10/08/2004 12:00 am EST
Drawing on a history of integrity dating back to 1860, Standard & Poor’s currently uses a team of 65 analysts to cull through some 1,250 stocks. Here, director of equity research,Stephen Biggar, looks their latest favorites - all stocks receiving their highest 5-star rating.
"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, then derive an intrinsic value and compare that to the current stock price. Second is relative value. This is assessing the security's relative value plus financial ratios across peer groups. In other words, what you might use for financial ratios for financial companies, are verydifferent than what you would use for telecoms, or utilities, or other industries. Third 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. The average annual return for 5 stars over the last 17 years has been 15.9% per year.
"Amgen (AMGN NASDAQ) is a large cap company. It is the world’s largest biotech company with treatments in several areas. We consider it undervalued based on very strong and protected earnings growth, an under-appreciated product pipeline, and a reasonable p/e based on their growth rate and that of their peers. They recently launched Enbril for psoriasis. We expect strong demand for the product. The firm history shows a very strong product pipeline and we think that will continue.
"Anhueser-Busch (BUD NYSE) is the world’s largest brewer. They also have entertainment operations. They are very targeted and are focused on demographic sweet spots that will lead to increased beer volume and market share gains. Market share is already about 50%. They’ve also had very successful promotional campaigns and are experiencing a very strong pricing environment right now. They have very consistent earnings and dividends, and sustainable cash flow growth. The company earns an A+ earnings quality ranking.
"BJ Services (BJS NYSE) is a large cap company that provides petro pumping and other oilfield services to the petroleum industry. Its customers are large oil firms. There is rising demand for pressure pumping services, and continued high capital spending by oil and gas producers. They are benefiting from higher crude oil prices. We do expect oil prices to come down a bit, but we expect prices to stay at historically high levels. We think the stock's premium multiple is warranted based on its much higher return on equity than its peers and also its market leadership position.
"In the consumer staples area, we like Chattem (CHTT NASDAQ), a small cap manufacturer of nationally-branded health and beauty care products. They are seeing strong sales from topical analgesics, one of their primary product lines, with such products as Gold Bond and Selsun Blue, and they have new product introductions in this area. The firm has some of the highest profit margins in the consumer staples sector. The shares trade at 17 times estimates, which is about a 17% discount to its peers, despite its leading market position and strong margins.
"FMC Corp. (FMC NYSE) is a mid cap company. It is a diversified maker of industrial specialty and agricultural chemicals used for insecticides and crop protection. It’s also the leading maker of hydrogen peroxide. Operating earnings are up about 65% for 2004. They did have a restructuring charge in the prior year, so its somewhat of an abnormal gain. We see strong pricing in agricultural chemicals. We are seeing a cyclical recovery in areas such as soda ash and phosphorus. The firm is generating very strong free cash flow growth and that cash is being targeted to debt reduction.
"In the consumer discretionary area, we like Guitar Center (GTRC NASDAQ), another small cap. It is one of the leading US retailers of guitars, amplifiers, and other musical instruments. We see them benefiting from gains in market share. This is a very fragmented industry. The top five retailers in the industry only hold 26% of the market share, so there is quite a bit of room for growth there. Organic growth is benefiting from 16 to 18 new stores, coming off a base of 130 stores. We also see high single-digit same-store growth. Sales are also benefiting from additional product offerings such as music lessons.
"Landstar (LSTR NASDAQ) operates a family of truckload carriers. This small cap company uses independent drivers and commissioned sales agents, rather than actually investing in the fixed assets themselves. They compensate the drivers with a percentage of revenues generated per load rather than at a fixed rate per mile that you would get if you owned the equipment. We see the strong pricing environment continuing. There is tight capacity out there for the transportation industry. It is a strong cash flow generator with a strong balance sheet, with lots of cash on hand and low long term debt levels.
"In the technology area, Qualcomm (QCOM NASDAQ) develops products in CDMA – code division multiple access – digital wireless technology. Wireless telcom is in a very strong uptrend right now. There is strong global demand for the chipsets. Its key markets are China, India, Japan, and South Korea. It has a strong product mix with higher margins, license fees, and very good cost controls. As far as the financial model, this company is basically an analyst’s dream, with 33% sales growth, 35% net margins, no long term debt, and $7 billion in cash on the balance sheet.
"SCP Pool (POOL NASDAQ) is a small cap company. It is the leading supplier of swimming pool supplies and equipment. This is a play off the favorable demographics of much higher ownership and aging baby boomers. We see double-digit sales growth for the company. We also look for consolidation in a fragmented industry. There are a lot of suppliers out there, but none of them have an overly dominant position in the market. Return on equity is up to 30% for 2003, from 14% in 1997. That’s a very large gain. We are also estimated 21% free cash flow growth through 2008.
"Winnebago Industries (WGO NYSE) is also in the small cap area. It’s a maker of motorhomes used for leisure travel and outdoor recreation. It’s another play on favorable demographics. In this case there is an expansion of its target market, which is the post 50-year olds. The firm has added vehicle enhancements and high demand for luxury products will likely help pricing. We see much higher margins and return on equity, which we feel will lead to a faster and more sustainable growth rate, a higher return on equity and assets, and a premium multiple versus its peers."