Three gems of 2017 that are set to shine on in 2018

These stocks all gained more than 50% last year, yet they continue to trade below or near their fair value estimates.

Vikram Barhat 17 January, 2018 | 6:00PM
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It was yet another year of spectacular gains for the North American stock markets in 2017. And if the initial days of 2018 are any indication, the equities party is likely to continue at least in the foreseeable part of this year.

While the S&P 500 returned more than 20% in a year of records, these hefty gains for the benchmark pale in comparison to the year's best performing stocks. At the top end of the performance pole are companies whose stocks gained more than 50%, a few of them racking up triple-digit returns for the year.

Often, the flip side of such remarkable performance is stretched valuations, which is indeed true of many companies in this exclusive group. However, despite delivering outsized gains, select stocks are still trading well under or close to their fair value. These companies have strong fundamentals and are poised for long-term growth as a tailwind of conspiring factors, including strong economic growth, improving corporate profits and the expectation of favourable tax and fiscal policies under Trump administration, continue to push them higher.

Investors exploring new opportunities may want to keep these stocks on their screen and wait for pullbacks that could offer attractive entry points and a greater margin of safety.

 

Vertex Pharmaceuticals Inc.
Ticker: VRTX
Current yield: -
Forward P/E: 51.3
Price: US$157.93
Fair value: US$175
Data as of Jan. 12, 2018

 Vertex Pharmaceuticals (VRTX) discovers and develops treatments for serious diseases including drugs for cystic fibrosis (CF) and HIV. The firm has several mid- and late-stage products targeting the CF market. Vertex's pipeline also includes therapies for cancer, pain, inflammatory diseases and influenza.

Once best known for discovering Incivek, a blockbuster hepatitis C drug, the firm's fortunes and future are now tied to its robust cystic fibrosis portfolio. "Approved [cystic fibrosis] treatments Kalydeco and Orkambi as well as additional pipeline assets are expected to create a dominant franchise in this lucrative rare disease market," says a Morningstar report. "Vertex's pipeline strategy has been to develop drugs known as correctors that work in combination with Kalydeco in order to treat other genetic subtypes that make up a larger portion of CF patients."

Morningstar expects the company to reach more than US$4 billion in peak sales in this patient segment alone. "Vertex's comprehensive approach is poised to dramatically change the treatment of CF and earn the firm a dominant position in this market worldwide," says Morningstar equity analyst Kelsey Tsai, who recently increased her estimate of the stock's fair value to US$175 from US$170, prompted by a "higher-than-expected uptake of Orkambi and Kalydeco sales in the company's third-quarter earnings update."

Given Vertex's monopoly in the CF market, and inherent competitive advantage, it's expected to remain the leader in this space for the foreseeable future. Despite the stock's meteoric rise in 2017, additional upside remains, as "the market is not fully appreciating the upside from likely approval of its next-generation doublet regimen tezacaftor/ivacaftor [expected in early 2018]," adds Tsai.

 

Adobe Systems Inc.
Ticker: ADBE
Current yield: -
Forward P/E: 35.3
Price: US$195.05
Fair value: US$190
Data as of Jan. 12, 2018

 Adobe Systems (ADBE) develops and sells software and services for content creation and the measurement of digital advertising and marketing. The company operates in three business segments: digital media (Creative Cloud services), digital marketing (Adobe Analytics and Media Optimizer) and print and publishing.

"Adobe has long been the crème de la crème of creative software, as design programs around the world continue to rely on its products to mold creative minds," says a Morningstar report. "The firm's seamless transition to the cloud has unlocked new opportunities as content becomes an increasingly valuable asset class."

Adobe had a stellar 2017 with strong growth in Digital Media User fuelled by its cloud offerings. "Creative Cloud remains Adobe's cash cow, as the service delivered US$1.16 billion in revenue in the fourth quarter and US$4.2 billion for the full year, representing year-over-year growth rates of 31% for both periods," says Morningstar equity analyst Rodney Nelson.

There's further room for growth this year as the wide-moat company rolls out its first set of price hikes across cloud services since their inception years ago. "Adobe is exercising its pricing power with Creative Cloud, and while this could yield some elevated churn in fiscal 2018, the dearth of viable alternatives to the offering will ultimately yield significant upside to Adobe's core business," says Nelson, who recently revised the stock's fair value estimate from US$170 to US$190, prompted by improved growth assumptions.

Although the shares are trading very close to fair value, Nelson asserts "investors should keep Adobe near the top of shopping lists should the shares display weakness moving forward."

 

Estee Lauder Cos Inc. Class A
Ticker: EL
Current yield: 1.09%
Forward P/E: 30.9
Price: US$128.53
Fair value: US$126
Data as of Jan. 12, 2018

Global cosmetics leader  Estée Lauder (EL) owns three of world's top 10 global makeup brands -- Clinique, Estée Lauder and MAC -- and enjoys a 28% share of the global prestige makeup market. The firm makes skin care (38% of sales), makeup (43%), fragrance (14%) and hair care (5%) products. It generates 39% of sales and over two thirds of its operating income in Europe, the Middle East and Africa, and 41% of sales in the Americas.

An enviable portfolio of brands has helped the firm build a robust competitive advantage and defend its leading position in the prestige beauty category where it holds a 15% global share. "The firm's premium positioning has allowed it to develop durable brand intangible assets," says a Morningstar equity report, noting that EL has been pushing to diversify its products' distribution over the past few years. "It has shifted its channel mix away from department stores (which now contribute slightly above 40% of sales, versus 54% in fiscal 2012) and toward the rapidly growing online, travel retail and specialty multi-brand channels that in total represent above one fourth of the firm's sales."

EL is using both inorganic and organic means to bolster its growth, including "tie-ups to broaden its reach into both specialty multi-brand retailers and with millennials," says Morningstar equity analyst Sonia Vora, who recently raised the stock's fair value to US$126 from US$120.

Additionally, Estée Lauder has been bulking up its digital presence with online sales growing about 25% annually for the past five years and e-commerce contributing 11% of revenue, compared with just 4% five years ago.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Adobe Inc553.44 USD2.95Rating
The Estee Lauder Companies Inc Class A149.99 USD0.89Rating
Vertex Pharmaceuticals Inc430.11 USD0.78Rating

About Author

Vikram Barhat

Vikram Barhat  A Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry, Vikram also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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