Upside: A Five-Pack of Favorites

06/04/2004 12:00 am EST

Focus:

Richard Moroney

Editor, Dow Theory Forecasts

"As an investor, you want to own well-managed companies with sustainable earnings growth," says Richard Moroney, whose Quadrix stock-rating system uses more than 100 variables to rank 4,200 US stocks. Here are five favorites from Upside.

"Efficient companies tend to generate more profits over time, so investing in well-managed businesses can help tilt the odds in your favor. Three tools especially useful for identifying such companies include: Operating profit margin, return on investment, and operating cycle, which measures how quickly a company turns inventory into cash. The five companies reviewed below outperform industry peers for all three metrics. All five had better-than-average operating margins, ROI, and operating cycles in their most recent quarter. In addition, all five had four-quarter averages above the industry average for each metric.

"Cost Plus (CPWM NASDAQ), a specialty retailer of casual home furnishing and entertaining products, operates 212 stores in 26 states. Investments in infrastructure should boost efficiency and spur margin expansion. At 8.3%, Cost Plus’ four-quarter average operating margin is slightly above the specialty-store average of 8.2%. In the January quarter, operating margin hit 15.6%, up from 15.3% in the year-earlier quarter. Cost Plus consistently delivers returns on investment near 12%. Steady store expansion and new business initiatives should drive near-term sales growth. Margins could trend higher over the next two to three years, fueling positive profit-estimate revisions. CPWM trades at 22 times the $1.79 in per-share profits expected for the year ending January, in line with its five-year average forward P/E.

"Electronics Boutique (ELBO NASDAQ) showed operating margins of 10.4% last quarter, compared to 7.8% for the average electronics retailer. A steady stream of new game titles should drive sales. In late March, Microsoft cut the price of its Xbox game console, the No. 2 game platform behind Sony’s PlayStation. The move should bolster near-term demand for hardware and boost software sales. For fiscal 2005 ending January, Wall Street expects per-share earnings to climb 14% to $1.93. Management is targeting sales growth of 17% to 21. Consensus profit estimates could prove conservative if game-console prices drop further in the near term. Aggressive expansion should fuel sales gains. At the end of January, Electronics Boutique had 1,528 locations, up 33% from a year earlier. At 15 times expected fiscal 2005 earnings, the shares trade well below their five-year average forward p/e of 18.

"Marine Products (MPX ASE) designs and sells recreational boats under the Chaparral and Robalo brands. Over the last four quarters, return on investment has averaged 26.6%, compared to 13.5% for the average leisure-products company. At 60 days, the operating cycle is less than one-half the leisure group average. December-quarter operating margins were 15.6%, versus 11.7% for the industry. Continued efficiency gains, coupled with price increases, should spur further margin expansion. While the stock has rallied to all-time highs, strong sales and profit growth should drive further gains. At 24 times expected 2004 earnings, the shares are not cheap. Higher interest rates and lofty fuel costs could cause buyers to delay boat purchases. But improved consumer confidence has contributed to a more optimistic outlook for near-term sales. A near-term move above $21 seems achievable given the company’s operating momentum.

"Sybron Dental Specialties (SYD NYSE) is built around two strong businesses. Ormco manufactures and distributes orthodontic products worldwide. The Kerr unit makes and markets consumable dental products, including light-curing instruments. Sybron plans to launch at least 18 new products this year. The company aggressively retired debt in 2003, and in April, Standard & Poor’s raised its credit rating. The company is also reducing the number of plants it operates, increasing production efficiency. Sybron has done a good job managing inventory, particularly in its faster-growing Ormco business. Return on investment was 12.5%, up from 8% a year earlier and above the industry average of 11.4%. Sybron is rated Buy.

"Techne (TECH NASDAQ), a leading supplier of research compounds used mainly for drug development, turned in a solid performance for the March quarter. Per-share earnings rose 17% from a year earlier. Revenue rose 13% to $43 million. Operating profit margin hit 54.2% and return on investment was 19.5%. Techne is positioned to benefit from the mapping of the human genome, as well as the targeting of significant diseases by the biotechnology industry. Product launches and improved spending by biotech companies should drive sales and profit growth. In fiscal 2003 ended June, the company launched 1,015 new products, bringing the total product count above 5,000. Techne is not cheap at 32 times trailing earnings. Still, the company warrants a premium valuation given its strong market positions and improving cash flow."

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