UBS Quality Growth at a Reasonable Price Stocks Beating the S&P 500

The rage for the past six years as the market has rocketed back from the depths of the 2008 subprime real estate collapse has been indexing. The basic tenet is buy a low-cost index fund and let it roll, as the index usually beats actively managed portfolios, and costs and commissions do not eat up gains. In many cases that has been the case, and the advocates of the strategy have been proven correct.

A new report from the UBS CIO Wealth Management team makes a good case that investors should consider the stocks in the firm’s Quality Growth at a Reasonable Price (Q-GARP) portfolio. With the market getting a little overextended, putting a large chunk of new capital in an index fund at all-time highs may not be the best plan. On average, the current Q-GARP stocks trade at a 5% price-to-earnings valuation premium to peers, compared to their 10-year average valuation premium of 23%.

According to the UBS, since its inception in 2007, the Q-GARP portfolio is up a cumulative 121.2%, versus the S&P 500 at 62.1%, for a relative outperformance of 60%. That is a staggering difference, and one that may even be greater going forward with a rich market.

We screened the Q-GARP portfolio for the five stocks with the highest projected earnings growth between last year and 2016. Earnings will prove critical as the market becomes more expensive.

Actavis PLC (NYSE: ACT) is a top generic-drug maker that continues to see unprecedented growth. The projected earnings growth from 2014 to 2016 is posted at 18.7%. A key element to its growth has been the so-called patent cliff, a period when many of the world’s best-selling drugs are losing patent protection. In fact, Actavis has specifically mentioned in the past the new generic introduction of drugs such as Suboxone, Lidoderm and Concerta as growth drivers. The Merrill Lynch team thinks this Irish-domiciled company could have earnings per share as high as $20 by 2017.

The UBS price target for the stock is $333. The Thomson/First Call consensus price target is higher at $313.11. Shares closed last Friday at $285.37.

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Apple Inc. (NASDAQ: AAPL) was recently reinitiated with an Outperform rating at UBS, and it absolutely crushed earnings estimates when it reported. The analysts expect 18.6% earnings growth in the 2014 to 2016 period. With huge sales of both iPhone 6 models, the iconic Silicon Valley firm traded in spectacular fashion last week. The UBS analysts say flat out since the first introduction of the iPhone, the company has transformed the world of mobility and totally re-morphed as a company. They point to what remains a very strong product cycle story, and basically call Apple the best in class technology story. With Apple’s huge $145 billion stockpile of cash, the UBS analysts expect new capital allocations strategies and see the new Apple Pay as a source of solid recurring revenue.

Apple investors are paid a 1.5% dividend. The new price target is set at $150, while the consensus target is $132.90. The shares closed trading last Friday at $127.08.

Hilton Worldwide Holdings Inc. (NYSE: HLT) is expected to have 2014 to 2016 earnings growth of a very solid 21.5%. The world’s largest hotel operator, it recently announced plans to buy San Francisco’s Parc 55 and four other properties for $1.76 billion to help defer capital gains taxes from its sale of New York’s Waldorf Astoria. In addition to the Parc 55 purchase, the company is buying two hotels in Orlando, Fla., and two in Key West that are already managed by Hilton. The sellers in the transaction include Hilton’s majority owner, Blackstone Group.

The UBS price target is $29, and the consensus target is $29.86. Shares ended the day Friday at $28.57.

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Intercontinental Exchange Group Inc. (NYSE: ICE) makes the Q-GARP list and is expected to have earnings growth in the 2014 to 2016 period of a very strong 21.3%. The company boasts the leading network of regulated exchanges and clearinghouses for financial and commodity markets. The company delivers transparent, reliable and accessible data, technology and risk management services to markets around the world through its portfolio of exchanges, including the New York Stock Exchange, ICE Futures, Liffe and Euronext.

Intercontinental Exchange investors are paid a small 1.1% dividend. The UBS price target is $256, and the consensus target is $251. The stock closed Friday at $233.22.

Starbucks Corp. (NASDAQ: SBUX) dominates the retail coffee business in the United States, and international growth is helping to boost earnings in the 2014 to 2016 period 17.4%. The Seattle-based company continues to diversify, adding new payment methods, new food and drink items, customer loyalty plans, music CDs and, of course, new flavors of gourmet ground coffee. After trading sideways for most of 2014, Starbucks stock jumped up in early 2015 trading, rising 6.6% on Jan. 23, a day after the company named Kevin Johnson its new president and chief operating officer. It also announced a new smartphone app that supports Apple Pay.

Starbucks investors are paid a 1.4% dividend. The UBS price target is $95, and the consensus price objective is $96.21. Shares closed last Friday at $91.58.

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It would seem that at least for the near term, the place for aggressive investors to make money will be growth stocks. The bottom line is they have to be reasonably priced with solid growth expectations. If not, they could sink like a rock during a stock market correction. The UBS Q-GARP picks make very good sense for investors now, as stock picking becomes more critical.

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