One Simple Step to Building a Smarter Portfolio

By Todd Campbell and Kristine Harjes Markets Fool.com

If you invest in growth stocks, value stocks, income stocks, or any other category of stocks, then watch lists can improve your process and keep you on track to building a well-rounded and profit friendly portfolio.

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In this episode of The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes is joined by Todd Campbell to provide a blueprint to building great watch lists capable of producingtop shelf returns. Also, the duo tackles Trump's tough talk on drug prices and shares with you whyslashing credit card debt is a great resolution for 2017.

A full transcript follows the video.

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*Stock Advisor returns as of January 4, 2017

This podcast was recorded on Jan. 11, 2017.

Kristine Harjes:Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every single day. I'm your host, Kristine Harjes, and it isJanuary 11th, 2017. I have healthcare contributor Todd Campbell joining me via Skype. Todd, is your new year off to a good start so far?

Todd Campbell:So far, so good. And I don't know if you're having the same weather down there as we're having in New Hampshire, but it's like spring outside. It's very odd for January.

Harjes:It's not bad. I wouldn't quite call it spring. But hey, it's some optimism. It's not too far away, too. It's January, it's close enough to March, which is close enough to spring.

Campbell:Yeah. Mud season will be upon us soon enough.

Harjes:Perfect, can't wait. So, aswe were discussing right before we started taping, there's some breaking news going on in the healthcare industry, that makes me kind of sad that this podcast isn't live, because then we could break the news. Right as I was walking into the studio today, I got an email saying "Donald Trump promises to slash drug prices by billions, pledging aggressive Federal bidding process." Basically, what this is saying is, in his press conference that is going on right now as we film -- which, by the way, is at 12:30 PM EST -- Trump says he's going to use the Federal government's power to overcome the lobbying that goes on with pharmaceutical companies and try to cut drug prices. What do you think? Breaking news?

Campbell:I suppose it's breaking news that he's saying it right now, again. This is what you call a lather rinse repeat kind of scenario. We know without a doubt that a major focus in Washington is on drug prices. We've heard it time and time again. If these companies don't self-regulate, they run the risk of Washington regulating prices for them. We've talked about it show after show after show. CEOs run the risk of either being tone deaf or downright oblivious, if they continue to embrace double-digit price increases in an environment where the president elect and soon-to-be president has said quite clearly that he wants prices to go lower, not higher.

Harjes:We have addressed this a good amount on this show, and honestly it's gotten a lot of coverage in the general media, not even just the financial media. So, I don't know if this is quite a breaking news topic, but I guess the story itself is, and the IBB, which is the biotechnology index, is down 3.45% as I speak this. I'm sure it'll bounce around some more today, but I bet it will end the day down.

Campbell:Yeah. Who knows. The topic we came into today to discuss before the breaking news actually dovetails beautifully with the fact that we're seeing a relatively sharp sell-off within biotechnology stocks.

Harjes:Right. Thank you for the segue. The topic of today's show is not breaking news. It would be kind of incredible if it were, because we would have had zero time to prep for this. But, our topic, as you listeners will know if you've been listening to us all week long on Industry Focus, it's Resolutions Week, so we decided we would talk about some of our financial New Year's resolutions. We alluded to that last week too, soI'm sure nobody is shocked to hear that that's what we're talking abouttoday. But,I know you guys have been dying to hear what our financial resolutions are. Because you segued so nicely into it, Todd, I'm going to start with my own New Year's resolution, which is to create a watch list. The reason that was a good segue from what we were just talking about with breaking news and the IBB bouncing all over the place is because creating a watch list, which is basically just a list of stocks that you're watching -- I feel like my elementary school teachers would not be happy with me for defining a word using the words I'm defining, but it is an Excel document or some sort of organized written form of the stocks that you're looking at that you find interesting, and some information that you think is relevant to whether or not you would want to buy them. The purpose of it is that you're well-prepared when a buying opportunity presents itself.

Campbell:Right. For example, the IBB falling 4%.

Harjes:I'm sure there are individual companies within the IBB that are getting slammed much harder than that. Usually, when the IBB falls, you get some smaller clinical stage companies that really take a dive, and some of the bigger, more established ones won't be down quite as much.

Campbell:Yeah. As everyone who tunes in week after week -- thank you very much -- to our show knows, we're not short-term investors. We like to embrace a longer-term outlook. The goal is to find what we think are great companies and watch them for an opportunity to buy them at a price that we feel comfortable buying them at.

Harjes:Exactly. For me personally, the purpose of my watch list is to force myself to be a little bit more patient. Typically, how do I do my investing, and this is a guilty confession right here, I get interested in a company, I do the research, and I'm either like, they're awesome, or they're not. If they're awesome, I'm in, I'm buying. And I think I could do a lot better if I took that information, wrote it down, and sat on it, and watched the stock for a little bit to see what changes over a short period of time, make sure the buy thesis is really sound, and maybe watch to see if its price goes down a little bit and I can enter at a more attractive price point.

