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Two Stocks for the New Year

By Scott Chan on December 30, 2017

Stock investors have enjoyed a merry 2017. The S&P 500 has returned almost 20%. Nevertheless, 2018 is just around the corner and it’s the time of the year for portfolio re-balance.

Here are two stocks to add to the wish list. It is a little too late to get them in time for Christmas, but they should keep on giving for next year and beyond.

Raytheon (NYSE: RTN) has largely tread water since the company issued light early guidance for 2018. The company expects sales to grow between 3% and 5% next year and free cash flow to be similar to 2017. However, the fundamentals look very good.

Raytheon owns strong defense franchises. It enjoys steady demand growth from diverse sources. Demand comes from both domestic and international clients, and there’s a good mix of near-term and long-term projects. Bookings are approaching $27 billion.

More Demand for Defense

With geopolitical tensions on the rise, and a pro-defense president in the White House, the outlook for defense remains positive.

President Trump’s recent recognition of Jerusalem as Israeli capital could further rile the volatile Middle East. Raytheon holds clear leadership in missile defense, and is winning more and more missile-related contracts.

In regards to the Middle East, CEO Thomas Kennedy has stated that the question isn’t if there are buyers. Rather, it’s a matter of how fast the company can deliver products. So the demand is very healthy.

And of course, North Korea remains a constant threat. Plus, higher NATO spending will also benefit Raytheon.

The company has one of the highest profit margins in the defense sector. If it continues to execute well, its financial results should beat the conservative initial 2018 outlook. Raytheon will issue a more detailed guidance in its upcoming January earnings call.

Dividend payout is growing at about 9% a year. With 2018 free cash flow projected to be about $2.5 billion, Raytheon should continue to increase its dividend at a solid clip. At the very least, RTN offers a high floor with small downside.

Technology Advancements Point to Steadier Growth

Applied Materials(NASDAQ: AMAT) rally has also slowed down lately. But like RTN, there is more upside left in the stock. Even after a big run this year, AMAT still only trades at 13-times estimated forward-year earnings. In comparison to its expected EPS growth of more than 11% per year, AMAT looks like a bargain. Keep in mind that 11% projection is likely too low.

The market doesn’t value AMAT highly despite a very strong 2017. The reason is that in the past semiconductor companies have been very cyclical. They make a lot of money during good times, but sales and earnings fall sharply during bad times.

But, the world is changing. Advancements in Artificial Intelligence (AI), the Internet of Things (smart TVs, smart cars, etc.), and even blockchain technology mean greater demand for computing power and memory. This means more consistent, and less cyclical, demand.

Since Applied Materials is a leading global supplier of chip-making equipment, more semiconductor demand leads to higher demand for its products and services.

Firing on All Cylinders

Over the past four quarters, year-over-year revenue growth has averaged 36%. Net income growth has averaged 24%, and the profit margin has increased in every quarter. Expect the revenue growth rate to slow since the comparison will be to a higher base, but revenue should still grow in the high teens or better a year.

The tailwinds driven by data and AI look like sustainable. These trends will continue to lift the whole semiconductor industry. And thanks to a strong product portfolio, Applied Materials has been delivering above-industry growth. The momentum should carry over into 2018 and beyond.

Besides semiconductor equipment and software, the company also makes displays for smartphones and TVs. This business is also booming. The company expects segment revenue to grow faster than 30% in 2018.

Applied Materials is firing on all cylinders and there’s no reason to expect anything different in 2018. The demand in all of its markets is growing.

Expect the stock price to keep rising as the company continues to execute and deliver fast revenue and profit growth. And as more investors realize that the demand increase will last, the share price should also gain from a higher trading multiple.

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