A Stock for the Dry Season

05/18/2010 1:00 pm EST

Focus: STOCKS

James Stack

President, Stack Financial Management

James Stack, president of Stack Financial Management and editor of InvesTech Research, likes a health care-related stock, which he thinks will outperform in a weak season.

Up to this point, the early bull market sector leadership that emerged shortly after the market bottom last year has continued. Cyclical sectors have led the market, with particularly strong performance in the consumer discretionary and industrial groups. While the nondiscretionary or defensive sectors—including health care, staples, and utilities—have also moved higher, they have lagged the index.

[But] leadership tends to change considerably between the winter period (November through April) and the summer months (May through October). Cyclical sectors tend to dominate November through April; performance over the past six months lines up well with historical precedent.

If you’ve watched an emergency room or crime investigation TV show, you’ve probably encountered the type of equipment made by Waters, (NYSE: WAT), a worldwide leader in the analytical instrument industry.

The company manufactures leading-edge liquid chromatography and mass spectrometry instruments used to separate and identify chemicals. As part of the health care sector, Waters derives more than half its revenue from companies that use its equipment to identify new drugs, develop manufacturing methods, and assure the quality of new medicines.

The diversity of its customer base increases the attractiveness of this stock, [however] Waters instruments support safety and compliance needs for analyzing air and water, chemical and consumer products, and food and beverages (such as the heightened need for melamine testing last year).

About 69% of sales come from international markets, providing a hedge in a weaker US dollar environment. And service contracts, which account for about one-third of the business, add resiliency to the company with a recurring source of income.

Even with the impact of the global recession, [its strong record of earnings growth] trend continued. Through both 2008 and 2009, the company generated strong cash flow and higher earnings. And now, with the first quarter of 2010 under its belt, management has already increased its revenue and earnings per share guidance for the year.

The stock is now [around 20%] above our initial purchase price while the Standard & Poor’s 500 is under water with a -8% return over the same time period.

Waters continues to look attractive. While the valuation metrics of the company are not as compelling as one year ago (most are near median levels now), the firm’s solid growth prospects should support further gains in this stock.

The expanding generic drug market presents an excellent opportunity to increase the number of customers using Waters equipment, and current indications are that an instrument replacement cycle may be on the horizon. Also, there certainly will be continued interest in testing the purity of the air we breathe and the water we drink.

Waters [is] a seasonally strong health care stock with fair valuations and excellent growth prospects amid rising global demand. (It closed Monday above $68—Editor.)

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