years to come. That’s not to say prices won’t dip; Jefferies, for example, predicts that selling prices will fall 5% to 10% in 2015, but production costs will decline 10% to 15%, keeping margins stable to rising. Meanwhile, the rise of smart watches and other wearable computing devices should support demand. So should expanded roles in cloud computing, like big data applications that must quickly make sense of vast amounts of information.
Micron could jump more than 40% over the next year, to $50, or just over 12 times projected 2016 earnings—a valuation more befitting the industry’s increased stability.
Macy’s: The average U.S. gasoline price has fallen by a third in a year. That could save $850 or so per family in 2015—enough to send households with tight budgets on extra shopping trips to Wal-Mart Stores (WMT). The problem is that Wal-Mart is a slow grower that now trades at nearly 17 times next-four-quarter earnings estimates. In other words, we like the thesis more than the stocks it leads to.
Macy’s holds plenty of appeal, however. Some of its shoppers will boost spending because of pump savings, while well-heeled ones won’t care. But the shares, at $64, go for just 13 times forward earnings, and the company looks capable of growing earnings at a low double-digit clip for years to come.
Macy’s is well ahead of its peers in dot-com savvy. Its stores act as fulfillment centers that can ship online orders or hold goods for pickup. Nearly half of its merchandise is private label or exclusive, which helps differentiate the chain from rivals. Because it’s more than double the size of J.C. Penney (JCP), based on revenue, Macy’s can land exclusive merchandise, which in turn helps it grow.
Look for Macy’s to return 20% in a year, including a dividend yield of 2%. That would leave its shares at 14 times the 2016 earnings forecast.
Royal Caribbean: Cruise operator Royal Caribbean trades at 24 times projected earnings for 2014. That would be too much to pay if not for the likelihood that its earnings per share will double in three years. In the U.S., retiring baby boomers will drive peppy growth for cruises for years to come. The cruise market in China is in its infancy. Royal Caribbean can deploy ships there in coming years and sell older vessels to operate under contract. Lower fuel prices offer a tail wind. Normalization of U.S. relations with Cuba could one day open a lucrative new route.
We view Virgin Group’s announcement that it will enter the business as good news for incumbents, both Royal Caribbean and larger Carnival (CCL), which we recommended earlier this month (“Carnival and Royal Caribbean Will Cruise Higher,” Dec. 15). Virgin, with financing partner Bain Capital, likes the demand outlook enough to order two new ships. Prices for those can approach $1 billion apiece—and shipbuilders are booked until 2018.
Carnival is the underperformer and could have more to gain if it can cut costs and repair its image with customers following some ship disasters in recent years. But Royal Caribbean maintains a pricing edge, and in this business, better pricing helps support higher free cash flow and new ship orders, and can quickly create a durable advantage. Royal Caribbean pays a 1.5% dividend and could double its payment over the next three years.
Gilead Sciences: Gilead Sciences won us over after last week’s 14% plunge in its stock, to $94. Earnings next year are expected to jump 26% to about $10, putting the shares at a scant nine times earnings. There’s a lot of uncertainty around those earnings. Among 26 analysts with estimates, the lowest is looking for barely $7 and the highest at more than $12. Investors are abandoning the stock, rather than face the unknown. Bargain hunters should take the other side of that trade.
Gilead last year introduced a revolutionary drug for hepatitis C, a debilitating viral infection that affects the livers of 3.2 million Americans and perhaps 150 million people worldwide. The price: $1,000 per Sovaldi pill, or $84,000 for a full treatment course. Sovaldi sales are expected to approach $12 billion this year, from next to nothing last year, and to top $17 billion in 2017. Gilead this year introduced a new hep-C product, Harvoni, that costs even more per pill, but can treat some patients faster, reducing the total cost. Gilead shares, even with their recent drop, have quadrupled in three years.
This past Monday, Express Scripts (ESRX), a leading drug-benefits manager, announced a deal with AbbVie to exclusively sell its newly approved hep-C treatment, Viekira Pak, to millions of patients. Viekira is more expensive than Harvoni and is widely believed to be inferior, suggesting that AbbVie (ABBV) offered a deep discount to Express Scripts.
Other payers could use the deal to secure discounts from Gilead. But the outcome will likely be less dire than what the stock valuation suggests, and the shares could rise 25% in a year. Gilead over the next four years is expected to generate free cash totaling $50 billion. Even half that much would be enough to fund substantial diversification into new drugs.
Fluor: If crude rebounds to $80 a barrel next year, oil stocks could shine, and those who shunned them could miss out. Long-term investors who are ready to scoop up bargains from the oil patch should see our cover story from last week, “5 Oils to Buy,” Dec. 22).
But this isn’t a list of stocks for the next few years. It’s a list for 2015, and Fluor, which builds complex structures like oil refineries and power plants, offers an excellent hedge. Earnings estimates for 2015 have slipped just 8% since the start of this year, but the shares are down 25%. One reason for Fluor’s earnings resilience is that about 55% of its recent revenue is linked to oil and gas—heavy but not total exposure. And much of that comes from refiners and other companies that can make good money on cheap oil.
Investors should assume that 10% of the company’s backlog of business, which topped $42 billion last quarter, is at risk. But even a $37 billion backlog would cover 1½ years of revenue. At its current price, Fluor fetches 12.6 times next-four-quarter earnings estimates, down from over 18 at the beginning of the year. Fluor holds cash and securities equal to a quarter of its market value. The stock yields 1.4%. Investors got a 31% dividend raise last February; look for something similar in coming months.
Fluor could rise 20% next year and still trade at just 13 times the Street’s lowest 2016 earnings estimate, just under $5 a share.