Seven Five-Star Favorites
05/21/2004 12:00 am EST
While Wall Street may be tarnished from scandal, Standard & Poor’s–for over eight decades–remains a model of i ndependent and objective advice. For a special panel in Las Vegas, Stephen Biggar, looks through the eyes of 65 analysts covering 1,250 stocks to offer seven favorites.
"Our investment approach utilizes three investment techniques. First, we look at intrinsic value, which is essentially determining projected cash flow. We do a 15-year model and we discount that rate back to a present value and derive an intrinsic value and compare that to the current stock price. Secondly, is relative value. This is assessing the security's relative value plus financial ratios and across peer groups. In other words, what you might use for financial ratios for financial companies, for example are much different than what you would use for telecoms, or utilities, or other industries. Thirdly, is the sum of the parts. That's determining the fair value by looking at the private market values. This is useful in cases where you have conglomerates that may not have easy comparisons with other companies. And our overreaching investment theme is growth at a reasonable price. We do like growth, but it has to carry with it a reasonable price. We use a star ranking system. We rate stocks from 1 to 5–with 5 being our strongest buy. A stocks needs have 20% upside appreciation in the target price to justify a 5-star buy recommendation. And that’s an absolute. Currently, we are overweight in discretionary, healthcare, and information technology, and here are a few our favorite 5-star stocks in these sectors:
"In the discretionary area, Harman International (HAR NYSE) is certainly one that we like. It may not be one you have heard a lot about, but this is a company that makes high-fidelity audio electronic systems. We think they are a technology market leader in the under-penetrated market for supplying high-end audio and info-tainment systems. These are very popular in new vehicles. We also think revenue visibility is going to be high as its products are scheduled to be installed in some of the higher-end auto models. And, they have changed their revenue mix towards a great proportion of auto OEM business, which we think is going to help margins as well.
"Next in the discretionary area is Comcast (CMCSK NASDAQ). This is the largest cable system operating in the US, with 2½ million home subscribers in 41 states. We see rising consumer demand for digital-based products and services. Anyone that has used broadband access is well aware of the speed capabilities, which is so much better than analog. They are also looking towards video-on-demand, digital video recorders, and high-definition TV, which are also bringing in subscribers. After several years of losses, we expect this company to have a transition to being free cash flow positive this year. That can provide some important catalysts for upside earning surprises. It's a little hard to pinpoint exactly when they are going to turn cash-flow positive, but as we look out, we think there could be positive surprises.
"The second industry we are overweight in is healthcare. We are emphasizing non-pharmaceutical areas. Many of the large pharmaceuticals have a lot of drugs coming off of patent and are going to have a difficult time. However, we like the medical-device stocks and think they are going to do well. A lot of product launches are expected in cardiology, orthopedics, and diagnostics. A weaker dollar has also helped them, as well as considerable pricing power. Also, clinical success in targeted oncology, particularly in the biotech industry, has been a benefit. We also favor HMOs, which are seeing better rates and improving medical cost spreads.
"One company we like is Mylan Labs (MYL NYSE), a $6.1 billion market-cap company that makes generic pharmaceuticals, such as the generic version of Prilosec, a gastrointestinal drug, and Xanaflex, for anti-spasticity. They have launches coming up to include generic versions of Duragesic, which is a transdermal patch for pain and Levoquin, an antibiotic drug. And they also have a considerable pipeline. The have about 40 compounds now in the application process for new drugs, some of which have six months of exclusivity, so that should provide them with a nice pipeline to continue at least for the next year-and-a-half for above-average earnings growth.
"Coventry Health Care (CVH NYSE) is a managed healthcare provider, with strong premium growth receipts from higher commercial premium yields. That is the difference between the costs they have out there versus the premium yields they are getting. We also see some organic enrollment growth here, but most of the gains coming from higher commercial premium yields. They also have strong pricing discipline, along with moderating medical costs trends and acquisition integration from a number of mergers that they did over the last two years.
"The third segment we are overweight in is technology. The replacement cycle for aging equipment is a major theme here. We see the semiconductors in a multi-year up cycle. We like the chip makers in particular. We also see early signs of growing demand in communications equipment, a sector that has been out of favor. One company we like is Vishay Intertechnology (VSH NYSE), which is benefiting from the cyclical expansion of electronic components. We are also seeing signs of a turnaround in Europe for this company. And, capacitor prices are strengthening. In addition, we see higher quality earnings here. Technology firms have substantially more options expenses than the average industry and this company has low option expenses compared to its peers. This is a focus of our full earnings methodology where we subtract options expenses from companies in order to compare them on an apples-to-apples basis with other industries. So we look at how much the company would have earned if they had backed out their option expenses.
"We also like Avaya (AV NYSE), which is about a $6 billion market-cap company. This is a former spin-off from Lucent. Avaya provides communications systems for enterprises such as voice-data networks. We see growth in new data solutions, Internet protocol convergence, and voice communication. This is the integration of voice, data, and video, which is a very popular area. The firm’s cost structure has been reduced. They had a restructuring in 2003 that we think will benefit expenses going forward. They are also changing their revenue mix towards software-based solutions, which is improving margins.
"Finally, in technology, we like Automated Data Processing (ADP NYSE). This is a company that provides data processing services. We think it’s going to benefit from expanding payrolls. Its employer services segment is also benefiting from acquisitions. We see strong retention for customers. Payroll outsourcing is certainly a very interesting trend right now and this area should also improve from an improving job market. The company also has a health balance sheet. We look for low debt ratios, which is particularly important in a rising interest rate environment. The firm has strong cash balances and strong cash flow generation. And based on this, we see a premium valuation warranted for the shares."