Stick to the basics

9/22/2008


We are living in interesting times. Whether this amounts to a curse or an opportunity has yet to be determined, but there is no denying the impact on stock-market volatility.

Over the last 100 days, the S&P 500 Index has averaged a daily decline of 0.13%, with a standard deviation of 1.36%. By definition, two-thirds of daily returns have been within a gain of 1.23% and a decline of 1.49% — a range considerably wider than what prevailed from 2004 to mid-2007.

While such volatility can frazzle the nerves of even the most experienced investors, history provides some time-tested coping mechanisms:  

First, don’t let Wall Street’s short-term focus distract you from your long-term goals. Do you expect the stocks in your portfolio to be considerably higher over the next 12 months and beyond? If so, you should not let the latest bad headline scare you into selling.

Second, hold some cash in reserve, and be prepared to raise more cash if needed. On Sept. 15, the Industrials closed below a significant July low. A close below 4,653.13 in the Transports would represent a bear-market indication — and a reason to raise more cash.

Third, focus on the basics. Don’t speculate on rumors or bargain-hunt amid troubled companies. Instead, look for companies with consistent growth, strong finances, and improving profitability.

To create a portfolio of all-weather stocks, we screened for companies that should make investors feel comfortable. All 14 stocks listed below have a standard deviation lower than that of the average S&P 500 stock. All have delivered per-share-profit growth for at least five consecutive years and have seen return on equity rise over the last three years. All have modest debt levels and operating cash flow higher than operating income. Lastly, all 14 earn a Quadrix® Overall score of at least 65, ensuring they are solid in a number of areas.

Five of the stocks in the table on page 5 are reviewed in the following paragraphs:

An aggressive acquisition strategy — more than 350 companies in the last 25 years — has helped fuel Airgas’ ($56; NYSE: ARG) growth. The packaged-gas industry is highly fragmented, populated with small, regional firms. Airgas, the largest independent distributor, controls more than 20% of the market. With about 900 locations in 44 states, Airgas can serve national customers that rivals cannot satisfy. The company has a track record of successfully integrating its purchases and will likely keep making acquisitions.

While acquisitions remain a key strategy for Airgas, internal growth has also been solid, helped by strength in the energy and metal-fabrication end markets. Airgas uses a number of distribution channels, and its specialized sales force has expertise in engineering and chemistry. Both of those factors give Airgas a competitive edge.

In recent quarters, Airgas has been expanding its product line, particularly targeting the health-care and food industries. Operating profit margins have expanded by more than three percentage points over the last three years. Further margin expansion is possible as Airgas works to cut costs and boost operating efficiency through improved cylinder maintenance and better management of trucking logistics. Airgas is a Buy.


Energen ($48; NYSE: EGN) operates in two markets. Energen Resources produces natural gas, and the utility Alagasco distributes natural gas to about 450,000 customers in Alabama. Energen Resources has accounted for most of the company’s profit growth in recent years, but Alagasco provides a fairly stable stream of revenue and cash flow that helps fund production projects.

Production rose a modest 3% in the six months ended June, but natural-gas fields in North Louisiana and East Texas should boost production in the second half of the year. Energen hedges its production to protect against volatility in energy prices. At the end of June, Energen had hedged about 75% of the production expected in the second half of 2008 as well as roughly 60% of estimated 2009 production.

Alagasco results have been weak in recent quarters, as high energy costs have sparked customers to use less gas. But the utility operates in a favorable regulatory environment and is allowed to earn a higher-than-average return on equity of around 13%. Consensus estimates project per-share-profit growth of 5% this year and 17% in 2009, and Energen seems capable of double-digit annual profit growth over the next five years. Energen is a Long-Term Buy.


Exxon Mobil ($76; NYSE: XOM) generates enough cash flow to fund increases in capital spending while also returning cash to shareholders via stock buybacks and dividends. In the June quarter, operating cash flow increased 36% to $13.42 billion. Exxon’s cash balance rose 16% to $38.97 billion, or $7.40 per share. In the six months ended June, Exxon distributed $20 billion to shareholders through dividends and stock repurchases, an increase of 12% from the first half of 2007.

The oil giant has a track record of delivering above-average returns on invested capital. With production projects under development around the globe, including in the Gulf of Mexico, the Middle East, West Africa, Russia, and Norway, Exxon seems capable of replacing mature assets over time and boosting production. In the first half of 2008, capital expenditures jumped to $12.5 billion, up 35% from the year-earlier period. The company is increasing its capital investment, planning to spend $25 billion to $30 billion annually on capital projects over the next five years. Exxon Mobil is a Long-Term Buy.


