Jubak's Journal
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5 growth stocks for a weak-kneed rally
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The hedge-fund problem
And then, there's a third reason for suspecting this rally will lead to profit-taking before too long. Hedge funds, many of which have taken a big beating of late, are only required to let their investors take money out on a set schedule. At some funds, withdrawals are allowed at the end of the quarter. At others, it's the end of the month. With some hedge funds down as much as 6% this year -- much of that in the last 30 days in the wake of the General Motors (GM, news, msgs) and Ford Motor (F, news, msgs) bond downgrades -- you can bet that fund managers are anticipating withdrawals. That means they are likely to sell into any rally in order to create enough liquidity to meet anticipated withdrawals. That, too, is likely to limit the duration of this rally. (For more on hedge-fund losses and their likely effects on the market, read my colleague Jon Markman's column, "Why you'll feel the hedge funds' pain.")
So what do you do?
If you believe that this rally is likely to falter even before it reaches the top of the recent trading range, you buy defensive growth stocks in anticipation of the stock market's rotation back toward safety when the rally ends. Some stocks that fit this bill are William Wrigley Jr. (WWY, news, msgs), PepsiCo (PEP, news, msgs) and Procter & Gamble. I already own PepsiCo in Jubak's Picks. If I were adding just one of the other two, I'd pick Procter & Gamble because the acquisition of Gillette (G, news, msgs) will give the combined company an ability to attack global markets where one or the other individual company is currently weak. That should add to an already impressive growth record at P&G.
If you believe that this rally will hit the top of the range and go no further, you buy the shares of cyclical growth companies that have been beaten down brutally during the weeks when the market was worried about slowing growth. These stocks fell harder and will rebound more strongly because of that punishment. Don't fall in love with these: you'll be looking to sell when they get near the top of their range. Some stocks that fit this bill are Companhia Vale Do Rio Doce, Caterpillar (CAT, news, msgs) and Schlumberger. If I were adding stocks from this group, I'd pick Companhia Vale Do Rio Doce and Schlumberger. The huge Brazilian iron-ore producer is extremely leveraged to global growth. You'll get the most bang for your range-bound pick out of this choice. Schlumberger is a more conservative choice that should rise along with oil company budgets. I'm adding Companhia Vale Do Rio Doce to Jubak's Picks with this column. I already own Schlumberger in Jubak's Picks
Technology industries' strange turn
If you believe that this rally has a chance to break through the top and keep on going, you look for stocks that began showing strength before the rally of the last few days and that have a fundamental story that supports a sustainable pickup in sales and earnings.
Certainly, technology shares would be heavily represented in this group. Something strange happened in the last month: after lagging the market since Dec. 30, 2004, technology industries have dominated our list of best-performing industries. On May 16, data-storage devices, communication equipment, Internet information providers, pollution and treatment controls, semiconductor (broadline), Internet service providers and networking and communication devices all made the top-10 performers list. I'd put technology stocks Applied Films, EMC (EMC, news, msgs), LM Ericsson (ERICY, news, msgs), Network Appliance (NTAP, news, msgs), Trimble Navigation (TRMB, news, msgs) and Yahoo! (YHOO, news, msgs) in this group. But I think you can find this kind of growth and momentum outside the technology sector, too. I'd suggest taking a look at Boeing (BA, news, msgs), Chicago Bridge & Iron (CBI, news, msgs) and Pentair. In this group I already own EMC and Yahoo!. If I were a firm believer in this market scenario, I'd pick two from this group, Applied Films and Pentair.
Since I have my doubts about this rally, I prefer Pentair over Applied Films for Jubak's Picks. The water equipment sector has been hot with mergers and acquisitions activity. 3M (MMM, news, msgs), for example, recently bought CUNO (CUNO, news, msgs) for a 31% premium. That gives Pentair downside protection if this rally does stall. And with that insurance I feel comfortable adding a little more upside potential to my portfolio.
And speaking of risk, my next column is on inflation. The working title: "Why everything Alan Greenspan tells you about inflation is wrong."
