DILIGENCE PAYS 3/16/16
Add the Best Large Cap Growth Stocks to Your Portfolio:
Style Analysis 1Q15
The Large Cap Growth style ranks fourth out of the 12 styles as detailed in the 1Q15 Style Ratings report and
receives our Neutral rating. The Large Cap Value style as a whole outperformed the Russell 3000 in 2014, rising
12% to the Russell’s 11%. It was the sixth-best performing style last year, surpassing All Cap and Small Cap
styles in terms of performance. While a 12% annual return is nothing to be ashamed of, there’s greater value
here for investors that play their cards right.
The Large Cap Growth style is comprised of large cap companies that are commonly classified as growth stocks.
Growth stocks consist of companies that generally have low dividends due to management’s desire to reinvest
earnings at a high rate to create exponential growth in share price. At New Constructs, we define growth stocks
as those for which the market has priced in a significant growth premium above the company’s current economic
earnings. As such, these stocks possess a higher price to economic book value (PEBV) than other stocks.
The Large Cap Growth style is a popular option for investors who are willing to wait for a company to grow, but
aren’t ready to jump into the risk-loving world of small cap stocks. The inherent risk in betting on a stock
classified as Large Cap Growth is that the growth happened well before you decided to invest. There are plenty
of large companies that falter in the stock market due to an inability to expand, diversify, or create new product
offerings.
Stock Picking is Paramount to Success
Last year, investors saw just how important buying quality stocks can be. Delta Airlines (DAL) and Dr. Pepper
Snapple were two of the best performing stocks in this style, up 77% and 50% over 2014. Both of these
companies earned our Attractive ratings in 2013. Due to their large price gains, they have settled at Neutral until
we believe their fundamentals change and they are ready to be upgraded.
On the other hand, Helmerick & Payne (HP) was one of the worst-performing stocks, declining by 18% during
2014. HP earned our Dangerous rating at the beginning of 2014, but has been upgraded to Neutral as the lower
stock price has started to reflect the company’s economic reality.
There are 182 stocks that receive our Attractive or Very Attractive ratings in the Large Cap Value style. These
are some of the most profitable and cash flow-strong business in the market, and they offer limited downside at
their current valuations.
The following are some of our favorite Large Cap Growth stocks. Investors seeking the best chance of
outperforming should look no further than the following:
1. Put Your Portfolio in the Cloud — Oracle (ORCL)
Oracle is the world’s largest software company, and produces and distributes hardware and software along with
support services to over 400,000 firms in over 145 countries. Enterprise software is at the heart of Oracle’s
business, but this segment is supported by other product offerings, including servers, databases, and storage
services aligned to provide businesses with a holistic package for all of their IT needs.
Over the last decade, Oracle’s after-tax operating profit (NOPAT) has grown by 17% compounded annually.
ORCL earns our Attractive rating due to its high 33% return on invested capital (ROIC) and 3.6% free cash flow
(FCF) yield. In addition, Oracle is able to achieve operational efficiencies with a high NOPAT margin of 31%.
Oracle’s main source of revenue — 48% in fiscal 2014 — comes from software license updates and product
support. But a growing portion comes from the company’s Cloud software services, with sales up 15% in 2014
over 2013. With two recent acquisitions, Datalogix and MICROS Systems, Oracle’s clear strategic focus is to
dominate this sector as it does many others. Between the first and second quarter of fiscal 2015, Oracle’s cloud
systems revenue increased by about 8%.
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DILIGENCE PAYS 3/16/16
Oracle’s current share price of ~$41/share gives its stock a PEBV of 1.1, which implies only a 10% growth in
NOPAT for the rest of the company’s lifetime. If ORCL can grow NOPAT by 5% compounded annually for 10
years, well below its historical rate, ORCL’s stock today is worth ~$48/share –– a 17% upside.
2. A Powerhouse Pharmaceutical Company That Keeps on Growing — Gilead Sciences (GILD)
Gilead Sciences started as a therapeutics firm primarily focused on developing and distributing HIV and Hepatitis
antivirals, but has grown to become one of the largest biopharmaceutical companies in the world. Gilead now
produces over 15 brand name drugs focused on treating HIV/AIDs, liver disease, cancer, and cardiovascular and
respiratory diseases.
Over the last decade, Gilead’s NOPAT grew by 26% compounded annually. GILD earns our Attractive rating due
to its ROIC of 45% and a free cash flow yield of 4.7%. In addition, Gilead’s ROIC and FCF yield have been
increasing for the past two years, rising from lows of 17% and -11.8% in 2012, respectively.
