Farr, Miller & Washington is a "buy-to-hold" investment manager, which means we make each investment with the intent to hold the position for a period of 3 to 5 years.
Nevertheless, in each of the past 14 Decembers I have selected and invested personally in 10 of the stocks we follow with the intention of holding for just one year. These are companies that I find especially attractive in light of their valuations or their potential to benefit from economic developments. I hold an equal dollar amount in each of the positions for the following year, and then I reinvest in the new list.
The following is my Top Ten for 2022, listed in random order. This year's Top Ten represent a nice combination of growth and defensiveness.
Results have been good in some years and not as good in others. I will sell my 2021 names Dec. 31 and buy the following names that afternoon. The reader should not assume that an investment in the securities identified was or will be profitable. These are not recommendations to buy or sell securities. There is risk of losing principal. Past performance is no indication of future results. If you are interested in any of these names, please call your financial advisor to discuss.
1. FedEx (FDX)
FedEx stock has been volatile over the past couple of years. The stock performed exceedingly well in the second half of 2020 as e-commerce package volumes surged during the Covid-related shutdowns. However, it became obvious during 2021 that Covid-related supply-chain bottlenecks and labor shortages were more than the company could effectively navigate without incurring significant expenses. The stock reacted negatively to these developments and dramatically underperformed during 2021. However, now that the company has made significant investments in capacity expansion and network density, we expect its future performance to reflect the bullish demand environment. The demand strength is evident in the huge growth in package volumes as well as the price increases that the company is easily able to pass on to its customer base. As industrial production, global trade and labor availability gradually begin to improve, the company should be able to post strong, consistent volume and revenue growth, market share gains, and very strong earnings leverage. In the meantime, we think the company's discounted valuation (11.6x CY22E EPS) relative to both the S&P 500 and its major competitor, UPS, provides downside protection. We believe patient investors will be rewarded by establishing positions at current levels. The yield is 1.3%.
2. Truist Financial (TFC)
Truist was formed by the recent merger of banks BB&T and SunTrust. The merger created the sixth-largest bank holding company in the U.S., by assets and deposits, while also forming a banking powerhouse in the high-growth Southeastern states. We were supporters of the merger as it will yield a large amount of expense synergies and provide the resources to accelerate investments in transformative technologies. The merger should also lead to significant revenue synergies and enhanced diversification as each legacy bank cross-sells its respective products and services. Once it is fully integrated, we expect Truist to generate industry-leading expense efficiency and returns on equity, allowing for a higher valuation multiple on a price-to-book, or P/B, basis. Because the integration has been managed by BB&T Chief Executive Kelly King, who has executed numerous integrations over his career, we know that it was done in a disciplined and conservative way. Finally, the earnings accretion from the integration should act as an engine for earnings growth even if the operating backdrop remains difficult, i.e., low interest rates, subdued economic growth. We believe the stock is attractively priced, especially given that earnings growth should handily outpace the peer group as the integration is completed.
3. Apple (AAPL)
Apple is the world's most valuable company by market capitalization. It designs, develops and sells electronic devices, computer software and online services. Devices include iPhone, iPad, Mac, Apple Watch and AirPods. Apple exercises control over the hardware and software on its devices creating a consistent user experience across devices and services. The iPhone segment is still the largest contributor to revenue and earnings, but Services is the fastest-growing and highest-margin business. When Apple enters a product category it often captures the attention of the masses. We think that will happen again in 2022 if, as expected, Apple releases its first augmented reality/virtual reality, or AR/VR, device. Looking further into the future, we see double-digit EPS growth through mid- to high-single digit revenue growth combined with a steady to increasing margin and share repurchases as the company moves toward a cash neutral balance sheet position. Shares trade at around 30x CY22E EPS. The company has a rock-solid balance sheet and returns significant amounts of cash to shareholders each year. We see growth in the installed base continuing with increased penetration of "halo" products and services such as the Watch, AirPods, Music, TV+, Arcade, Fitness+, News+ and iCloud.
