Three Bites At The Apple

11/3/2014


Have you ever gone to a new restaurant because a friend told you the food was great?

Most of us can answer that question "Yes." Unfortunately, recommendations don't always pan out; sometimes you hate the food. In such cases, your friend probably meant well. But because of differences in individual taste, acting on a single recommendation can leave you with an upset stomach.

The same goes for investments. Sure, we love good values, but plenty of stocks with attractive valuations look pretty bad from other directions. With that in mind, we identified the most appealing industries based on three screens:

1) Low valuations.
2) Sales and profit growth.
3) Rising profit margins.

As often occurs when we overlay screens, each one eliminates a lot of possibilities. Simply by requiring average price/earnings and price/sales ratios in the bottom half of the 66 industries, we cull the herd to 22. Our second screen (one-year growth in sales and operating earnings per share) knocked out 14 more industries, and our third screen (widening gross and operating profit margins) dropped the count to six. To see how all 65 industries performed in our screens, visit www.DowTheory.com/Go/Screens.

SCREEN FOR TOP INDUSTRIES
We put the 66 industry groups in the S&P 1500 Index through three screens. The first, a value screen, left us with the 22 industries presented below. Our growth screen knocked out 14 of those industries, then our profit-margin screen culled the herd down to just six industries. Industries that passed each screen are presented against a white background. All numbers other than company count are averages for stocks in an industry. You can find numbers for all 66 industries at
www.DowTheory.com/Go/Screens.
--- Screen 2: Growth ---
--------------- Screen 3: Profit Margins ---------------
---- Screen 1: Valuation ----
Quadrix
Momen-
tum
Score
12-Month
--- Change ---
-- Gross Margins --
Operating Margins
Industry (No. Of Companies)
Quadrix
Value
Score
Price/
Earnings
Price/
Sales
Oper.
EPS
(%)
Sales
(%)
Quadrix
Fin'l Str.
Score
Trailing
12 Mos.
(%)
Change
From 1
Yr . Ago
(%)
Trailing
12 Mos.
(%)
Change
From 1
Yr . Ago
(%)
Aerospace & Defense (29)
62
20
1.35
54
5
4
65
29
(0.1)
15
0.5
Airlines (6)
77
18
1.05
74
44
6
56
25
2.0
17
2.0
Auto Components (9)
72
16
1.34
61
27
7
68
27
1.7
15
1.7
Automobiles (5)
83
14
0.87
49
12
7
63
20
0.3
12
1.1
Chemicals (47)
62
19
1.61
49
4
3
61
34
0.1
18
0.4
Construction & Engin. (12)
72
20
0.53
33
(6)
3
57
14
(0.6)
6
(0.8)
Containers & Pkg. (13)
68
18
0.91
49
11
8
54
26
0.2
14
0.5
Distributors (4)
57
20
0.95
50
14
11
58
33
(0.2)
8
(0.5)
Divers. Cons. Svcs. (12)
58
18
1.50
43
1
(1)
59
52
(0.3)
20
0.0
Electrical Equipment (14)
59
19
1.60
43
6
8
49
33
0.0
15
0.0
Electronic Equipment (46)
67
19
1.52
56
16
8
54
34
0.2
13
0.6
Energy Equip. & Svcs. (41)
83
18
1.42
59
7
9
58
36
0.8
27
0.8
Gas Utilities (13)
63
18
1.58
57
7
19
54
24
(1.0)
23
(0.9)
Health Care Providers (47)
55
21
0.83
57
(5)
12
61
24
(0.5)
10
(0.7)
Household Durables (25)
61
18
1.26
61
26
18
65
32
0.8
12
1.3
Insurance (54)
81
15
1.32
61
22
5
59
19
1.2
17
1.4
Leisure Products (7)
61
18
1.35
41
(2)
7
53
39
(0.6)
15
0.0
Machinery (53)
63
20
1.50
55
12
4
59
35
0.2
16
0.0
Multi-Utilities (20)
59
19
1.66
59
11
10
54
26
(1.0)
26
(1.0)
Paper & Forest Prod. (11)
64
19
1.19
53
24
12
73
22
(0.7)
13
(0.9)
Specialty Retail (63)
67
20
0.93
48
(4)
5
53
38
(0.6)
11
(0.7)
Wireless Telecom Svcs. (3)
66
14
0.86
16
(43)
(3)
79
47
(3.2)
21
(4.7)
Notes: Quadrix scores are percentile ranks, with 100 the best.  Averages exclude some outliers.

The table above lists the industries that satisfied our screens. The table below lists A-rated stocks in the industries that passed all three screens, including the three profiled below:

Alaska Air Group ($53; ALK) has taken investors on a turbulent ride in recent months, buffeted by concerns about rising competition from Delta Air Lines ($40; DAL) in Seattle, Alaska's plans to boost capacity, and most recently the Ebola virus. However, the shares have jumped 13% in the five days since Alaska declared earnings, setting new all-time highs. Despite that gain, Alaska still trades at 14 times trailing earnings, 29% below the industry median.