One concerning feature about Gilead is that the pharmaceutical sector is in flux. Various acquisitions and
divestitures of certain drug product lines can make for tricky forecasting of future returns of any pharmaceutical
company. However, Gilead’s aggregate drug sales increased by 15% last year with an 837% increase in sales of
Stribild, Gilead’s once-a-day prescription pill for the treatment of HIV-1. This development, as well as the
company’s impressive drug approval rate, indicates that Gilead has the ability to continue providing specialized
and groundbreaking drugs that will keep margins strong and after-tax operating profits rising.
At its current price of ~$102/share, GILD has a PEBV of 1.3. This ratio implies the market does not expect more
than a 30% growth in after-tax profits for the rest of the company’s lifetime. If we forecast even just a 10%
NOPAT growth rate (far below Gilead’s historical rate) for 10 years, the stock is worth ~$156/share –– a 50%
upside. For this reason, Gilead made our Hot Stock Commentary feature in January.
3.
More Than Just Credit Cards — Visa (V)
Visa is no longer just a credit card company: it’s a payments technology firm. This strategic shift in how the
company’s brands itself and perceives its own business acknowledges the fact that Visa has grown far beyond a
piece of plastic.
Over the past five years, Visa has grown NOPAT by 22% compounded annually. V earns our Attractive rating
because of its strong 23% ROIC and encouraging 3.6% FCF yield. Visa’s high ROIC, which is up from 10% in
2009, is due in part to better NOPAT margins, up 16 basis points since 2009. Over this time, Visa only increased
its invested capital by 11%.
One concern with Visa will be its ability to maintain margins and growth as competition from mobile payment
systems like Apple Pay and Venmo continues to grow. Apple Pay has partnered with Visa to actualize its
transactions, and Venmo can only transfer payments between bank accounts. But as the sector expands and
more technology firms find ways to manage quick credit payment systems, it may spell trouble for this giant. Of
course, Visa could also purchase any smaller competitors or develop its own forward-thinking electronic system.
At its current price of ~$246/share, V has a PEBV of 2.1, implying that the market expects V to double after-tax
profits. If we expect that Visa will be able to grow NOPAT by 12% compounded annually for 12 years, V is worth
$312/share –– a 27% upside.
The Best & Worst Large Cap Growth ETFs and Mutual Funds
Not the type to buy individual stocks? We also cover 687 ETFs and mutual funds in this style. We rate these
ETFs and mutual funds based on their holdings as well as their total annual costs (TAC).
The following are the top three ETFs or mutual funds in the Large Cap Growth style:
1. iShares MSCI USA Quality Factor ETF (QUAL) — Very Attractive
Quick Take: QUAL’s 10 top holdings only account for about 40% of its total portfolio. ORCL, GILD, and V are all
holdings. QUAL has Very Attractive Total Annual Costs of 0.17%.
2. iShares Russell Top 200 Growth Index Fund ETF (IWY) — Very Attractive
Quick Take: IWY has a similar holding concentration as QUAL, except that IWY has about 9% of holdings
concentrated in Apple (AAPL). ORCL, GILD, and V are all holdings as well. XLU fund has Very Attractive Total
Annual Costs of 0.22%.
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DILIGENCE PAYS 3/16/16
3. PowerShares Fundamental Pure Large Growth ETF (PXLG) — Very Attractive
Quick Take: PXLG’s holdings are less diversified than those of QUAL and IWY, with its top five holdings
accounting for about 36% of the total portfolio. In addition, ORCL, GILD, and V are all holdings. Like IWY, 9% of
these holdings are currently invested in AAPL. FIUIX has Very Attractive Total Annual Costs of 0.43%.
Figure 1 ranks from best to worst all nine Utilities ETFs and Figure 2 shows the five best and worst-rated Utilities
mutual funds.