Campbell:Many savvy investors embrace similar approaches. One that comes to mind is George Soros, who people probably recognized as being one of the most successful investors over the last 50 years. One of his approaches is to say, "I have an idea, I'm going to take a little bit and see how it goes,and if I'm proven right I'm going to double down on it. And if I'm proven wrong, I'm going to move on." That's the same kind of idea. You do your due diligence, do your homework, and then hold yourself to a high standard of tracking the stock, seeing whether or not the catalysts that you expect to happen start to happen, and if they do, taking action and buying. But in creating any watch list, Kristine, I think you'll probably agree with this, the first step would be know thyself. You need to knowwhat kind of investor you are so that you can separate out the stocks into the appropriate baskets. Are you a growth investor? Are you a value investor? Are you an income investor? Are you an investor that likes logos that have frogs on them? You need to be able to know your investing style and then create and craft watch lists for each one of those pieces of your style so you don't accidentally end up overweighting value stocks if you're a growth investor, or growth stocks if you're a value investor.

Harjes:Exactly. I think it's important to have, as a column in your spreadsheet or a box in your notepad or wherever you're keeping this list, the category of investment, and say, "This is an income play." That way, when you have an opening in your portfolio for an income stock, right there, bam, you filter on it and you say, "Give me my best income choices," and you can scan through your watch list and say, "This one is rising to the top of the list, it's at the most attractive price point, my thesis is still strong," and you're in.

Campbell:Correct, exactly. You don't have to be all of one or another. You're alluding to asset allocation, figuring out what portion of your portfolio you want to be income or growth or value. And yes, absolutely, having a spreadsheet that allows you to quickly scan through and sort your top picks gives you a way bigger advantage over the everyday investor who, maybe, when the IBB is falling 4%, isn't prepared to either select aGilead Sciences, if they're a value investor, or maybe aKite Pharmaif they're a more speculative growth investor, on a big drop like that.

Harjes:Yep. I totally agree. I thought it would be really helpfulto go through an example ofhow you would get a stockon your watch list. For me,I'm actually not really looking to put healthcarestocks on my watch list,because I don't need more healthcare allocation right now. I'm heavy weight, if anything, in healthcare. If you listened to the resolutions show from last year, I was saying the same thing. I'll have you know I made a little bit of progress. I guess now it's a good time to pitch it. All the hosts of Industry Focus wrote articles about our 2017 resolutions. Many of them touch on our progress from 2016 resolutions. I know mine sure did. If you listeners are interested in reading the written version of all of our resolutions, you can find them at resolutions.fool.com. For me personally, I need to find some large dividend-paying companies that are stable, profitable, and not healthcare. But, because we're on the Healthcare show, we're going to usePfizer(NYSE: PFE) as an example. What would you go through if you were considering Pfizer, and how it would end up looking on your watch list. Todd, what would be your first step in looking at this company?

Campbell:I think, when you'retrying to narrow down a list of thousands of stocks -- that's the reality, there are thousands of stocks that are publicly traded that theoretically we could be watching. We know that we can't track all of them, or even a fraction of them, well. So, you need to be very careful about what you add to your watch list. Personally, I would recommend somewhere between 10 and 20 names, tops. Anything more than that and it's going to get too cumbersome. So then, the question becomes, Todd and Kristine, how do I narrow that list down? How do I get thousands of stocks through the funnel and have it trickle out 10 or 15 ideas? I think there's a few basic questions that investors can ask themselves about each company, to help them with that process. The first is, is the company a leader within its industry? Or, looking at it another way, could it become a leader? Or is it just an also-ran? What we've found time and time again is that truly game changing, disruptive, and profitable companies are those that reinvent or reshape their industry.It doesn't matter if we're talking about healthcare or industrials, that's the case.

Harjes:Yes. So, Pfizer, is Pfizer a leader and industry?

Campbell:I think it absolutely is. It's one of the largest biopharma companies in the world. It does about $13 billion in sales every quarter. So,I think it's safe to say that it's a Goliath, and it is one of the leaders in biotech and pharmaceuticals.

Harjes:I think, also, a caveat to include with that question: is this company maintaining its leadership? Is Pfizer maintaining it?

Campbell:Right, that's one of the things. Looking at the different questions, you say, is it a leader? And what is it doing to maintain it? To do that, you have to look at the product they currently have on the market, and with a stock like Pfizer, you have to look at the pipeline, what they have in the wings that could continue to keep them at the top of their game. I think in both cases, Pfizer matches up pretty well. You have a company that has a dozen Phase III and a dozen Phase II key programs that could help drive sales higher over the coming years. That's great. This is a company that has top-selling drugs in cancer, in anticoagulation, in smoking cessation, in vaccines, and potentially in biosimilars. And they're not only willing to make investments in their own R&D to create growth in the future, but they've also been very actively acquiring innovation. So, they're using -- we'll get to cash later -- alot of the money they have stockpiled to buy innovationthat they haven't created internally, and that can produce growth and keep them in a leadership position, as well.

