We’ve all seen the disclaimer on stock market analysis that past returns are no indication of future performance. This rings especially true when looking for stocks with strong upside potential for price growth. Growth over the last couple of years is important to gauge how management’s plans are working out but I want to see a strong outlook, preferably one that isn’t priced in the shares.
Exelon Corporation (EXC)
Exelon, the country’s largest provider of nuclear power, cut its dividend by 41% in February. After the initial recoil, understand that the company still pays a healthy 4.2% that should be sustainable after the cut. In March, the U.S. Nuclear Regulatory Commission accepted the company’s application to increase output at its Peach Bottom plant by 12.4% and has 18 months to review the application. The increase could significantly add to the company’s bottom line and isn’t yet baked into estimates. The shares trade for 22 times earnings, well above the five-year average of 13.8 times but the price-to-expected earnings ratio is much lower at just 11.5 times. Nuclear energy is still the least costly of the alternative sources and should provide a larger share of total production over the long-term. The downward trend in the shares has halted around $30 over the last year and an increase in output could easily drive the price back up to $40 over the next few years. Even over a long-term holding period, this 33% increase can add significant growth to your portfolio.
Potash Corporation of Saskatchewan (POT)
Potash got slammed in July on fears that the international potash oligopoly would no longer be able to control prices. The shares have since rebounded 9% but are well off their 52-week high. While potash prices may come down somewhat, prices in North America will not be affected as much and the company’s profit margin makes it a best-of-breed among peers. Increasing demand for food is continuously driving higher planted acreage and needs for higher crop yields. This means that farmers will need to use more fertilizer and that means more potash. The shares trade for just 12 times earnings, way under the company’s five-year average of 18.8 times earnings. The dividend of $0.35 per share, a yield of 4.4%, was increased 25% in July. Even on some weakness in prices, increasing demand and fundamentals means the shares should be worth between $35 and $40 for a price return of at least 11% off of current levels.
E.I. du Pont de Nemours (DD)
E.I. du Pont de Nemours is a diversified chemicals manufacturer with a growing share in the agricultural chemicals space. The boom in natural gas production in the United States is reducing costs for chemical manufacturers and should continue through the foreseeable future. The demand side is weak but stable due to stagnant global economic growth. The shares trade for 23 times earnings, above the five-year average of 14.7 times but earnings are expected to pick up and lower the valuation premium. The dividend of $1.80 per share, for a yield of 3.1%, represents a 6% increase over last year. Shares are already up 28% this year so it may take a couple of quarters for earnings to catch up to the price but it could easily breach $70 per share over the next couple of years.
We all love that quarterly check that comes with strong dividend payers but there are good reasons to balance it with growth in your portfolio. Look for names that have stronger outlook that recent performance might suggest. As a long-term investor, you have the advantage of waiting for the strong cyclical stories to play out and don’t have to worry about near-term weakness.