Figure 1: ETFs with the Best & Worst Ratings – Top 5
Allocation of ETF Holdings
Ticker
Attractiveor-better
Stocks
QUAL
IWY
PXLG
54%
42%
39%
PWB
VOOG
14%
35%
QQXT
FTC
RPG
ALFA
RWG
19%
14%
18%
14%
12%
Neutral
Stocks
Dangerousor-worse Predictive Rating
Stocks
Best ETFs
42%
2%
42%
14%
48%
12%
59%
41%
Worst ETFs
45%
48%
42%
32%
33%
Very Attractive
Very Attractive
Very Attractive
24%
22%
Very Attractive
Attractive
29%
38%
39%
42%
51%
Attractive
Attractive
Neutral
Neutral
Neutral
Source: New Constructs, LLC and company filings
Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5
Allocation of Mutual Fund Holdings
Ticker
Attractiveor-better
Stocks
MIGNX
MGTIX
MIGKX
26%
26%
26%
FLGEX
JGIRX
40%
36%
IALAX
SIAAX
AIXAX
QUAGX
MDFOX
14%
6%
18%
19%
24%
Neutral
Stocks
Dangerousor-worse Predictive Rating
Stocks
Best Mutual Funds
48%
17%
48%
17%
48%
17%
41%
12%
33%
23%
Worst Mutual Funds
26%
44%
50%
39%
5%
57%
42%
23%
25%
45%
* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.
Sources: New Constructs, LLC and company filings
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Very Attractive
Very Attractive
Very Attractive
Very Attractive
Very Attractive
Dangerous
Very Dangerous
Very Dangerous
Very Dangerous
Very Dangerous
DILIGENCE PAYS 3/16/16
Disclosure: David Trainer owns AAPL and ORCL. David Trainer and Hunter Gray receive no compensation to
write about any specific stock, style, or theme.
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DILIGENCE PAYS 3/16/16
New Constructs® – Profile
How New Constructs Creates Value for Clients
1. Superior Recommendations – Our stock picks consistently outperform. See our track record
in our stock-picking accolades and Proof Is In Performance reports.
2. More Accurate Research – Our patented Research Platform for reversing accounting
distortions and discounted cash flow analysis leverages better data to deliver smarter research.
3. Time Savings – We check the fine print in thousands of corporate filings so you don't have to.
As reported by Barron’s, our expertise in analyzing SEC filings delivers Hidden Gems and Red
Flags that drive long-term stock-picking success.
4. Transparency – We are proud to share the results of our analysis of over 50,000 10Ks. See
the Corporate Disclosure Transgressions report we provided the SEC. Our reports detail all
data and assumptions. Company Models enable users to change them.
5. Objectivity – New Constructs is an independent research firm, not tied to Wall Street or
investment banking services. Our models are driven by comprehensive high-quality data not
stories. See our presentation to the Senate Banking Committee, the SEC and many others in
DC.
Our Philosophy About Research
Accounting data is not designed for equity investors, but for debt investors. Accounting data must be
translated into economic earnings to understand the profitability and valuation relevant to equity
investors. Respected investors (e.g. Adam Smith, Warren Buffett and Ben Graham) have repeatedly
emphasized that accounting results should not be used to value stocks. Economic earnings are what
matter because they are:
1.
2.
3.
Based on the complete set of financial information available.
Standard for all companies.
A more accurate representation of the true underlying cash flows of the business.
Additional Information
Incorporated in July 2002, New Constructs is an independent publisher of investment research that
provides clients with consulting and research services. We specialize in quality-of-earnings, forensic
accounting and discounted cash flow valuation analyses for all U.S. public companies. We translate
accounting data from 10Ks into economic financial statements, i.e. NOPAT, Invested Capital, and
WACC, to create economic earnings models, which are necessary to understand the true profitability
and valuation of companies. Visit the Free Archive to download samples of our research. New
Constructs is a BBB accredited business and a member of the Investorside Research Association.
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DILIGENCE PAYS 3/16/16
DISCLOSURES
New Constructs®, LLC (together with any subsidiaries and/or affiliates, “New Constructs”) is an independent organization with no
management ties to the companies it covers. None of the members of New Constructs’ management team or the management team of any
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perform any investment or merchant banking functions and does not operate a trading desk.
New Constructs’ Stock Ownership Policy prevents any of its employees or managers from engaging in Insider Trading and restricts any
trading whereby an employee may exploit inside information regarding our stock research. In addition, employees and managers of the
company are bound by a code of ethics that restricts them from purchasing or selling a security that they know or should have known was
under consideration for inclusion in a New Constructs report nor may they purchase or sell a security for the first 15 days after New
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New Constructs is affiliated with Novo Capital Management, LLC, the general partner of a hedge fund. At any particular time, New
Constructs’ research recommendations may not coincide with the hedge fund’s holdings. However, in no event will the hedge fund receive
any research information or recommendations in advance of the information that New Constructs provides to its other clients.
DISCLAIMERS
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