Sector Q&A

1/5/2009


Q You recommend a lot of technology stocks. Why are you so high on the sector?
A On a fully invested basis, technology accounts for 36% of our Buy List and 27% of our Long-Term Buy List. Technology dominates our lists for several reasons. First, the group boasts solid all-around Quadrix scores. The average tech stock in the S&P 1500 earns an Overall score of 58, with above-average scores for Momentum, Value, Quality, and Financial Strength. Second, many firms have carved out strong niches, translating into superior profit margins and competitive advantages. Third, the tech sector is generally characterized by rock-solid balance sheets and healthy cash flow.

Recommendations: IBM ($81; IBM) and Harris ($36; HRS) represent standout tech picks. Both stocks are Focus List Buys and Long-Term Buys.

Q Oil prices are very low. Why should I be interested in energy stocks?
A Crude oil sells for $39 a barrel, a far cry from the all-time high of $145 set in July. In addition, prices for both natural gas and coal have retreated in recent months. In our view, the pullback has unfairly punished energy stocks. To be sure, escalating fears of a massive slowdown in global economic growth have weighed on profit prospects. But the long-term story remains intact: Growth in demand for oil should outstrip new supply. Moreover, many stocks are trading near historic lows and earn outstanding Quadrix scores. The 89 energy stocks in the S&P 1500 Index average a trailing P/E ratio of seven, suggesting expectations of lower oil prices are already reflected in share prices.

Recommendations: Two of our favorite energy stocks are Oceaneering International ($28; OII) and Transocean ($46; RIG). Both stocks are Focus List Buys and Long-Term Buys.

Q Industrial stocks were hit hard last year. Will operating results be strong enough to fuel a rally?
A Worries about the severity of the U.S. economic slowdown are weighing on industrial stocks. While fears of a prolonged recession have lowered expectations, the news isn’t all bad. Overall, order backlogs remain in decent shape and should drive sales in the year ahead. And many companies have strengthened cost controls to sustain profit margins. Meanwhile, the average industrial company is expected to post less than 1% per-share-profit growth for 2009 — a figure that seems conservative. Finally, P/E multiples seem too low, based on abnormally depressed earnings and profit margins.

Recommendations: Two industrials to consider include Manitowoc ($8; MTW), a Focus List Buy, and General Dynamics ($55; GD), a Buy. Both are Long-Term Buys.

Q Health-care stocks have been surprisingly volatile, yet you increased your stake in the group in recent months. What gives?
A Often viewed as defensive, the health-care sector’s returns have been anything but steady — the average health-care stock in the S&P 1500 is down 30% over the past year. The presidential election clipped several industries, particularly managed care, because of concerns about reimbursement rates. Meanwhile, many drug stocks have been hurt by stringent regulatory processes and thin product pipelines.

Despite the volatility, we still like the group. Looking ahead, biotech firms should benefit from product launches and merger activity. In addition, big drugmakers can bolster profits by acquiring biotech companies. Finally, medical-device makers, which are less sensitive to reimbursement issues, should deliver decent growth.

Recommendations: Three health-care names capable of delivering solid growth are Biogen Idec ($47; BIIB), a biotech firm focused on treatments for non-Hodgkin’s lymphoma and multiple sclerosis; medical-device maker St. Jude Medical ($31; STJ); and drug and device giant Johnson & Johnson ($58; JNJ). All three stocks are Focus List Buys and Long-Term Buys.


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