In the September quarter, Alaska earned $1.47 per share, up 37% and $0.05 above the consensus, on 7% higher passenger revenue. Cost per available seat mile fell 3.6% excluding fuel, reflecting not just belt-tightening but also long-term changes such as retrofitting planes to carry more seats. Per-gallon fuel costs fell nearly 3%, while fuel efficiency (seat miles per gallon) rose nearly 3%, mostly because of the shift toward newer planes that use the same amount of fuel but boast a more than 10% higher seat count. Strong bookings and margin gains appear to have blunted investors' concerns about the expansion. Alaska is a Focus List Buy and a Long-Term Buy.


Halliburton ($54; HAL) and other energy stocks have taken a beating in recent months as a combination of low oil prices, generous supplies, and fears of waning demand got investors concerned about the sector's prospects. In October, Halliburton CEO David Lesar said price swings are not unusual, and that both energy producers and the energy-services industry can do just fine with per-barrel oil prices between $80 and $100. As of Oct. 28, West Texas Intermediate crude traded at $81, down 24% from the June high of nearly $108.

The company went a step further, projecting a rise in exploration-and-production spending next year, driven by higher global demand for oil and gas. Over the last 12 months, Halliburton grew sales 9% and per-share profits 32%. The consensus projects profit growth of 30% in the December quarter and 22% next year. While Halliburton may remain under pressure in the near term, we buy the company's contention that the world's thirst for oil will increase over time.

Halliburton is deploying cash in its U.S. operations, with plans to more than double its fleet of railcars and sand-terminal capacity. Drillers have reported shortages of sand, a key component of the hydraulic-fracturing (fracking) process used for shale drilling, and Halliburton's investments should improve its pricing power. Halliburton is a Buy and a Long-Term Buy.


In the September quarter, Lear ($91; LEA) posted 8% sales growth and 33% higher per-share profits, boosting profit margins along the way. Lear encouraged investors with its guidance, projecting higher margins going forward for both the seating and electrical businesses. Seating sales rose 10% on roughly flat margins, while the smaller electrical business delivered 2% sales growth but boosted operating margins to 13.3% from 10.9%. Based on total industry production, Lear's content per vehicle rose 10% to $356 in Europe and Africa and 4% to $408 in North America.

During the quarter, global vehicle production rose 3%, paced by 10% growth in China and 8% in the U.S. Demand for cars, particularly overseas, should support continued growth for Lear. Researcher IHS Automotive expects annual auto sales to top 100 million in 2018, up from 86 million this year, representing annualized growth of roughly 4%.

Despite its growth, Lear trades at 12 times trailing earnings, 29% below its peer-group median, and earns a Quadrix® Value score of 90, above the industry average of 70. Lear is a Focus List Buy and a Long-Term Buy.

OUR STOCKS IN TOP INDUSTRIES
Using three screens, we identified seven particularly attractive industry groups with the S&P 1500 Index. We follow A-rated stocks in four of those industries; companies on our buy lists are in bold.
--- Screen 2: Growth ---
--------------- Screen 3: Profit Margins ---------------
---- Screen 1: Valuation ----
Quadrix
Momen-
tum
Score
12-Month
--- Change ---
-- Gross Margins --
Operating Margins
Industry (No. Of Companies)
Quadrix
Value
Score
Price/
Earnings
Price/
Sales
Oper.
EPS
(%)
Sales
(%)
Quadrix
Fin'l Str.
Score
Trailing
12 Mos.
(%)
Change
From 1
Yr . Ago
(%)
Last
12 Mos.
(%)
Change
From 1
Yr . Ago
(%)
Airlines
Alaska Air Group ($53; ALK)
83
14
1.4
96
56
8
74
31
4.4
22
3.9
Southwest Airlines ($34; LUV)
66
19
1.3
98
87
6
71
28
5.2
16
5.2
Auto components
Lear ($91; LEA)
90
12
0.4
67
23
11
38
10
0.2
7
0.4
Magna Int'l ($98; MGA)
91
12
0.6
87
39
10
58
13
1.0
9
1.0
Energy equipment & services
Halliburton ($54; HAL)
84
14
1.5
56
32
9
60
23
1.4
21
1.5
National Oilwell ($73; NOV)
96
13
1.4
74
4
10
67
29
(0.2)
20
0.1
Schlumberger ($97; SLB)
74
18
2.7
60
22
8
82
31
10.9
27
1.0
Insurance
Manulife Financial ($18; MFC)
98
10
1.0
72
125
96
61
26
(10.4)
NA
NA
MetLife ($52; MET)
98
10
0.8
53
133
5
40
11
5.4
NA
NA
Travelers ($99; TRV)
96
10
1.2
75
35
5
78
34
3.8
23
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