Bernie's Best Bets

01/20/2006 12:00 am EST

Focus:

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer has been so well-respected in the financial advisory community for so long, he hardly needs introduction. Here's his top picks for '06, based on his proprietary "expectational analysis" strategy, which combines technical, fundamental, and sentiment strategies.

"My conservative pick for 2006 is Moody's (MCO NYSE), which provides credit ratings and research and analysis covering debt instruments and securities in the capital markets worldwide, as well as credit assessment services, credit training services, and credit process software to banks and other financial institutions. The corporate bond market has been attractive of late, as credit default swaps have become a massive market among institutions, particularly the growing hedge-fund industry. Given that MCO provides analysis for this area of the market, demand for their products should continue to shine.

"Fundamentally, the company has shown excellent earnings momentum. During the past five quarters, the firm has surpassed the consensus earnings estimate on the Street by an average of around 12%. Turning to the stock's technical picture, MCO has outpaced the SPX on a monthly basis since January 2000. In fact, during this time frame, MCO soared an astounding 548% while the broad-market barometer has slipped by nearly 9%. The stock is facing long-term support at its ten-month and 20-month moving averages, trendlines it has not closed a month below since March 2000. These trendlines should continue to be supportive through 2006.

"Despite this impressive combination of fundamental and technical strength, signs of pessimism continue to plague the shares. Wall Street is giving the research firm the cold shoulder, with 90% of the analysts following MCO rating it a ‘hold’ or worse. Any upgrades or additional coverage as the firm sees its earnings grow could add to the stock's rally. Short sellers have begun to feel the pinch of the equity's impressive uptrend. While the number of shorted MCO shares has rolled over from its peak, a continued unwinding of this accumulation of bearish bets could provide the stock with ample fuel for a strong rally higher.

"My top speculative pick is Western Digital (WDC NYSE), one of the largest independent makers of hard disk drives and the second-largest disk driver maker in terms of market share. Disk-drive makers are benefiting from strong unit growth in PC sales and diversification into other consumer-related areas such as music players, digital video recorders, set-top boxes, and video game consoles. This diversification beyond the PC market is not only an engine for growth, but should also result in less earnings volatility.

"The company's September quarterly earnings of 31 cents per share surpassed the consensus estimate and grew 126% on a year-over-year basis, while revenue shot 23% higher. In addition, the firm announced in late November that it now expects earnings of 34-37 cents per share in the December quarter, compared to its previous guidance of 31-34 cents, due to better-than-expected pricing and strong demand. Furthermore, WDC has authorized an additional $150 million for share repurchases.

"Despite the company's strong earnings growth and diversification of revenues, WDC trades for a price-to-earnings ratio based on one-year forward earnings of about 11, and its market capitalization is a modest $3.2 billion. This is hardly a stock pursued by overzealous buyers. Wall Street has by no means jumped aboard the WDC bandwagon. Zacks reports that just five of the 14 analysts following the firm rate it a ‘buy,’ while seven rate it a ‘hold’ and two maintain ‘sell’ ratings. This configuration leaves plenty of room for upgrades stimulated by continued strong earnings growth and share price recovery. In fact, Bear Stearns lifted its investment rating for the disk drive group on December 2.

"Short covering represents an additional source of potential buying power for WDC, as short interest is very heavy at roughly seven times the stock's average daily trading volume and 10% of the security's total share float. While WDC shares have rallied sharply from their low under 2 in September 2001, they remain far below their all-time high of 54.75 from August 1997. Based upon the company's growth potential, its modest valuation and market cap, and the potential kicker from analyst upgrades and short covering, it is not unreasonable to expect a rally to the low 20s in 2006 for a gain of about 50% from current levels."

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