Practicing What I Preach

9/28/2009


Looking back at my July 27 column on this page, it occurred to me that some of you may wonder if I practice what I preach. In particular, my conclusion that a stock should be sold if it does not qualify as a buy may have raised some questions — like how can I call Cognizant Technology ($39; CTSH) a buy when it is up 118% this year, or why do I recommend GameStop ($26; GME) when it never goes anywhere?

To answer such questions — and hopefully shed some light on our stock-picking approach — the paragraphs below review the outlook for several Buy List recommendations about which you may have questions. On pages 1 and 6, two additions to our Buy List are profiled.

Laboratory Corp. ($67; LH) is being dropped from the Buy List, as the stock no longer ranks among our top picks for 12-month gains. Based on LabCorp’s quality, defensive appeal, and 36-month potential, the provider of medical testing services remains on the Long-Term Buy List. The stock’s Overall Quadrix® score has dropped to 80, down from 90 on July 31, because of sharply lower scores for Earnings Estimates and Performance. Analysts have been cutting profit estimates for the September and December quarters, and consensus forecasts now call for less than 5% year-to-year growth for both quarters. Over the long haul, we expect market-share gains and new tests to sustain LabCorp’s impressive record of growth.


At 23 times expected 2009 earnings and 21 times expected 2010 earnings, Cognizant is no longer cheap. But the stock trades roughly in line with its three-year average price/earnings ratio, and the PEG ratio (forward P/E to expected five-year growth) is still lower than that of most U.S. stocks. Moreover, the company seems well-positioned to exceed consensus expectations over the next several quarters. The Overall Quadrix score is 98, and the stock earns the maximum of 100 for both of our sector-specific scores. While we don’t want to overstay our welcome in this high-flying stock, a move to $45 seems achievable over the next six months.


GameStop has been our worst new recommendation of 2009, dropping about 20% since its April addition to the Buy List. Since then, the video-game retailer has posted a disappointing quarter and lowered its full-year earnings guidance. Meanwhile, worries about the advent of Internet-delivered games have escalated. Normally, such disappointments would send us to the exits, but several factors suggest GameStop deserves one more chance. First, consensus estimates have dropped to levels that seem achievable. Second, makers of video-game consoles have cut prices to spark growth — historically a bullish development for game sales. Third, game sales proved more vulnerable to recession than many anticipated, so a rebounding economy should help GameStop regain its sales momentum. Finally, the stock is cheap, with a trailing P/E of 11.


DirecTV ($27; DTV) missed consensus profit estimates for the March and June quarters, and the stock has been choppy because of restructuring developments and takeover speculation. Once the company completes its merger with Liberty Entertainment ($31; LMDIA), expected sometime in October, many analysts expect AT&T ($27; T) to acquire the combined company. While such a deal makes strategic and financial sense, DirecTV has considerable appeal on a stand-alone basis. Recent profit disappointments reflect stronger-than-expected customer additions, which tend to crimp margins in the near term. Cash flow and free cash flow have shown solid growth, and share repurchases seem likely if DirecTV is not acquired. At 12 times expected 2010 earnings, the stock represents an attractive value.


Johnson & Johnson ($61; JNJ) has been a lackluster performer, reflecting sluggish results and Wall Street’s recent preference for more speculative names. The stock’s Overall Quadrix score has dropped to 83, with below-average scores for Earnings Estimates and Performance. While the stock may lag in the near term if the market remains in rally mode, J&J seems capable of a move to $72 over the next 12 months. The consensus forecast of 8% per-share-profit growth in 2010 seems achievable. If the 2010 consensus profit forecast of $4.89 is met and the stock’s P/E returns to the five-year norm of nearly 17, the stock would trade at $82.


Oracle ($21; ORCL) posted somewhat disappointing August-quarter results, and delays in its pending acquisition of Sun Microsystems ($9; JAVA) are leading to customer defections. While Oracle is not our favorite technology name on the Buy List, the stock seems capable of a move to $25 or $26 over the next 12 months. The stock trades at less than 14 times the consensus per-share-profit estimate of $1.53 for the year ending May. Over the last three and five years, the stock’s average trailing P/E has exceeded 20. A speedy return to such a lofty valuation seems unlikely, but Oracle seems undervalued considering its track record, cash flow, and exposure to a rebound in technology spending.


