If we see higher risk assets further over-valued, do not chase the move, but rather sell into price ...
Dessauer's Out of Favor Favorites
08/27/2004 12:00 am EST
"Stocks are cheap," says John Dessauer in his always unhedged manner. The advisor, well-known for his long-term global focus—and often contrary positions—looks at several plays from the out-of-favor mortgage, healthcare, finance, and telecom industries.
"Corporate profits clearly are on a roll, with four consecutive quarters of profit growth over 20%. That has happened only twice in the last 25 years. Even assuming significantly slower growth of 15% in the next 12 months, the S&P 500 would still trade at 15 times estimated 2005 earnings. What we are seeing in the stock market is a ‘compression’ where profits are growing faster than expected, while stocks stay flat or decline. At some point, stock values will become so compelling that there will be an upward thrust in prices. I believe that over the next six–nine months, the broad averages will rise 15% to 20%, depending on the strength of corporate profits. In addition, companies are generating cash like mad. My expectation is that unless something terrible and unexpected occurs, that the next move in the Dow will be substantially higher— more than most would predict today.
"What could go wrong? One of the favorite stories around is that there is a bubble in the housing market in the US that is going to burst like the tech stocks and that this collapse in housing will drag the economy down. That is an absolute fabrication. It won’t happen. Why not? Consider a bubble such as what we saw with tech stocks. A stock like Cisco Systems turns over its total number of outstanding shares about every six or seven months. How often does the whole housing market in the US turn over? It turns over less than 10% per year. So when you compare housing to stocks, it’s just silly. It’s not apples to oranges— it’s like apple carts to mountains. When I look at the latest data on the economy there is a slight slowing. And, yes, oil is up there. But oil is probably going to go back down and it does not appear that US economy will either boom or bust. We don’t have a major problem with inflation and so we don’t have a problem with long-term interest rates. Overall, I see an economy that’s really on pretty darn good footing, neither boom nor bust. Therefore, I have come to the conclusion that given corporate profits and balance sheet improvements, the odds are in our favor for the next 12-15 months. What would I buy to take advantage of the situation?
"One stock I like is a simple idea. The risk level in Nokia (NOK NYSE) has gone way down, and if this company does even anything right, the stock will go higher. They have a mountain of cash and despite problems, they still sell more hand-held telephones than the next two competitors combined. The stock recently fell to a low not seen since 2002. The firm's cash hoard is $14 billion and management intends to buy back shares and raise the dividend. Meanwhile, Nokia has opened another door: software, and the inner stuff that makes the phones work. Nokia has the strongest balance sheet in the industry. Its network infrastructure business is doing very well. Management has a history of excellence and has a plan for renewed growth. With the company aggressively buying its shares and a yield over 3% that is likely to rise, I see little risk, with a good chance to double or triple within two years. Nokia is a Buy.
"Another idea that I also think is a no-brainer is IndyMac (NDE NYSE). This is a hybrid company; it’s neither a mortgage bank or a thrift but a blend of both. Michael Perry, the CEO, is someone I have followed for many years and the company has an outstanding record. This quarter they again blew away all the estimates; they earned 90 cents a share compared to estimates of around 76 cents. IndyMac will most likely raise its 2005 guidance to more than $4 a share. The dividend was raised again—to $0.32 per share per quarter, for a yield of 3.8%. Indymac’s business model is working beautiful and the stock is worth far more than 9 times earnings. The industry average is near 14. My conservative 12-month target is $45. Their goal is to earn $8 a share in 2008, and if they make it, we could have a triple in the stock.
"A third idea would be SEI Investments (SEIC NASDAQ), a company that helps trust departments, mutual funds, registered investment advisors, and hedge funds with their back office operations. Their business is therefore very much tied to the investment markets. They have done a lot of new things to adapt to the post-Enron, post-WorldCom market that are now beginning to show signs of real growth. SEI’s new initiatives are producing solid results. Signs of fresh growth are now visible. The stock is selling at 20 times earnings, which is reasonable, in light of future potential. Wall Street is estimating anemic 6.5% earnings growth in 2005, to $1.65. That is why the stock is still low. But I think earnings this year will be up 16%. At that rate, next year’s earnings would be $1.80, and SEI would trade near $40. Below $30, I think the stock is extremely attractive.
"For a very short-term play, I would speculate on Cardinal Health (CAH NYSE). The pharmaceutical and stocks continue to get beaten up left and right; it happens during every presidential election year. I think the stock will pop after the election, when politicians stop beating up on these companies. The stock recently got hammered when the company delayed release of its fourth-fiscal-quarter results after its CFO resigned, as part of an ongoing SEC probe into its accounting practices. The market overreacted, in Enron-style shock. That is shortsighted. Cardinal will get through this probe. There will be some accounting changes, but I doubt they'll materially impact results. Cardinal has a very strong balance sheet, generates significant cash, and is buying back its shares. Earnings estimates for this year are $3.55 a share. At under 13 times this year’s estimate, CAH is a Buy."
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