4. Donaldson (DCI)
Donaldson is a global manufacturer of filtration systems and replacement parts for engines in on- and off-road trucks and heavy machinery for the transportation, construction, agriculture and mining industries, as well as in industrial plants, gas turbines and other applications. The company has dominant market share in many of its businesses, which are very diverse by geography and end market and have attractive long-term secular growth potential. The company is also looking to aggressively expand its addressable market in life sciences, and it has already completed its first acquisition in the space. The company has a razor/razorblade model that results in well over half of revenue and income coming from aftermarket replacement filters and services, as compared with filters produced for new equipment. The company just completed a three-year investment cycle that should result in a boost to cash flow and margins. Management runs the business for the long term, and so it will continue to invest at the cost of some near-term performance. Finally, the balance sheet is very strong and free cash flow generally approaches net income on an annual basis. Lastly, the company has paid a quarterly dividend every year for more than 60 years, and the dividend has increased annually for 24 years in a row. The stock trades at a market multiple (20.9x CY22E) compared with a historical average of about a 27% premium.
5. Disney (DIS)
The Walt Disney Company is one of the most prestigious brands in the world. Over the past 98 years, the company has evolved from a small animation studio to a vertically integrated media and entertainment conglomerate. Disney+, the company's streaming platform, has amassed nearly 120 million subscribers in the first two years since it was launched, putting it in direct competition with Netflix's roughly 215 million subscriber base. However, Disney's stock has been pressured as the momentum in subscriber growth has slowed in recent months. Management is guiding for 240 million to 260 million subscribers by the end of its 2024 fiscal year, but the company won't achieve this target in a linear fashion. We expect subscriber growth to improve over the next few quarters as the service is launched into new markets and as original content that was delayed due to the pandemic is added to the service. As for the legacy businesses, the theme parks have seen an uptick in recent months, and that should continue given the pent-up demand for travel and experiences. Movie theaters have been slower to recover, but we expect demand to be the strongest for tentpole films, as seen by the release of "Spider-Man: No Way Home." Disney shares trade at 33x CY22E EPS, which is above historical levels. However, if we exclude the losses from the streaming segment, the multiple for the legacy business is trading below historical averages. The company suspended its dividend to pursue growth opportunities.
6. Mondelez (MDLZ)
Mondelez International is a leading food and beverage manufacturer that was spun off from Kraft in 2012. The company has broad geographic reach with operations in Europe, North America, Latin America, Asia, the Middle East and Africa. Since taking the helm in 2017, CEO Dirk Van de Put has introduced a variety of strategic initiatives that have improved Mondelez's competitive position, including: 1) investments in its brands to drive higher market share, 2) a decentralized organizational structure that allows for more efficient decision-making, and 3) investments in the supply chain, which have proven to be a competitive advantage during the pandemic. Recently, the company has been able to offset inflationary pressures, thanks to its pricing power and productivity initiatives. Additionally, there is very little private label competition in sweet snacks and chocolate, which is 80% of total revenues. That means consumers are less likely to trade down when prices rise. A strong balance sheet and steady cash-flow generation allow the company to pursue tuck-in M&A as management looks to expand into higher-growth category adjacencies, e.g. cakes/pastries, premium snacks and "better for you". The stock trades at 21x CY22E EPS – a mid-teens discount to other multinational CPG companies, e.g., PepsiCo, Coca-Cola, Procter & Gamble, and Colgate-Palmolive. Over the long term, we would expect Mondelez to generate double-digit total returns, consisting of high-single digit EPS growth and the 2.2% dividend.