Hewlett-Packard ($48; NYSE: HPQ) operates six diverse business segments: personal computing, imaging and printing, enterprise storage and servers, services, software, and financing. While some units have been stronger than others, all six units grew revenue in the July quarter. H-P generates 68% of revenue from international markets, and strength overseas has offset weakness in the U.S. In the July quarter, revenue in the emerging markets of Brazil, Russia, India, and China combined to jump 24% and generate 10% of total sales.

In August, H-P completed its acquisition of technology-services firm Electronic Data Systems for $13.9 billion. H-P plans to cut about 24,600 jobs in connection with the deal, taking a $1.7 billion charge this year but saving roughly $1.8 billion annually. The deal significantly expands the company’s services business, giving H-P the scale to better compete with industry leader IBM ($116; NYSE: IBM). Hewlett-Packard is a Buy and a Long-Term Buy.


Laboratory Corp. of America ($73; NYSE: LH), the nation’s second-largest independent clinical laboratory, operates a national network of 37 full-service labs and more than 1,600 patient-service centers. LabCorp often acquires smaller regional competitors to extend its reach in this highly fragmented industry.

Services include a range of clinical tests performed on behalf of physicians, hospitals, and managed-care organizations. In recent years, the company has expanded into such new areas as genetic and cancer testing. Such esoteric testing accounts for more than a third of LabCorp’s revenue. This high-growth market requires specialized equipment and expert technicians — and commands premium prices.

Strong testing volumes and higher prices have driven solid results in recent quarters. Revenue increased 10% in the first half of 2008, while per-share profits rose nearly 16% excluding special charges. Tight cost controls should help fatten profit margins, and more improvements to operating efficiency are in the works. In July, LabCorp shares fell after the company lowered its 2008 profit target. But consensus estimates project solid per-share-profit growth of 10% in 2008 and 12% in 2009, targets the company should be able to meet or exceed. Trading at 15 times estimated year-ahead profits, LabCorp is a Buy and a Long-Term Buy.

ALL-WEATHER STOCKS
All 14 stocks below have grown per-share profits for five straight years. All have decent profit-growth potential, clean balance sheets, good cash flow, and low or below-average risk as measured by our proprietary Risk Rating.
12-Month
—— Growth ——
—— Est. EPS Growth ——
Company (Price; Ticker)
Trailing
P/E
Ratio
Sales
(%)
Earnings
Per
Share
(%)
Current
Fiscal
Year
(%)
Next
Fiscal
Year
(%)
Next
5 Yrs.
(Ann.)
(%)
LT Debt
as % of
Capital
(%)
Quadrix
Overall
Score
Standand
Deviation
of Monthly
Returns
(%)
Risk
Rating
Advice
Accenture ($37; ACN)
15
20
34
35
10
14
0
95
5.7
Below Avg.
Focus
Buy †
Airgas ($56; ARG)
20
26
35
27
15
15
50
90
7.3
Below Avg.
Buy
Disney ($33; DIS)
14
6
22
21
6
12
25
76
5.1
Below Avg.
LT Buy
Energen ($48; EGN)
11
8
5
5
17
11
33
78
6.6
Low
LT Buy
Exxon Mobil ($76; XOM)
9
27
18
28
7
10
6
94
5.5
Low
LT Buy
Hewlett-Packard
($48; HPQ)
14
12
27
23
12
14
15
94
6.1
Below Avg.
Buy †
IBM ($116; IBM)
14
10
27
24
10
11
43
86
5.3
Below Avg.
Focus
Buy †
Laboratory Corp. of
Amer. ($73; LH)
16
11
13
10
12
14
35
69
5.7
Low
Buy †
Lockheed Martin
($112; LMT)
15
6
22
9
9
12
29
90
4.9
Low
Focus
Buy †
Microsoft ($26; MSFT)
14
18
32
15
12
11
0
95
6.2
Below Avg.
Buy †
PepsiCo ($73; PEP)
21
14
10
11
11
11
27
74
3.6
Low
Buy †
Questar ($45; STR)
13
16
25
30
6
9
44
90
7.1
Low
LT Buy
St. Jude Medical
($43; STJ)
20
16
31
25
13
15
6
90
6.8
Below Avg.
Focus
Buy †
United Technologies
($63; UTX)
13
13
15
16
11
12
26
93
4.3
Low
Buy †
Notes: Quadrix scores are percentile ranks, with 100 the best. Standard deviations reflect five years of monthly returns. † Also qualifies as a Long-Term Buy.

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