Changes to Jubaks Picks
Buy Pentair
The logic here is very, very simple. First, in the last year Pentair (PNR, news, msgs) has finished its transformation from an unfocused industrial conglomerate to a company specializing in just two markets: security enclosures (about 30% of sales) and water purification and transport equipment (about 70% of sales). Second, huge multinationals like General Electric (GE, news, msgs) and 3M (MMM, news, msgs) are gobbling up water equipment companies because projections show that demand for clean water will grow by 50% in the next 20 years and supply will actually shrink due to growing pollution. Three, because there aren't very many pure plays in the water business, recent buyouts have been at big premiums: 3M just paid a 31% premium to acquire CUNO (CUNO, news, msgs). If Pentair isn't acquired, sales growth in the water business -- up 60% in the first quarter of 2005 -- will drive this stock to a $51 a share in a year. If Pentair is acquired, the gain is likely to be larger: I'd project a 20% or better premium based on a comparison with the CUNO deal. I'm adding this stock to Jubak's Picks with a target price of $51 a share by May 2006.
Buy Companhia Vale Do Rio Doce
Companhia Vale Do Rio Doce (RIO, news, msgs) bounced strongly off its 200-day moving average in this week's rally, gaining 12% in the first three days of the week. That just makes up some of the ground that the stock gave up from its February 24, 2005 high of $36.50. The 30% drop to the May 13 low, though, makes this an attractive stock to pick for a May growth surprise rally. There are good reasons to want to own Companhia Vale Do Rio Doce for the long term: iron ore and other metals sales should climb 50% in 2005 on higher prices for iron ore and an 8% increase in iron ore shipments. That should drive margins and earnings higher this year to about $4.00 a share, a 40% increase in earnings from 2004. But this is a very volatile stock and it's likely to sell off again the next time the market starts to worry about a slowdown in global growth. So I'm adding this stock to Jubak's Picks as a relatively short-term play on a swing back toward optimism on economic growth. I'm setting a target price of $34 a share for July 2005. And, because these shares are so volatile, I'm setting a stop loss for the shares of $25 a share. (Setting a stop loss is a new addition to Jubak's Picks. For more on why and how they work see "New developments on past columns" below.)
New developments on past columns
Stop loss targets added to Jubak's Picks
I'm adding a new tool to Jubak's Picks: stop loss targets. You'll find the first of these in the pick of Companhia Vale Do Rio Doce (RIO, news, msgs). I've started with that stock since it's especially volatile right now and the pick is a relatively short-term trade. Stop loss targets are a traditional way to control losses in a portfolio. The idea is that setting a mechanical sell point -- usually about 15% below the current price but sometimes more and sometimes less according to the volatility of the individual stock -- prevents moderate losses turning into the kind of huge losses that can sink a portfolio. They're also a good way to capture profits if an investor moves the stop loss targets up as a stock's price climbs. I will gradually add stop loss targets to all the stocks in Jubak's Picks. They'll work like this: I will sell a stock on the next column date after it falls below a stock loss target even if it has since recovered. That way, my trading results in this portfolio will mirror the real time effects of any stock loss I set. Thanks to those of you who have bugged me over the years to add this kind of tool to Jubak's Picks.
5 stocks for an up-and-down year
Shares of L-3 Communications Holdings (LLL, news, msgs) dipped slightly on May 19 on speculation that the company was in negotiations to buy Titan (TTN, news, msgs). It's typical for Wall Street to take a bite out of the shares of a potential acquirer on rumors of a deal, but this acquisition, if it happens, seems like a good fit for L-3 Communications. Titan's expertise in the deployment, testing and evaluation of communications equipment and programs for the military would help expand L-3 Communications Holdings' government service business. As always, the price of the acquisition is the critical variable. Prudential Securities estimates that at a price of $22 a share, Titan would add 18 cents to 36 cents a share to L-3 Communications' earnings per share in 2006. At $25 a share, the deal would add 7 cents to 26 cents.
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 owned or controlled shares of the following equities mentioned in this column: EMC, L-3 Communications, PepsiCo, Schlumberger and Yahoo!. He doesn't own short positions in any stock mentioned in this column.
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