Give Yourself A Better Chance To Predict The Future

1/21/2013


Anyone who questions whether investors crave certainty need only recall the market's weakness last month, as lawmakers flailed to break the stalemate over the fiscal cliff — and the market's relief after a deal was struck.

Along similar lines, investors prize earnings visibility — knowing what a company is and where it's headed. The complexity of modern corporations makes this no easy feat. But investors can use several techniques.

At some companies, management shares its own plan. Earlier this month, Celgene ($99; CELG) introduced long-term earnings and revenue targets. That guidance, along with bullish comments about the year ahead, helped boost Celgene shares to an all-time high.

For other companies, investors must connect the dots of multiple data points to sketch what the future might hold. Valuable markers include:

• Recurring sales, such as software licenses or royalties.

• Solid orders, the pipeline for future revenue.

• Big backlogs, which measure projects pending for industrial companies.

• Earnings quality, including operating cash flow greater than net income.

That last point, earnings quality, helps guard investors against aggressive — and unsustainable — accounting choices made by management to prop up earnings. Other signs that a company is growing the right way include improving operating profit margins and rising returns on equity and investment.

The S&P 500 Index, on the whole, looks good based on two measures of earnings quality. Average cash provided by operations consistently exceeds net income. And operating profit margins have steadily climbed, reaching the highest level since at least 1990.

Drilling down further, we review three stocks for which management comments and underlying fundamentals suggest the outlook is attractive.

Foot Locker ($34; FL) shares have slid 5% since the end of November, while the S&P 500 index has advanced 4%. That pessimism might reflect concerns that an increase in payroll taxes will crimp consumer spending. Not helping matters, rival Finish Line ($18; FINL) released disappointing results for the November quarter. That weakness could be specific to Finish Line, which blamed the results on problems with its e-commerce website and soft demand for running shoes, which account for a larger portion of sales than they do at Foot Locker. Finish Line's weakness could also stem from market-share losses to Foot Locker.

Analyst estimates for Foot Locker's January quarter have climbed 3% in the past 60 days to $0.72 per share, implying 31% growth on 12% higher sales. Foot Locker has a track record of managing expectations, topping the consensus profit estimate in each of the past 11 quarters.

By keeping its inventory channels lean, Foot Locker has also pushed its return on assets to the highest level in more than a decade. And here's another positive data point: For the week ended Jan. 5, U.S. sales of athletic footwear rose 13%, according to researcher NPD. That growth was paced by a 25% jump in basketball shoes, where Foot Locker has a strong presence. Foot Locker is a Focus List Buy and a Long-Term Buy.


Oracle ($35; ORCL) is navigating the brave new world of cloud computing, which lets clients run programs over the Internet and store data remotely rather than on their own servers. The cloud could endanger Oracle's revenue stream from pricey business-software packages and annual maintenance fees. But Oracle has embraced the new technology in the past 16 months, bolstering its own applications portfolio with the acquisition of about a dozen companies.

Oracle has proven adroit at tucking acquisitions into its business, with return on assets rising in each of the last nine quarters and operating profit margins rebounding since the Sun Microsystems acquisition in 2010. Moreover, cloud services are generally offered via annual subscriptions, providing yet another reliable revenue stream.

Oracle shares have climbed 27% in the past year, earlier this month reaching their highest level since May 2011, a sign of increasing investor confidence. Licenses for new software and cloud-based software subscriptions rose 12% in the first half of the fiscal year ending May 2013, positioning Oracle to deliver its 10th straight year of higher annual sales, cash provided by operations, and net income. Oracle, scoring above 60 in all six Quadrix categories and 97 Overall, is a Long-Term Buy.


Thermo Fisher Scientific ($68; TMO) sells analytical instruments and laboratory equipment for drugmakers, hospitals, and research institutions. The environment remains challenging, with many government and academic customers postponing big-ticket purchases. But market-share gains have helped support Thermo Fisher's sales growth of 5% to 15% in the past six quarters. Operating profit margins have also steadily expanded over the six-quarter period.

Thermo Fisher's most profitable segment, specialty diagnostics, drove sales growth in the first nine months of 2012. Bookings exceeded sales in the September quarter, laying the foundation for future growth. Cost benefits from a restructuring program should continue in the year ahead.

Known for its highly predictable earnings, Thermo Fisher plans to post December-quarter results Jan. 31. The consensus profit estimate of $1.28 per share has edged higher in the last 60 days, and the spread of estimates is fairly narrow, ranging from $1.21 to $1.31. Management has topped the consensus in seven of the last eight quarters. With a Quadrix Earnings Estimate rank of 81 and Overall score of 91, Thermo Fisher is a Focus List Buy and a Long-Term Buy.

STOCKS WITH EARNINGS QUALITY
All 10 of the A-rated stocks below generate quality earnings, as illustrated by operating cash flow greater than net income. All of the stocks have beaten consensus quarterly profit estimates and seen their operating profit margins widen in at least five of the last eight quarters. We also required that the highest analyst profit estimate for the current quarter be less than 20% above the lowest estimate. Stocks recommended for purchase are presented in bold.
Quadrix
Earnings
Predict-
ability
Rank
No. Of
EPS
Beats,
Past
8
Qtrs.
No. Of
Oper.-
Margin
Gains,
Past
8 Qtrs.
Return On
--- Equity ---
Operating
---- Cash Flow ----
-- Net Income --
Net
Income
As % Of
Cash Flow
Spread
Between
High, Low
EPS Est.
Curr. Qtr.
(%)
Company (Price; Ticker)
Consecutive
Quarters Of
Operating
EPS Growth
Last
12 Mos.
(%)
1 Yr.
Earlier
(%)
Last
12 Mos.
($Mil.)
Growth
(%)
Last
12 Mos.
($Mil.)
Growth
(%)
Bed Bath & Bey.
($56; BBBY)
94
11
7
6
25.9
23.6
1,264
14
1,015
10
80
7
Celgene
($99; CELG)
94
8
5
6
27.6
19.2
1,998
29
1,603
43
80
19
EMC ($24; EMC)
90
12
5
7
13.5
12.8
6,547
31
2,695
19
41
7
Foot Locker
($34; FL)
81
15
8
8
17.2
12.2
491
4
374
47
76
17
McKesson 
($102; MCK)
98
13
8
7
22.2
16.4
2,014
(31)
1,602
38
80
14
Oracle
($35; ORCL)
99
9
6
8
24.5
24.1
13,533
3
10,564
13
78
4
Thermo Fisher
($68; TMO)
97
7
7
7
7.7
6.6
2,016
35
1,090
(19)
54
8
TJX ($44; TJX)
97
11
5
6
53.6
43.3
3,165
85
1,777
31
56
3
Union Pacific
($131; UNP)
95
14
6
5
20.5
17.2
5,905
3
3,871
25
66
6
Zimmer Holdings
($71; ZMH)
95
6
7
5
13.4
10.9
1,177
5
759
19
64
5
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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