Going Beyond The Numbers

2/16/2009


Readers often ask how we select stocks.

Many of the characteristics we consider important are popular with many investors, including growth, valuation, and earnings-estimate trends. Our Quadrix® stock-rating system distills such factors into a single score that is simple to interpret. But we can’t just buy all the high Quadrix scorers. With more than 4,000 stocks in our research universe, more than 800 stocks earn scores above 80.

We use individual company analysis to identify the very best options among high-scoring stocks. And we don’t necessarily dump a stock when its Quadrix scores fall if it still has excellent investment appeal, especially if the stock helps diversify a portfolio.

What makes one stock more appealing than another with a similar (or higher) Quadrix score? Factors that a quantitative system like Quadrix cannot measure. For instance, while St. Jude Medical’s ($36; STJ) Quadrix scores have dipped in recent weeks, the stock still looks good. Its focus on heart-related ailments, the type that even cash-strapped consumers cannot afford to leave untreated, has historically provided a strong — and defensive — stream of cash flow. And while consumer stocks have been pounded in recent days, DirecTV ($22; DTV) seems poised to deliver continued strong results despite the economic slowdown. Recreational spending may decline, but consumers seem loath to give up their satellite TV.

The Focus List contains our top selections for 12-month gains. Since its inception in 1994, the Focus List has gained 139.4% on a fully invested basis, versus 79.9% for the S&P 500 Index. The Focus List is up 4.1% this year, versus an 8.4% decline in the S&P 500.

At the moment, the Focus List contains 11 stocks. Most have appeal in several areas, as shown in the table below. Three of our top selections are discussed below.

Outsourcing accounts for 40% of Accenture’s ($32; ACN) sales and should provide a steady revenue stream during the economic downturn. The $50 billion-a-year offshore outsourcing business could grow 10% in 2009 — slower than in years past, but still attractive relative to other businesses. Technology budgets will likely contract this year, driving companies to save costs by outsourcing.

The outsourcing businesses faces both economic and competitive pressure, especially in India. But large, multinational players like Accenture should weather the storm better than most. With a retention rate above 90%, Accenture has given no sign that clients are canceling contracts.

Accenture seems likely to pick up defectors from Satyam, the Indian consultant caught cooking its books. While other Indian companies seem sensitive about appearing too eager to poach Sataym’s clients and employees, an aggressive push by Accenture could advance its market share.

Accenture enjoys a sterling balance sheet with $2.80 billion in cash and virtually no debt. Operating cash flow rose 36% in the past 12 months, while free cash flow jumped 53%. Wall Street expects per-share earnings to rise 6% in the year ending August. Accenture is a Focus List Buy and a Long-Term Buy.


Airgas’ ($37; ARG) diverse mix of specialty gases, dry ice, and safety equipment has provided some shelter from economic weakness. That breadth of products helps customers manage and simplify their supply chain, often an area of focus during downturns. Airgas services a similarly broad client base. In the December quarter, per-share profits rose 13%, helped by higher operating profit margins.

Organic revenue growth may slow in the year ahead, but recent acquisitions should help Airgas boost the top line. Since April, Airgas has purchased 13 companies with annual sales totaling $200 million, about 5% of Airgas’ yearly revenue. Acquisitions — more than 350 in the past 25 years — have helped Airgas gain ground in the fragmented packaged-gas industry.

Airgas shares, down 25% in 2008, held up better than many peers, as the Dow Jones U.S. Chemicals Index slumped 44%. Wall Street expects profits to slip 3% to $0.74 per share in the March quarter but still be up 18% for the fiscal year ending March. Airgas is a Focus List Buy.


Declines in oil prices and expected oil consumption have battered Oceaneering International ($34; OII) shares in recent months. In the world of deepwater drilling, oil’s short-term price volatility has modest effect on rig contracts that average six years in length. Oceaneering provides equipment for deepwater drilling and owns 34% of the global fleet of remotely operated vehicles (ROVs) that operate underwater.

As shallow-water oil reserves get depleted, oil companies move further offshore. More than 400 deepwater oilfields are being evaluated or developed — twice the number currently in production. About 20 new floating rigs are expected to come online this year. In 2008, the spread between the supply and demand of floating rigs hit a nine-year low, and those tight supplies are keeping rig lease rates high. Despite oil’s current price of less than $40 per barrel, there’s decent momentum in the deepwater drilling market.

Yet 2009 expectations for Oceaneering seem unduly low. The consensus forecasts roughly flat per-share profits in 2009. In February, the company set a profit target of $4.00 per share, assuming oil sells at $70 per barrel. Oceaneering is slated to report December-quarter earnings Feb. 18 — Wall Street expects per-share growth of 15%. Oceaneering is a Focus List Buy.

FOCUS LIST
Estimate-Momentum
————— Factors —————
—————— Growth Factors ——————
———— Value Factors ————
No. of Estimate
Increases
— Last Month —
Quadrix
Earnings
Estimates
Score
Company (Price; Ticker)
12-Mo.
Sales
Growth
(%)
12-Mo.
EPS
Growth
(%)
Est. EPS
Growth,
Next Yr.
(%)
Quadrix
Momentum
Score
Trailing
P/E
Ratio
P/E Over
Industry
Avg.
Quadrix
Value
Score
Curr.
Qtr.
Curr.
Year
Quadrix
Overall
Score
Accenture ($32; ACN)
15
34
9
75
11
0.7
60
0
1
85
97
Consulting and outsourcing save customers money and should remain in demand during recession.
Airgas ($37; ARG)
17
27
(2)
59
12
1.0
60
1
3
32
77
Many of company’s gases are staples difficult for customers to cut, and tank rental provides solid, steady cash flow.
Biogen Idec ($51; BIIB)
29
25
9
94
14
0.8
47
5
6
99
96
Biogen has a robust drug pipeline, and demand for multiple sclerosis treatments is not likely to flag.
DirecTV ($22; DTV)
14
15
24
87
17
0.9
40
3
3
48
89
While consumers have cut back on pricey entertainment spending, they don’t seem to be giving up their satellite TV.
Harris ($43; HRS)
17
20
11
76
12
0.7
53
0
0
84
91
U.S. and foreign militaries keep ordering Harris radios, and the company should also benefit from the move toward digital TV.
IBM ($93; IBM)
5
25
9
74
10
1.0
55
5
15
73
89
Surprisingly strong December-quarter results suggest IBM’s broad business base is recession-resistant.
John. & John. ($57; JNJ)
4
10
8
52
12
0.9
39
1
0
42
67
Giant operates 3 businesses — drugs, medical devices, and cons. health products — not too sensitive to economic slowdowns.
NII Holdings ($19; NIHD)
40
32
(16)
87
7
0.4
91
1
1
31
90
NII’s Latin Amer. markets are enjoying strong growth in wireless telephony, and is among the most profitable firms in each market.
Oceaneering ($34; OII)
21
17
(2)
62
10
1.6
62
1
1
29
87
Oilfield-services stocks look oversold, and expectations for Oceaneering appear unduly low.
St. Jude ($36; STJ)
15
20
14
55
16
0.8
25
6
12
70
60
Focus on heart-related ailments represents a defensive business strategy likely to keep generating steady cash flows.
Transocean ($59; RIG)
109
26
3
66
4
0.9
90
3
1
34
93
Stock is priced as if the world’s oil cos. had stopped drilling. But drilling continues, and RIG should top lowered expectations.
Notes: Quadrix scores are percentile ranks, with 100 the best. Industry averages exclude P/E ratios below 0 or over 75.

 


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