You make a point to patronize farm-to-table restaurants. Drink in local microbreweries. Buy goods from local designers. Why not invest locally, too?
The idea isn’t as crazy as it may seem. Sure, one basic rule of investing is to diversify. Owning stocks of companies of various types, sizes, and locations insulates you better against market downturns than keeping all your eggs in one basket. But within the portion of your portfolio that you’ve earmarked for U.S. stocks, there’s a good case to be made for tilting your holdings—at least a bit—toward local stocks.
The reason is simple: The more you know about a company, the better your position to judge its prospects. If the company is nearby, you’re more likely to hear whether it’s hiring or looking for new office space, for example.Consider the results of a classic study by finance professors at the business schools of Harvard University and the University of Chicago. It found that from 1975 to 1994, the return scored by the average mutual fund manager from local stocks (those of companies headquartered less than 60 miles away) was 2.7 percentage points higher than from others.
Granted, Chicago’s economy has been relatively slow to recover from the 2007–9 recession. But that hasn’t stopped the city’s giants from delivering good results during the current five-year bull market. At Chicago’s request, local investment researcher Morningstar created a portfolio of all public companies in the six-county area with market capitalizations of at least $15 billion as of September 24. (There are 19 of them.) While that portfolio trailed the S&P 500 index (a proxy for large U.S. companies) over the past 12 months, it beat the index over the past five years—and by a not-inconsequential 2.5 percentage points.
As you might expect, returns varied considerably among those large-cap Chicago stocks. And just because a stock performed well in the past doesn’t mean it’s going to do well in the future. To predict which of these biggies is likely to deliver the best returns over the next year, I quizzed investment managers and stock analysts, consulted earnings reports and research notes, and drew on my decade of experience as an investing reporter at Money and other publications. I then sorted the 19 companies into four categories: Strong Buy, Buy, Hold, and Sell.
As you rebalance your portfolio this year, consider this list a starting point for a little locavesting.
Strong Buy
Stocks with potential for robust growth next year—and P/E ratios below the average of their peers.
AbbVie
Thanks to tougher tax rules announced in late September, AbbVie—the biopharma company that spun off from Abbott Labs in early 2013—won’t save as much money as it had been hoping. (Using a controversial strategy known as tax inversion, AbbVie is planning to move its tax headquarters to the United Kingdom as part of its pending acquisition of the Dublin-based drug maker Shire.) But “I still think [the merger] makes economic sense,” says Stewart Mather, founder of the Mather Group, an investment advisory firm in Oak Brook. It will diversify AbbVie’s drug pipeline—currently dominated by the arthritis med Humira, which goes off patent in 2016—and give the company a new cash source in the United States. (Shire earned about two-thirds of its revenues here last year.)
United Continental Holdings
Airline stocks are notoriously volatile, at the mercy of such forces as swings in fuel prices and traveler demand. But air travel worldwide is on the rise, climbing an estimated 5.9 percent this year, the highest increase since 2011, according to the International Air Transport Association. And CEO Jeff Smisek pledges to keep slashing costs—by $2 billion annually over the next few years. In 2015, analysts estimate that United Continental’s earnings could grow by nearly a third. The clincher: UAL stock is a bargain. Its P/E ratio is just two-thirds that of the average airline.
Buy
Stocks of companies whose businesses are strong but growing less quickly—or whose prices aren’t superlow.
Allstate
In an age of geckos peddling insurance online, Allstate may seem like a dinosaur: It primarily uses agents to sell home and auto policies. But the company also owns Esurance, giving it a foothold in the Internet market. What’s more, says Brett Horn, a Morningstar analyst, “I don’t see the agent model going obsolete.” Allstate successfully increased premiums nearly 6 percent in the second quarter, year-over-year.
Archer Daniels Midland
Recent strong demand for ethanol and agricultural services has boosted ADM, which transports, stores, and processes crops (and which moved its global headquarters to the city from Decatur in August). Analysts applaud CEO Patricia Woertz’s announcement this summer that ADM will buy Wild Flavors, a Swiss maker of natural flavorings, for about $2.8 billion. They expect the company’s earnings to grow a robust 15.7 percent next year.
Baxter International
When will spinoff mania end? Not in 2015, apparently: CEO Robert Parkinson Jr. plans to turn Baxter’s $6 billion biotech business into a separate company by mid-2015. Post-split, Baxter will be largely a medical-products concern, making items such as IV solutions and drug delivery systems. Many analysts believe that the restructuring will unlock value: “We encourage investors to consider this [stock] in front of next year’s spinoff,” says a report by the Chicago investment bank William Blair.
Boeing
The stock of this aerospace and defense giant lagged earlier this year; a slowdown in government defense spending may be one cause. But Boeing has a backlog of orders worth $440 billion, including orders for such aircraft as the 787 Dreamliner, which seems to have finally overcome the technical issues that plagued its debut a few years ago. NASA also recently awarded Boeing a $4.2 billion contract to build and fly its next passenger spacecraft.
Discover Financial Services
Americans have been spending more money lately—good news for this credit card issuer. Card balances at Discover were up 5.9 percent at the end of the second quarter, year-over-year. The company also provides personal loans, which could grow by as much as 20 percent a year in 2014 and 2015, according to the investment bank UBS. One risk: Charge-offs for loan losses—unusually low right now—could rise. “But as long as the economy is doing well, there’s no reason to believe losses will go up materially,” says Eugene Novak, a research analyst at Chicago-based Nuveen Investments.