7. Ross Stores (ROST)
Ross Stores is the second-largest off-price apparel and home fashion retailer in the U.S. The company has more than 1,900 stores under the Ross Dress for Less and dd's Discounts banners. It's one of the few retailers growing its store base. Unlike most specialty retailers and department stores, Ross does not require fashion or product innovation to drive profits. Instead, access to cheap inventory and the quick turnover of that inventory allow the company to leverage operating costs. This results in a "treasure hunt" experience whereby a different assortment of merchandise is on display each time a customer visits the store. The low prices and "treasure hunt" environment drive repeat visits and are difficult to replicate in an online setting. We see continued opportunities for Ross to gain market share following the record number of retail closures in 2020. Additionally, the company should benefit as consumers look to trade down in this inflationary environment. The stock trades at 21x CY22E EPS, which represents a slight discount to the S&P 500, compared with its historical average of a mid-teens premium. Long term, we would expect Ross to generate a low-double digit total return, consisting of double-digit EPS growth and the 1% dividend.
8. Medtronic (MDT)
Medtronic is the largest pure-play medical device manufacturer in the world. The company is diversified across several end markets, including cardiovascular, medical surgical, neuroscience, and diabetes. CEO Geoff Martha has implemented several initiatives that should transform Medtronic into a faster-growing, more efficient company. MDT has launched more than 180 products across key geographies over the past 12 months, and the pipeline remains robust, with multiple opportunities at high-growth markets such as robotics, renal denervation, diabetes, and AF ablation. The stock has been under pressure in recent months due to a few pipeline setbacks, as well as industrywide headwinds that have led to lower procedure volumes. However, at about 17x CY22E EPS, Medtronic is one of the cheapest large-cap medical device manufacturers. The company should be able to achieve double-digit total returns, consisting of high single-digit EPS growth and the 2.5% dividend. Finally, Medtronic has one of the strongest balance sheets among its med tech peers, and the company generates very strong cash flow. This will allow management to pursue tuck-in acquisitions to complement its current and future product portfolio.
9. Raytheon Technologies (RTX)
Raytheon Technologies was formed through the combination of Raytheon Company and the legacy United Technologies aerospace and defense businesses. The merger created a powerhouse in the A&D industry, but management's near-term sales and profit targets for the combined entities have been pushed out because of the Covid-19 crisis. The crisis took an enormous toll on the commercial aerospace industry as steep production cuts at Boeing and Airbus combined with a massive drop in airline passenger miles. Fortunately, the defense side of the new company, which contributed 65% of total company pro forma sales in 2020, is doing just fine. The defense side should provide downside protection and steady cash flow, allowing the company to continue investing in R&D during this crisis and any future downturns. As conditions improve on the commercial side, the company should start to benefit from aircraft production increases as well as greater aircraft utilization. Furthermore, the growing installed base of the company's groundbreaking geared-turbofan, or GTF, engine, combined with a rebound in aircraft utilization, will contribute to a growing stream of high-margin and high-visibility aftermarket revenue. Finally, we also expect the company will ultimately reap huge cost and revenue synergies from the ongoing integration of both Rockwell Collins and the Raytheon Company. The synergies will help the company return an expected $20 billion in capital to shareholders in the four years following the merger. The stock offers strong value at about 17x CY22E EPS — a significant discount to the overall market. The dividend yield is also highly attractive at 2.5%.
10. Visa (V)
Visa is one of the world's leading payments technology companies. The company continues to pursue its network-of-networks strategy, connecting individuals and businesses across the globe. In addition to facilitating payments, the company provides merchant clients with a broad range of products, platforms and value-added services. We still see a long runway for growth in electronic payments with business-to-business payments as an opportunity to significantly expand its addressable market. We think the threat from "buy now, pay later" is overblown as up to 80% of those using such services pay off their balance using a debit or credit card, resulting in Visa revenue being as much as or greater than if the network had been used on the initial purchase. The balance sheet is solid, we expect a recovery in personal travel over the next several years, and secular tailwinds from cash-to-card and digital should continue. Shares trade at about 29x CY22E EPS. We expect EPS to grow in the low teens over the next several years.
— Michael K. Farr is a CNBC contributor and president and CEO of Farr, Miller & Washington.
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