05/26/2006 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Supported by a strong team of analysts, Schaeffer’s Investment Research Web site offers an ongoing daily stream of trading ideas. But for those who want to focus on just one or two key stock plays each month, he offersPower Stocks. Here’s a look.

"Stock featured in our Power Stocks service will be purchased for their strong appreciation potential over longer time frames generally ranging from two to six months. Stocks with higher dividend yields will be considered as well, such as one of our latest featured Power plays Reynolds American (RAI NYSE). The company trails Altria Group (owner of Phillip Morris) as the #2 US tobacco firm. Its Camel and Salem brands are among the best-selling cigarettes in the US and are joined by well-known brands Kool and Lucky Strike.

"Reynolds American has beaten the consensus Wall Street earnings estimate in each of the last eight quarters. On April 27 the company reported first-quarter earnings per share of $1.89, excluding non-recurring items, versus Wall Street’s expected profit of $1.87 per share. The company also reaffirmed its earnings guidance for fiscal year 2006, predicting full-year earnings of $8.00-$8.40 per share versus the $8.11 per share consensus. The next earnings report is due July 27.

"Technically, the stock has been strong. On a year-to-date basis, RAI is up almost 17%. In the last three years, the stock is up more than 226%. Also, the shares have been supported by its intermediate-term ten-week and 20-week moving averages. Those trendlines, currently near 108.40 and 105.50, respectively, have supported pullbacks well over the last seven months. The stock’s long-term ten-month moving average (currently near 97) has provided strong support as well. Reynolds American has not closed a month below this trendline in 2-1/2 years.

"Reynolds American’s short interest has risen sharply over the last four months. Over that time it’s up nearly 44%. It now stands at just under 13.7 million shares. That comprises a big 9.3% of the stock’s float. At the stock’s average daily volume of about 650,000 shares, it would take more than 21 days to cover these shorted shares. This combination could provide the fuel needed to spark a substantial short-covering rally, especially on any good news.

"Option players are also pessimistic. For all near-term Reynolds American options, there are more than three open put contracts for every open call contract. An unwinding of this bearish configuration could also have a positive effect on the stock. According to Zacks, of the eight analysts who cover the stock, four have ‘hold’ ratings on it and one maintains a ‘sell’ rating. This leaves ample room for fresh positive coverage or brokerage upgrades to help the shares.

"One concern might be the litigation surrounding the tobacco industry. However, a firm stop-loss just 11% below the shares current price should protect from significant losses. Also, most of the recent court rulings have been favorable for the industry. We consider the stock a buy at a maximum entry price of $112.50 or less for a target of $139 a share. Additionally, at its current price, Reynolds American’s $1.25 per share quarterly dividend amounts to a 4.5 percent annualized dividend yield."

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