Harjes: Yeah. And if this were meputting Pfizer on my watch list, that is a key thing thatI would want to watch going forwardwith this company. Are these acquisitions paying off? There werequite a few acquisitions made in the last year or so that were pretty big. There was theMedivationdeal for $14 billion. I think that was at a 38Xmultiple of 2017 earnings, which is not cheap at all. This was an acquisition,essentially, for one drug, Xtandi, peak sales of $5 billion. There's a couple of question marks around it, there's somelitigation, you never quite know if you'll hit those peak sales numbers. It looks promising, but again, it's a question mark. You want to make sure you're watching it.

Campbell: Yeah.One of the advantages there, though, Kristine,is that because Pfizer is so big and has so much cash, it can buy this thing for cash, so whatever you're generating in earnings is really just a return on investment.

Harjes: Yep, it's all accretive. They had theAnacor acquisition, that was $5.2 billion for aneczema drug. There was also Hospira for $17 billion a while back, which got them into biosimilars, whichI think will be huge. As a reminder, biosimilars are generic versions of biologic drugs, so,a little bit more complicated than the generics that we're all very used to,but a new and very exciting market for this company and healthcare as a whole. So,definitely would want to make sure that these acquisitions are paying off. I would listen closely to see from management whatthey have to say about potentially making more acquisitions, and to see what sort of valuation they think is out there in the healthcare landscape.

Campbell: Yeah.I would also say it's important for investors, as they'reconsidering names to be on their watch list, to evaluate management, and to say, "OK, they're leaders,they have products, they have pipeline, they have the ability to maintain their leadership position, be disruptive. Do they have the right executives in place to deliver on their goals in the future?"

Harjes: Yeah. And I would say, with Pfizer, Ian Read, the CEO, he's a really solid leader.

Campbell: Yeah. He's been at the helm since 2010. This is a person who has ushered Pfizer throughwhat is arguably some of the toughest times for any drug maker, when you lose patent protection on a mega blockbuster,which is what happened to Pfizer in 2011when they lost patent protection on Lipitor, a drug that at one point was racking up $13 billion in sales on its own. So, he has been there, he has done that, he has piloted this company through verydangerous waters. I feel, overall, Pfizer is a check mark in the column of good management.

Harjes:I would agree with that. So we have top-notch management,we have a company that's a leader in its industry. What else would you look at?

Campbell: Financial footing. I really thinkyou can't ignore that. You can have the ability to disrupt and you can have greatmanagement, but if you don't havethe financial flexibility or financial depth to execute on your strategy, then it'sgoing to be irrelevant, you're going to end up with a bankrupt company with a great idea. So,you have to take a look at the financial situationfor these companies, you have to consider the cash,you have to consider how quickly they're going through their cash, you have to understand how they're using their cash,you have to look at how much debt they have,you have to look at if they're profitableand what their operating margin might be, andwhat their earnings outlook is going to be. Those are all important considerations for any stock that I put on my watch list.

Harjes: So,how does Pfizer stack up here?

Campbell: On balance,I think it does very well. This is a company that hasa lot of cash on its balance sheet. I think it has $13 billion on its balance sheet.I think it has another $80 billion inunrepatriated cashsitting overseas, who knows if they'll get to tap into that under a Trumppresidency or not, that could help them fuel growth. They do have debt, but you'll find that,when you're talking about larger companies, debt is a little bit easier to handle. If you'regenerating a lot of cash flow likea company like Pfizer is, and a lot of earnings, it's easy to finance that debt. So, I'd be more concerned about their debt level if they were a small, emerging, or clinical stage company, thanI would be for a company as big as Pfizer. And,like I said, they generate atremendous amount of revenue, atremendous amount of cash flow,and they're a very profitable company, soI feel like they have the financial footing necessary.

Harjes: Yeah. AndI would say, on a related note, anotherimportant thing to look at is,how cheap or expensive is this company? There area lot of useful metrics you can use there. Themost basic of them would be the P/E (price to earnings) ratio. On this front, it looks like Pfizer is trading fairly cheaply right now,particularly on a forward basis. They'retrading for a forward P/E of 12.9X, which ispretty low when you compare it to some of its peers, they're in the 16X-19X range, more or less. So, 13X, that's pretty good.

