Falling Into The Right Crowd
The stock market is bright with fall blooms. The S&P 500 Index is flirting with its April high and only 10% below the high from August 2008, just before the market implosion. For the investor seeking to re-enter the market or fill a gap in his portfolio, we screened our top-ranked stocks based on:
• cash flow.
• sector leadership.
For the results of the screen, visit DowTheory.com/Go/Screen. Below, we review each category and include a favorite stock.
To uncover our favorite income play, we screened for A-rated stocks with at least 10 consecutive years of dividend increases. We focused on stocks yielding at least 2%, with payout ratios (dividends as a percentage of trailing earnings) below 50%. Finally, we required above-average Quadrix scores for Financial Strength.
Abbott Laboratories ($53; ABT) offers a high yield (3.3%) and consistent dividend growth (38 consecutive years of higher payouts). The company generated $5.10 billion of free cash flow in the year ended June, up 55%, enough to fund a steady diet of acquisitions without sacrificing dividend growth. No major patents are set to expire in the next couple years, though arthritis drug Humira (19% of sales in the nine months ended September) and HIV treatment Kaletra (4%) will lose patent protection in 2016. Abbott Labs is a Buy and a Long-Term Buy.
We looked for stocks trading at a discount to their five-year median trailing P/E ratio, as well as sector and industry medians. In addition, we required Value scores above 80.
Despite a recent jump on takeover speculation, Research In Motion ($55; RIMM) trades at 10 times trailing earnings, 68% below its five-year average and 46% below the median communications-equipment maker. The stock even looks cheap relative to slow growers AT&T ($28; T) (trailing P/E of 13) and Verizon Communications ($33; VZ) (trailing P/E of 15). RIM’s valuation does not reflect its operating momentum, or its 38% share of the fast-growing U.S. smart-phone market. RIM is a Buy and a Long-Term Buy.
In our quest for growth stocks, we looked for stocks with bright profit-growth outlooks and high Earnings Estimates scores, which reflect trends in analyst profit estimates. Our screen focused on companies projected to grow earnings this year, next year, and over the next three to five years. In addition, we required at least five consecutive years of increased per-share earnings.
Apple ($308; AAPL) is expected to increase per-share profits 24% in fiscal 2011 ending June and at an annual rate of 19% over the next five years. Driving that growth will be Apple’s stable of mobile devices: iPhone, iPad, and a new Macintosh laptop. At 20 times trailing earnings, Apple trades at a 20% discount to its three-year average P/E ratio. Apple is a Focus List Buy and a Long-Term Buy.
More than earnings, cash flow reflects how much money a company takes in. Cash provided by operations starts with profits, then backs out a variety of noncash items to determine how much cash is generated. Free cash flow equals cash from operations minus capital spending and dividends. We looked for four consecutive quarters of higher 12-month operating cash flow and free cash flow.
Newmont Mining ($59; NEM) can diversify an investor’s portfolio by acting as an inflation hedge. But the gold miner also enjoys substantial operating momentum and generates plenty of cash, with free cash flow of $1.84 billion in the last four quarters, versus a negative $755 million in the year-earlier period. Newmont is a Focus List Buy and a Long-Term Buy.
We screened for stocks scoring above 80 in Quadrix Overall and two sector-specific ranks. Our 12-Factor Sector score considers 12 statistics that work well within a given sector. The Reranked Overall score uses the same categories that derive the traditional Overall score, but overweights scores that work best in the sector. In addition, we looked for gross profit margins and return on equity above industry averages.
Supplemental insurer Aflac ($55; AFL) escaped many of the potholes that upended other financial stocks during the downturn. Aflac’s 12-Factor Sector score is 94, while the stock earns the maximum Reranked Overall score of 100. The stock also generates strong operating cash flows, earns a Quadrix Value score of 93, and yields 2.2%. Aflac’s September-quarter results are reviewed in Portfolio Review. Aflac is a Focus List Buy and a Long-Term Buy.
Our momentum screen is built around high Quadrix Momentum (recent operating results) and Performance (stock returns) scores. Stocks also needed to outpace the average return for the companies in their industry group as well as the Standard & Poor’s index for that group.
Lubrizol ($114; LZ), a maker of additives for industrial polymers and motor oil, enjoys strong operating and share-price momentum. The stock has surged 56% this year, well ahead of the 23% gain for the average specialty-chemical company in the S&P 1500 Index. Rising analyst estimates reflect the company’s bullish profit outlook. Lubrizol is a Focus List Buy.