CSX and IBM: Buy Here, Sell Higher

05/17/2011 5:28 pm EST

Focus: STOCKS

Charles Carlson

Editor, DRIP Investor

Just because these market leaders have done well doesn’t mean their run is done, writes Charles Carlson in the DRIP Investor.

I am not necessarily an advocate of the “buy high, sell higher” school of investing. Obviously, you want to buy low and sell high. However, judging whether an investment is “high” or “low” requires more than just a casual glance at the stock’s price relative to historical levels.

Too often, I see investors gauge a stock’s value looking solely out the rearview mirror. The thinking is that if a stock is trading around its 52-week high, the stock has already had its move and is “too high” to buy.

There are at least two problems with this investment mentality.

  • First, if you eliminate stocks simply because they have done well over the last year, you limit your opportunity set from which to find winning stocks. I hate to limit my opportunity set. I want my fishing pond as big as possible to find good stocks. In fact, I would argue that because many investors routinely avoid stocks that do well, opportunities are created in those stocks.
  • Second, avoiding stocks simply because they have done well in the past gives no credence to the future. The stock is “too high” just because it is higher than it was a day ago, a week ago, a month ago, a year ago. Whether a stock is “too high” (or, for that matter, “too low”) should be gauged not so much by where the stock has been, but where you think it can go in the future.

I typically don’t like to buy bombed-out stocks, especially bombed-out smaller companies. One reason is that such stocks tend to have bombed out for very legitimate reasons, and smaller companies that tank may not have the staying power to stick around until things get better.

Indeed, many “dirt-cheap” stocks are often “value traps”—stocks that seemingly are cheap, but get cheaper and cheaper and cheaper.

I prefer to buy quality stocks at what I think are reasonable prices—not dirt-cheap prices, mind you, but at valuations that should permit decent upside potential over the long term. Sometimes, such stocks are trading around their yearly highs. But their valuation is still reasonable, and further upside is probable.

Two stocks that fit this bill right now are CSX (CSX) and IBM (IBM).

CSX has been an outstanding performer over the last year. However, I continue to like the company’s potential. The railroad giant should continue to experience excellent operating momentum. Rail traffic remains strong, and global economic expansion bodes well for continued revenue and earnings growth.

At Tuesday’s mid-afternoon price of $73.50, the stock trades at 14 times the 2011 estimate of $5.13 per share—not cheap, but not especially pricey given the stock’s excellent prospects. Our Quadrix stock-rating system gives CSX a Value score of 63 out of 100, so the stock still scores in the upper half in terms of value.

IBM has also had a nice run and is trading at its 52-week high. The stock’s strength is probably giving plenty of investors a reason to avoid it. It shouldn’t. Trading at 13 times the 2011 earnings estimate of $13.21 per share, the stock is still reasonably priced given its expected growth. [Shares dipped below $169 Tuesday—Editor.]

And the stock’s Quadrix Value score is 69, which means IBM is still more attractively valued than two-thirds of the some 4,000 stocks in our universe.

The bottom line is that while CSX and IBM have enjoyed good gains over the last year, the stocks are still valued at levels that should afford market-beating returns for near- and long-term investors. The stocks are strong buys at current levels.

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