NII Holdings ($31; NIHD) has among the lowest Momentum and Earnings Estimates scores of the stocks on our Buy List. But recent unfavorable profit comparisons reflect adverse currency translation. On a constant-currency basis, operating income increased 32% on a 19% revenue gain in the June quarter. Customer growth has held up surprising well, with growth of 23% for the 12 months ended June. The stock, trading at a modest 12 times expected 2010 earnings, seems capable of reaching $38 over the next 12 months.

OUR BUY LIST REVIEWED
—— Price Change ——
Company (Price; Ticker)
Comments
3
Months
(%)
6
Months
(%)
Trailing
P/E
Yield
(%)
Quadrix
Overall
Score *
Key Risk
Accenture ($37; ACN)
15
19
14
1.4
94
Consulting weakness
Stock seems undervalued considering outsourcing prospects
Aflac ($43; AFL)
40
103
10
2.6
91
Investment losses
Core insurance business solid, yet stock still bargain-priced
AmerisourceBergen ($22; ABC)
18
39
13
1.1
93
Health-care reform
Appealing blend of operating momentum and defensive business mix
AstraZeneca ($46; AZN)
5
36
8
4.6
98
Generic competition
Decent product pipeline suggests stock is overly cheap
Biogen Idec ($51; BIIB)
(3)
1
14
0.0
95
Tysabri side effects
Decent product pipeline has been overshadowed by Tysabri
BMC Software ($39; BMC)
12
27
16
0.0
94
Sluggish orders
Unique niche in growing markets points to continued profit growth
CA ($22; CA)
30
34
14
0.7
93
Management change
Solid grower, with modest expectations and attractive valuation
Cognizant Tech. ($39; CTSH)
53
80
24
0.0
98
Valuation stretched
Outstanding grower capitalizing on outsourcing trend
Comcast ($17; CMCSA)
25
31
15
1.6
97
Internet TV
Undervalued considering strong cash-flow trends
CVS Caremark ($36; CVS)
16
31
14
0.8
91
Acquisitions
Steady grower trades at discount to drugstore and PBM peers
DirecTV ($27; DTV)
20
23
22
0.0
85
TV via Internet
Superior television product keying robust customer growth
Dolby Laboratories ($40; DLB)
6
18
18
0.0
92
Consumer slowdown
Seems likely to continue exceeding consensus profit expectations
GameStop ($26; GME)
15
6
11
0.0
79
Games via Internet
Results likely to improve in near term, and stock very cheap
General Dynamics ($64; GD)
10
63
10
2.4
96
Military cutbacks
Business jets rebounding, yet stock still very cheap
Hewitt Associates ($36; HEW)
18
31
14
0.0
95
Double-dip recession
Leveraged to global recovery, and profit margins rising
Hewlett-Packard ($47; HPQ)
25
62
13
0.7
94
Rising competition
Well-managed, with impressive market-share gains
Hospira ($44; HSP)
27
71
16
0.0
92
Product setbacks
Strong results, and likely to benefit from health reform
IBM ($122; IBM)
14
32
13
1.8
89
Rising competition
Reliable profit grower seems undervalued
Johnson & Johnson ($61; JNJ)
9
21
14
3.2
86
Generic competition
Steady grower trades at big discount to its historical norms
National Oilwell ($44; NOV)
26
48
9
0.0
94
Drop in oil prices
Stock very cheap for industry leader in growth market
NII Holdings ($31; NIHD)
58
103
17
0.0
84
Currency swings
Stock still cheap considering underlying growth
Oceaneering Int'l ($60; OII)
27
65
17
0.0
93
Drop in oil prices
Not cheap, but well-positioned for profit growth
Oracle ($21; ORCL)
6
35
15
0.9
91
Rising competition
Well-positioned for rebound in technology spending
Precision Castparts ($103; PCP)
25
72
14
0.1
90
Aerospace downturn
Improving profit outlook points to further upside for shares
Stryker ($47; SYK)
16
41
16
0.9
95
Health-care reform
Very cheap versus history, and growth likely to rebound
Transocean ($87; RIG)
13
47
6
0.0
93
Drop in oil prices
Leader in deepwater drilling trades at discount valuation
*Quadrix scores are percentile ranks, with 100 the best.

 


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