Track These Sectors After Earnings

10/28/2011 7:00 am EST

Focus: STOCKS

Among others, industrial names have been encouraging this earnings season, says Stephanie Link. She tells MoneyShow.com about stocks showing potential, and describes the metrics she watches to determine if a stock is a good buy.

Kate Stalter: I am on the phone today with Stephanie Link, and she wears a number of different hats. She’s Director of Research and Vice President of Strategy at TheStreet.com, as well as a co-portfolio manager of Jim Cramer’s charitable trust, Action Alerts Plus. And that’s a mouthful right there.

Let’s chat a little bit about earnings season and how that has been affecting your investing or trading decisions lately.

Stephanie Link: It’s interesting. The earnings season has been somewhat of a surprise in certain areas, and not a surprise in other areas. And by that, I mean, the third-quarter numbers are actually coming in better than expected, which is a good thing. A little bit stronger than I thought, about 15% year-over-year growth.

We still have quite a few companies have yet to report, but at least so far for now, it looks like the numbers are coming in better.

The surprise to me is that the guidance for the fourth quarter is in fact a little bit more negative than I had expected. We know that the global growth is slowing down. We know China clearly is intentionally slowing things down. The US has been kind of sluggish and Europe has their issues, but I thought that the companies might be a little bit more upbeat, just in terms of their own prospects for growth.

So it’s been kind of interesting in terms of hearing the companies, and making the conference calls all that much more important to listen to.

Kate Stalter: What are some of the sectors or sub-sectors, or industry groups, that have stood out to you as showing either unusual strength or weakness in this earnings season?

Stephanie Link: Well, I think that clearly, the industrial companies have reported, those companies that have lagged like a Caterpillar (CAT) or like a Boeing (BA), actually are rallying on their good reports, whereas something like a Cummins (CMI), which rallied 24% into the quarter, sold off.

I think that industrials are still seeing pockets of strength and pockets of weakness. I’ve been impressed by the fact, though, that they are still able to deliver growth and expect growth even in the fourth quarter.

I also was very surprised in the banks. Now the banks all reported really crummy numbers across the board—not surprising, given the slowdown in the economy and also the flat yield curve. But the surprise, Kate, has been the reaction to these stocks. They’ve actually rallied on the news, and that kind of tells me that they’re probably washed out.

Do I want to get overweight financials? Probably not, and not banks. I think non-banks, you can look at something like a Prudential (PRU) or an American Express (AXP) or even a Visa (V), those kinds of names. But it’s interesting the way stocks react based on the news.

Then the only other callout, I would say, is technology. It’s been pretty mixed—mixed to down, if you will, and again, this sector rallied very hard into earnings, so the sell-offs are not entirely surprising, but they’re pretty big.

NEXT: Other Picks to Watch

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Kate Stalter: You just mentioned a few of the financials that could be potential buy candidates. Anything else, just across the board, in any industry or sector that you believe is a good watch list candidate, that might be worth some research on the part of retail investors?

Stephanie Link: Yeah, I would say that energy stocks are probably the best value here, along with industrials. I still feel like industrial companies are doing better than what their valuations are implying, but in terms of energy, those stocks too, they’ve gotten hit very hard. Particularly the ones that don’t have the dividend yield.

Something like an Ensco (ESV) or something like an Apache (APA), something even like a Schlumberger (SLB) or Weatherford (WFT). These companies have been hit very hard, and yet I don’t think that it’s as gloomy as the share prices suggest.

And oil has actually come down from the mid $115, $116 level, down to as low as about $75, $76. Now it’s kind of rebounded again, and I think if you listen to what companies are saying, they can still grow production. That’s the most important thing, for an oil company to grow production.

They can still grow production with Brent Oil above $80. Now WTI is the number that we normally look at. Brent is the global price, and Brent right now is over $100. So for it to get to $80, it would have to get really, really bad, and I think we’re a far cry from it. So in the meantime, there are some serious values, I think, in that sector.

Kate Stalter: Now Stephanie, I know just over the past few months, different interviews you’ve given, different times that we’ve talked in the past, you tend to focus on various indicators, whether it’s story or fundamentals or technicals. Tell us some of the key metrics that investors should be looking at.

Stephanie Link: Yeah, every industry has different metrics. Do people look at earnings growth? Do they look at EBITDA growth? Do they look at revenue growth, that kind of thing?

So from a fundamental point of view, I like to look at things in two ways. On a fundamental point of view, looking at all the things that I just mentioned; revenues, earnings, growth—but also end-market opportunity.

That’s why I say some of these industrials are pretty attractive, because if you look at, say, within industrials you have auto and you have truck and you have aerospace and you have agricultural, and all of those are actually in secular growth trends. They’re improving off the lows. There’s been massive underproduction over the last several years. And so those are kind of important end markets that I like to look at and focus on.

Again, say, for the industrial companies, clearly it’s important from a fundamental point of view to look at margins, and that was the big concern for so many people, that margins have peaked.

And within the earnings season so far, actually, margins have held up pretty well. And again, that’s a function of companies lowering costs as well as taking price increases.

So to the extent that they can continue to see strong margins, may not have to be expanding margins, but at least strong margins, I think earnings should hold up.

From a technical point of view, I’m certainly aware and looking at various different charts and whatnot; what I think is more important are sentiment indicators. If you look at the S&P oscillator or you look at a lot of different sentiment indicators, like the AAII numbers—all kinds of ways of seeing what is sentiment out there.

And it’s still pretty low, even though it has increased over the last couple of weeks. Sentiment is pretty low.

And then I look at money flows, and when money flows out of the market in such droves that we’ve seen in the last couple of months, it’s actually a contrarian indicator, which is actually an interesting data point as well.

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