Dont let the red ink fool you

8/18/2008


All sectors of the capitalization-weighted S&P 500 Index have declined in 2008 as of Aug. 12. In the 12 months ended June, the index’s per-share profits fell an estimated 17%, not the kind of number that excites investors. But look past the index to the individual stocks, and you see a different picture.

Per-share profits for the median S&P 500 stock rose a respectable 11.4% in the 12 months ended June, meaning that half of the companies in the index topped that number and half lagged. Since the median stock in the index is down 8.6% for the year, investors can be forgiven for not noticing the solid operating momentum.

The Quadrix® Momentum score, reflecting recent growth in sales, earnings, and cash flow, has historically been effective at selecting winning stocks in most sectors of the market. Weakness in the financial stocks has attracted a lot of attention, but investors can still find momentum in many portions of the market, as shown in the chart below.

The Momentum score does not work as well during periods when weak industries rally — such as the second half of July, when financials led the market upward. But we expect Wall Street to reward stocks with operating momentum over the next year.

Adobe Systems ($46; NASDAQ: ADBE), the maker of Photoshop, Acrobat, and other publishing and design software, enjoys solid demand for its products. To accommodate the growing thirst for digital content, Adobe has broadened its product lineup with software to develop graphics-rich Internet and animation applications.

International demand has also powered growth. More than half of Adobe’s sales come from overseas, and emerging markets in Eastern Europe, Brazil, and China represent promising expansion targets.

Consensus estimates for fiscal 2008 ending November and fiscal 2009 have been trending upward and project per-share-profit growth of 21% this year and 13% next year. Adobe is a Buy and a Long-Term Buy.


Acquisitions have fueled much of Airgas’ ($58; NYSE: ARG) growth in recent years, but the company still generates plenty of momentum from existing operations. Same-store sales rose 7% in the June quarter, similar to growth in the year ended March.

Airgas, the largest independent distributor of industrial, medical, and specialty gases in the U.S., controls more than 20% of an industry populated by hundreds of small, independent firms. Over the last 25 years, Airgas has purchased more than 350 companies and now operates about 900 locations in 44 states, Canada, and Mexico. The company is likely to pursue additional acquisitions to extend its geographic reach and beef up its product lineup.

In the June quarter, Airgas grew sales 22% and per-share profits 29%, helped by strength in the energy, chemical, and metal-fabrication markets. Price increases and cuts in operating costs have helped offset higher fuel and material expenses, fattening profit margins. Airgas is a Buy.


National Oilwell Varco ($69; NYSE: NOV), which provides equipment and services to energy producers, is benefiting from increased drilling activity worldwide. The combination of strong demand and a tight global supply of drilling equipment should drive sales and profit growth.

The world’s fleet of drilling rigs is in need of modernization, as drillers have historically had trouble generating enough cash to keep their rigs up to date. Many older rigs require expensive upgrades and replacement parts to maintain their productivity. Fortunately for National Oilwell and other suppliers, today’s high energy prices have sparked a rise in rig lease rates, enabling drillers to invest heavily in equipment. National Oilwell enjoys considerable pricing power.

National Oilwell has purchased more than 50 companies over the last eight years and now controls about 60% of the market for rig equipment. On the strength of $4.2 billion in new orders during the first half of 2008, the company’s backlog reached $10.8 billion — more than a year’s revenue — at the end of June. Order trends point to strong demand and inspire confidence in consensus estimates, which call for per-share-profit growth of 33% in 2008 and 21% in 2009. National Oilwell is a Buy and a Long-Term Buy.


St. Jude Medical ($46; NYSE: STJ) has branched out beyond its original core business of mechanical heart valves into the higher-growth market for implantable cardioverter defibrillators (ICDs). The company estimates it gained two to three percentage points of global ICD market share in the first half of 2008.

Sales of ICDs, pacemakers, neuromodulation products, and devices that treat atrial fibrillation have been robust. An aging population has supported higher demand in recent years, while a slew of new products has helped St. Jude differentiate itself from rivals and gain market share. St. Jude spends aggressively on research and development, including $476 million, or 13% of sales, in 2007.

In the six months ended June, St. Jude’s sales rose 17%, while earnings excluding unusual items jumped 34%. Expect more double-digit growth in coming quarters. Spending on devices to treat cardiac ailments tends to be recession-resistant, as most products used to treat such health problems are covered by insurance. St. Jude is a Focus List Buy and a Long-Term Buy.


United Technologies’ ($67; NYSE: UTX) diverse business mix helps insulate it from downturns in any one slice of the market. But so far this year, every unit is pulling its weight. In the six months ended June, each of the company’s six divisions grew revenue and operating profits.

While concerns about a global economic slowdown have many investors worried, United Technologies credited strong construction markets overseas with driving demand for many of its products. In the June quarter, orders for elevators jumped 23%, with double-digit growth in North America, Europe, and China. Worldwide orders for heating and air-conditioning equipment also rose at double-digit rates. The company generates more than half of its revenue overseas and is expanding in such emerging markets as China and India.

United Technologies holds leading positions in most of the markets it serves. That size and global scale represent competitive advantages, allowing the company to grab market share during periods when weaker rivals are under pressure. United Technologies is a Buy and a Long-Term Buy.

MOMENTUM STANDOUTS
Quadrix
——Scores * ——
—— Change, Last Qtr. ——
Change, Last
——— 12 Months ———
Estimated
——— EPS Growth ———
Revisions To
Curr.-Qtr. Est.
—— Last Mo. ——
Company (Price; Ticker)
Momen-
tum
Overall
Sales
(%)
EPS
(%)
Cash
Flow
(%)
Sales
(%)
EPS
(%)
Cash
Flow
(%)
Curr.
Fiscal
Year
(%)
Next
Fiscal
Year
(%)
Next 5
Years
(Ann.)
(%)
No.
Up
No.
Down
Advice
Adobe Systems ($46; ADBE)
91
93
19
60
18
32
56
36
21
13
16
1
0
Buy †
Airgas ($58; ARG)
92
92
22
29
27
26
35
29
27
15
15
6
1
Buy
Apache ($104; APA)
98
100
60
126
69
48
81
49
90
6
9
11
6
Neutral
General Dynamics ($94; GD)
91
92
11
31
22
12
28
25
20
9
10
15
0
Buy †
IBM ($125; IBM)
86
94
13
33
19
10
27
23
23
11
11
12
1
Focus †
National Oilwell ($69; NOV)
90
96
39
33
30
34
53
44
33
21
23
15
1
Buy †
Schlumberger ($93; SLB)
86
91
20
14
16
18
19
20
17
24
20
16
1
LT Buy
St. Jude Medical ($46; STJ)
89
92
20
29
40
16
31
32
25
13
15
18
0
Focus †
Transocean ($125; RIG)
89
99
116
32
122
98
61
56
67
20
25
6
4
Focus †
United Tech. ($67; UTX)
87
91
13
17
12
13
15
22
16
11
12
8
1
Buy †
Waters ($70; WAT)
87
89
13
25
38
14
24
23
21
13
16
9
0
Neutral
* Quadrix scores are percentile ranks, with 100 the best.    † Also qualifies as a Long-Term Buy.

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