Campbell: Yeah. And Kristine,you're really driving it with the heart of the next question would be on any watch list -- when do you buy something on your watch list? You look at it, what's the valuation like? That could be one determinant tofiguring out whether or not now is the time to act. I'mnot going to tell you that you should wait to buy Pfizer until it has a 10X forward P/E ratio, or if it's a screaming buy at 13X. But I think if you're specific in where you want to buy, it's less likely that you're going to let emotion overtake you when the IBB falls 4%, and say, "No,I'm not going to buybecause things are too risky right now."

Harjes: Yep.I think the really important point to drive home here is that it's not about timing the market,it's about finding an attractive price point andtaking the emotion out of it, so you know, "I have done my research,I like this company because they arevery smart in their acquisitions, they pay a great dividend, and they're getting into biosimilars," orwhatever your buy thesis is. You have that documented, and then when you notice that the price has come down a little bit, you can refer back to that and say, "Are these things stillpart of the same buy thesis, or has something changed?" If the prices dropbecause of something like Trump saying that he wants to bring drug prices down,which is something that we already knew,and kind of a silly reason for the price of this company to dropwhen nothing material has changed, then all of the sudden you can confidently get in there and make some purchases.

Campbell: Absolutely. So, what do you think, Kristine,after we've gone through all these nuts and bolts? Do you think that Pfizer is going to rate making your watch list in 2017?

Harjes: The way thatI'm personally approaching Pfizer is that it is an income play.I would be seriously intrigued if the dividend yield hit 4%, whichit's not too far away from. Right now, it's yielding about 3.8%. If the current price of this stock dropped 4%, you would hit that dividend yield of 4%. But I am probably not putting Pfizer on my watch listsimply because I think I can find companies that check off the same box of stable, dividend-paying, cash-generating in other sectors that could use morerepresentation in my personal portfolio.

Campbell: Absolutely. And diversification is key,not only within industries like biotech or sectors like healthcare, butacross the entire market.

Harjes: Yep.Todd,we spent a while talking about my resolution,and we're running a little bit behind because of our breaking news earlier, butI wanted to give you a chance to share your resolution,if you have a financial one to share with the crowd.

Campbell: Well,after hearing about that delicious meal,I think my resolution might be to make lunch soon.

Harjes:(laughs) I can't blame youif you haven't eaten already, it's almost 1 PM.

Campbell: I know. That sounded fantastic to me. No, on a serious note,every year I try to make a resolution. I know that resolutions are hard,and a lot of people don't follow through with them, myself included. ButI think it's a good way to take stock of your personal situation, and point yourself in the right direction. So,don't beat yourself up too muchif you don't end up executing on the resolution 100%. But for me, I use them as a guide post to say, "What would I like to see myself accomplish this year?" Personally,I have a little bit of credit card debt still kicking around, and I'd love to see that gone when we ring the bell into 2018.

Harjes: I think that's something that a lot of listenerscould also probably also afford to do. Not everybody in the United States has credit card debt, but those that do have, on average, $16,061 in credit card debt, which totals, within the U.S., to $747 billion in credit card debt. It costs these people, on average, $1,292 in interest payments every year.

Campbell: Right. And what's scary, Kristine, and one of the reasons this is my 2017 resolution, is that we know the interest rates, the trend now is toward higher, not lower. So, those interest costs could become a much bigger burden on myself, and anyone else who's listening who happens to be still having credit card debt out there. It's something that's getting more and more important as we move away from the 0% interest rate environment. And, as an added benefit, as you pay down those credit cards, it improves your utilization, which means that your credit score climbs, which means if you do go out and get a loan, say, for a car, at some point, or to refinance your home,maybe you get a little bit better of a rate and save some money in the long run that way, too.

Harjes: Yep. It's a win-win. Interestingly, I found a NerdWallet report that states that a 0.25% increase in thefederal funds rate -- which is exactly what was voted on by the Fedin its December meeting -- will increase the average annual credit cardinterest payment for households that have this type of debt from that $1,292 that I mentioned earlier to $1,309. If you'redoing the math, that's only $17 difference. But as you mentioned, Todd, that rate isexpected to keep climbing. So that $17 could add up to $34, andeven more than that as time goes on andinterest rates go up. So, I think your resolution is awesome, and I think the earlier you act on it, the better.

Campbell: I agree.(laughs)

Harjes: Well,good luck with it.I hope everyone has been enjoying our Resolutions Week. Ifanyone wants to share their resolution with the team, we would love to hear it. Or,if you want to bat around some ideas for how to approach your resolution,you can always email us. Our email address is industryfocus@fool.com. If you think you can keep your comments to 160characters or less, or 140,I don't know, this isn't the Tech show,(laughs) you can tweet us @MFIndustryFocus. As always,people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. For Todd Campbell, I'm Kristine Harjes, thanks for listening and Fool on!

Kristine Harjes owns shares of Gilead Sciences. Todd Campbell owns shares of Gilead Sciences and Pfizer. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool has a disclosure policy.