Exelon
A glut in natural gas has pushed down power prices, hurting this energy producer and distributor. But Exelon has made some smart moves, such as acquiring regulated utilities—most recently, Washington, D.C.’s Pepco Holdings—to stabilize earnings. And in May, the Illinois House of Representatives passed a resolution urging state and federal environmental agencies to adopt rules that support nuclear power plants. As the nation’s largest producer of nuclear power, Exelon would be the biggest beneficiary if such rules get enacted, says Travis Miller, director of utilities research at Morningstar.
W.W. Grainger
Grainger’s business—distributing industrial maintenance, repair, and operating supplies (otherwise known as MRO)—isn’t sexy. But its 10-year results sure are. A significant tumble in Grainger’s stock price this year, in part because of slower economic growth in some overseas markets, presents a buying opportunity. After all, sales are strong—they increased 7 percent in August, year-over-year (before currency adjustments)—and many analysts say that there’s plenty of potential for more growth. Earnings are expected to rise 13.2 percent next year.
Hold
Stocks of companies that face short-term challenges. If you own these, keep them; if you don’t, bide your time.
Abbott Laboratories
Its pharma business (AbbVie) isn’t the only thing Abbott has shed lately. The maker of medical devices, infant formula, and other health care products is shifting some operations overseas, where expenses are lower—good for stockholders. But Abbott’s operating margins (profits before interest and taxes) are forecast to be 11.4 percent this year, less than half those of its average competitor, in part because the company still needs to trim costs.
CME Group
CME’s stock suffered after the March publication of Michael Lewis’s book Flash Boys, about the rise of high-frequency trading and its potential cost to small investors. (CME manages four exchanges that trade an average of $1 quadrillion annually in futures and options contracts—bets on changes in interest rates, agricultural prices, and so on.) And lower trading volumes caused revenues to fall in the first half of the year. But a rise in interest rates could turn the tide. “People are anticipating that when rates rise, investors will use interest rate futures to hedge positions,” explains Nuveen’s Novak.
Illinois Tool Works
A rebound in car sales is benefiting this century-old industrial giant, which makes everything from automotive nuts and bolts to beverage packaging equipment. Analysts estimate that ITW’s earnings could rise 14.8 percent next year. So what’s not to like? The P/E ratio, for one thing. It’s 14 percent higher than that of the average industrial company.
Kraft Foods
Kraft (which owns such durable brands as Maxwell House and Oscar Mayer) yields 3.7 percent annually, almost double what the S&P pays, making it an appealing choice for investors who want a stream of income. The company even raised its dividend 5 percent last year. However, Kraft’s second-quarter operating margin of 18.4 percent disappointed analysts. Can CEO Tony Vernon improve the company’s efficiency? The jury is still out.
Mead Johnson Nutrition
This maker of infant formula and kids’ nutritional supplements may be headquartered here, but its growth is overseas. Sales increased 14 percent in Latin America and 11 percent in Asia (before currency adjustments) in the second quarter, year-over-year. A rising middle class in emerging markets points to continued growth, according to a William Blair report. But the company’s stock, currently trading well above the average P/E of 17 for its industry, is too costly to be a good deal.
Mondelez International
CEO Irene Rosenfeld has pleased analysts by announcing a five-year plan to cut $3.5 billion in costs out of Kraft’s former snacks division (which owns such big brands as Oreo and Trident) and by combining Mondelez’s coffee unit with a firm in the Netherlands (the spinoff should be final sometime next year). Unfortunately, dairy, cocoa, and other ingredients have gotten more costly recently, prompting Mondelez to raise prices. Retailers balked, forcing Rosenfeld to lower the company’s sales forecast twice this year.
Northern Trust
The barely-there interest rates of recent years have hurt this venerable institution, which provides wealth management services for high-income families and banking and investment services for institutional investors. A rise in short-term rates could dramatically increase the fee income that Northern Trust collects from cash balances. The potential for that earnings growth warrants holding on to any stock you may own, says Charlie Bobrinskoy, vice chairman and head of investments at Chicago’s Ariel Investments: “It’s a great company.”
Sell
Stocks of companies struggling with fundamental business problems. Consider trimming your stake.
McDonald’s
McDonald’s sales are skidding (down 1.5 percent in the United States and 1 percent in Europe in the second quarter versus the year-ago period). Its stock is in a swoon. And Consumer Reports readers recently ranked its iconic burger the worst tasting of any major burger chain. CEO Don Thompson plans to spend as much as $20 billion on dividends and stock buybacks through 2016—not a bad payout while you wait for a turnaround. But with consumers seeking out fresher meals, analysts predict Mickey D’s is in for a tough slog.
Motorola Solutions
CEO Greg Brown has chopped heads and divested divisions; he is finalizing the sale of Motorola Solutions’s barcode scanner business to Chicago firm Zebra Technologies for $3.5 billion. The sale should help the company focus on its core business: voice and data systems for police, fire, and other public safety services. But some analysts worry that government budget cuts, to name one factor, could depress sales. And though the stock has fallen more than 7 percent since January 1, its P/E still exceeds its peers’ by 42 percent.
Walgreen
Walgreen investors have been disappointed recently by a jump in generic drug costs. Some wonder whether buying the Swiss pharmacy chain Alliance Boots was worth it, given that the retailer will not move its tax headquarters to Europe after all. The stock has been volatile lately, and more upset could lie ahead: Walgreen has already restated its expected 2016 fiscal year earnings before interest and taxes, lowering them from $9.5 billion to $7.2 billion. Good thing Greg Wasson, CEO of the drug retailer, has easy access to aspirin.