Jubak's Journal
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5 above-average stocks
Stocks have dropped since the end-of-the-year rally, which makes it a good time to look at 50- and 200-day moving averages as a way to find bargains.
By Jim Jubak
This is just a test.
Thats the technical term for the action investors are seeing in the stock market now. After last years gains, investors are taking a collective break to figure out how attractive stocks are at current prices.
Want to know when, and what, theyll start buying again? Take a look at two simple technical indicators called the 50-day and the 200-day moving averages.
After looking at those measures, I recommended three stocks in my regular weekly appearance on CNBCs "Morning Call." And, as usual, I have two more exclusive picks for CNBC.com on MSN readers.
In commonsense terms, think of it this way: Investors are trying to decide what they want to pay for stocks. In the fourth quarter, the Nasdaq climbed 12% and the Standard & Poors 500 index rose 7%. The gains from the Aug. 12 low to Dec. 31 are even higher, with the Nasdaq Composite up 24% and the S&P 500 ahead 14%.
The markets moves this year make it clear that few investors want to load up on stocks at end-of-the-year prices: Theyre too expensive. This is why the Nasdaq is down 4%, the S&P 500 is off 2% and the Dow Jones Industrial Average has fallen 2% since the beginning of 2005.
But at some point stocks will drop enough so that investors will buy again. (Remember that January is historically among the strongest months for stocks because investors making end-of-the-year contributions to retirement accounts flood money managers with cash.)
So far, it looks like a modest pullback in prices to the 50-day-moving average might be enough. Thats the level that stocks tested at the beginning of this week. On Tuesday, the S&P 500 and the Nasdaq pulled back to their 50-day moving averages. Individual stocks like Autodesk (ADSK, news, msgs), Caterpillar (CAT, news, msgs), Charles Schwab (SCH, news, msgs), Fluor (FLU, news, msgs) and U.S. Steel (X, news, msgs) tested their 50-day moving averages then, too.
Tracing a line
Theres nothing magical about the 50-day moving average. It's the line traced out by calculating the average price for a stock or index over the previous days over and over again. As the date of the calculation changes, the average moves up or down depending on the stock's trend. The 50-day moving average is often the price level that supports a falling stock (or provides resistance to a climbing one) because it represents the average price at which a large number of investors holding the stock purchased it. (It is, in fact, the average purchase price over the last 50 days.) As a stock falls, some investors who bought above the average may decide the stock is cheap enough to buy, which can limit a stocks decline.
Can is not will or must. If selling is strong enough, the price can plunge straight through the 50-day moving average on its way to stronger support at the 200-day moving average, a point that represents the average price for purchases over the last 200 days. A stock that drops to the 200-day moving average represents a bargain to an ever larger pool of investors.
Looking at the current market, and especially at the technology sector, you can find stocks that have already plunged through their 50-day moving average and are looking for support at their 200-day moving average. Advanced Micro Devices (AMD, news, msgs), for example, plunged through its 50-day moving average at $20.86 and fell to the vicinity of its 200-day moving average at $15.74 when the company cut its fourth-quarter guidance.
As an investor, youd certainly like to avoid stocks that are set to plunge through their 50-day moving average on their way to potential support at the 200-day level. AMD's plunge represents a short-term 30% loss, after all.
While theres never a guarantee, a stock that holds above its 50-day average in a testing market is showing the kind of strength that should result in profits to investors when the market starts to rise.
So I looked for stocks with top ratings of 10 from our StockScouter that were holding at or near their 50-day moving average.
Finding what I'm looking for
J.B. Hunt Transport Services' (JBHT, news, msgs) chart shows exactly what Im looking for: The shares are kissing the 50-day moving average at $41.63, which is well above 200-day support at $36.36. Support between those two lines comes in at $40 and $38, intermediate highs.
On the fundamental side, I like this stock because the company has been able to generate record earnings despite severe handicaps including steep fuel costs, higher pay for drivers and rail-service delays. But theres little that a price increase, made possible by the high demand for shipping and the lack of industry capacity, cant fix.
Third-quarter earnings hit 57 cents a share, and the consensus is for the same in the fourth quarter. This would represent a 78% increase over 2003's fourth quarter and an increase in annual earnings per share of almost 80%. I dont expect the same big earnings jump this year but 20% is certainly possible since the driver shortage, which led to that higher pay, also makes it difficult for trucking companies to expand capacity and undercut each others' prices.
Two paths
Cognizant Technology Solutions' (CTSH, news, msgs) chart is hanging in there. On Tuesday, the stock dipped just below its 50-day moving average. From here it has two likely paths: 1) it could rebound from a brief dip below the average as it did in July, or 2) it could head for the lower end of its price channel near $35. The worst of these two scenarios results in a decline of less than 10% from recent prices. Thats a risk worth taking since the last time the stock ran through these two recovery scenarios the gains were 86% and 101%, respectively, from the dip through the end of 2004.
Those kinds of gains are possible because Cognizant is riding the global outsourcing trend for information technology services as hard as it can. The only limit on near-term revenue growth seems to be the companys ability to manage new business. Fortunately for investors, management seems to recognize a need to slow down, if you can call the projected drop in revenue growth to 45% in 2005 from 60% in the fourth quarter to be slow. Wall Street is calling for 36% earnings growth in 2005, which makes the stocks price-to-earnings ratio of 58 on estimated 2004 earnings seem relatively reasonable.
Investing wisely
FactSet Research Systems (FDS, news, msgs) is showing the kind of strength I like to see in an uncertain market: The shares are still solidly above their 50-day moving average.
But its another set of averages that really sells me on this stock. FactSet has earned a startling 26% return on its invested capital over the last five years. The figure jumped to 37% in the last year, which makes me very interested in the companys big jump in capital spending in 2004. According to Value Line Investment Survey, capital spending per share hit $1.21 in 2004, up from 25 cents a share in 2003. This increase is necessary to fend off the hot competition from other companies that supply financial data to institutional investors. But the companys huge return on invested capital argues that this capital spending will keep earnings growing at something near the 18% average annual rate of the last five years. And since the company generates a flood of cash -- cash flow was about $2.30 a share in 2004 -- FactSet can make this capital commitment while keeping its books free of long-term debt.
In my two exclusive picks for CNBC.com on MSN readers Ive found two stocks showing rock solid price action during the recent pullback.
2 exclusive picks
Patterson Cos. (PDCO, news, msgs) is the one stock on this list with a StockScouter rating of less than 10 (its a 9), but the shares have barely budged from their recent 52-week high. Thats a disappointment to bargain hunters but encouraging to those of us who believe that stocks that can rise when the market sags are likely leaders when the market recovers.
Actually that steadiness wont be a surprise to anyone who knows the fundamentals of this company, which specializes in dental, veterinary and medical rehabilitation supply. Earnings growth has averaged 22.6% over the last five years. Wall Street estimates earnings growth of 25% in the fiscal year that ends in April and 20% growth for fiscal 2006.
American Eagle Outfitters' (AEOS, news, msgs) chart makes the other four stocks in this column look volatile. The shares havent even blinked during this pullback, continuing an upward march that stretches back for more than a year. You get quite a different picture, however, if you extend the stocks chart back five years. The volatility in that chart is a result of soft sales and uneven performance in from 2000 to 2002 just as the recent gains are a result of strong same-store sales growth and solid execution that has slashed the amount of merchandise getting marked down.
I wouldnt call any fashion-trend dependent retailer a buy-and-forget stock but American Eagle has shown a sure sense of trend -- both in merchandise selection and stock-price momentum -- recently that should keep the stocks run going into 2005.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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