Details
|  | | Price | 0.000 | | | Change | unch | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 15.670 | | | Change | -0.680 | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 21.400 | | | Change | -0.540 | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 0.590 | | | Change | unch | |
Research Wizard
Add to MSN Stock List
Message Board
| | Jubak's Journal
Look for growth in late bloomers
Early cyclicals are already in full flower, so it's time to consider a little more risk. Here's how to look for stocks that haven't hit their peak.
By Jim Jubak
On Feb. 7, the Dow Jones Industrial Average ($INDU) stood at 9,625. A month later, on March 8, with evidence mounting that the economy had moved out of recession and that investors might expect to see improving corporate profits, the Dow closed at 10,630.
The same is true of the Standard & Poors 500 ($INX), which moved up from 1,081 on Feb. 7 to a close of 1,165 on March 8, and the Nasdaq Composite ($COMPX), which has climbed from 1,782 to 1,924.
So what do you do now? Load up on more of the cyclical stocks that led the markets advance in the hope that the rally will just keep on rolling? Thats risky, because valuations for many of the stocks that have led the recent advance seem extended without more concrete evidence of an earnings recovery. And with earnings warnings season about to start, the odds are that near-term surprises are likely to be more negative than positive. (Problems in the General Electric (GE, news, msgs) 10K, released on Friday, reversed a good part of the rally in the Dow, after all.)
How about waiting on the sidelines in the hope that the kind of pullback that periodically strikes any recovering market will create a buying opportunity? That carries its own risk. While its true that the major indexes are flirting with levels that have brought corrections in recent months, theres no guarantee that they wont blow through these prices on a wave of economic good news.
Youd be dead on if you said that I dont find either of these choices especially attractive. I do take the risks of each -- buying at a temporary top, or missing out on a continuing rally -- very seriously. Some of the early cyclical stocks that I added to Jubaks Picks in late January and early February are pushing up against my target prices. Selling at least a few of them here would be a tempting way to lock in some profits and minimize my exposure to any correction.
On the other hand, with my cyclical exposure limited to four stocks -- American Express (AXP, news, msgs), Rohm & Haas (ROH, news, msgs), Praxair (PX, news, msgs) and Continental Airlines (CAL, news, msgs) -- its not like Im over-weighted toward the sectors that are likely to rally in a recovery. (I suppose I could add my energy stocks, Apache (APA, news, msgs), Arch Coal (ACI, news, msgs) and Forest Oil (FST, news, msgs), and even AOL Time Warner (AOL, news, msgs) as an advertising play, but that still adds up to just eight out of 17 positions.)
Both strategic options seem to be based too much on hope -- hope that nothing bad will happen to take down temporarily extended valuations, or hope that something bad will give me an opportunity to jump in before prices go too much higher.
The late-bloomer strategy
So Ive decided to follow a third strategy, one that uses rotation inside economically sensitive sectors to take advantage of the historical patterns surrounding stock market recoveries from recessions. I call this my late-bloomer strategy.
Recovering markets tend to broaden as they climb. In the early stages, most gains go to the safest stocks in the economically sensitive sectors that lead such a move. As the upward trend in the economy gets more established, however, participation in the rally gradually broadens to include riskier members of those sectors that have lagged. These stocks, because they were often severely depressed on worries that a recession would devastate earnings or revenue, often outperform the early leaders as a rally based on an improving economy continues.
Theres nothing magical behind that tendency. As valuations in the sectors that benefit from the early stages of a recovery rise, investors new to the rally try to buy into the rally by finding sector stocks that havent moved up yet, and investors who have already scored profits seek to deploy some of their cash into the same relative laggards in order to repeat their success. The call goes out to Find me something that hasnt gone up yet. With the unspoken proviso, of course, that the new stock has to resemble the stocks that have already gone up.
Heres an example of what I mean (Its from the financial sector, traditionally an early beneficiary of even the slightest signs of an economic upturn): Fannie Mae (FNM, news, msgs), traditionally a safe haven in the sector, turned in a more-than-decent 10% gain from Sept. 3 to Nov. 11, 2001, at a time when any economic recovery was just a hope unsupported by data. During the same time, American Express, plagued by worries about its junk bond portfolio and the possibility of credit problems in its consumer credit card businesses, sank 12%.
In 2002, however, that relative performance has been reversed. From Feb. 1 Fannie Mae has declined 3% while American Express has climbed 15%.
Its always hard to disentangle why a stock did what it did after the fact. Certainly worries about Fannie Maes financial disclosure and use of derivatives have hurt the shares in the post-Enron atmosphere. But theres no doubt in my mind that the stock has felt that pressure more as the need for the safety that it traditionally embodied diminished, with the economy recovering and investors feeling more able to buy shares in other financials that had until recently looked too risky.
How to profit from the broadening rally
That change in the perceived economic risk in the financial sector enabled investors to feel more comfortable buying the upside potential of an American Express -- because an economic recovery diminished the downside risks to the companys business.
This process of broadening isnt over either. Just as American Express began to outperform Fannie Mae as the perceived economic risk diminished, so has a stock like Capital One (COF, news, msgs) begun to outperform American Express in recent days. Investors were worried that Capital One, as a very aggressive issuer of new credit cards, would go down in flames if the economy continued to sink. Especially worrisome was the companys subprime auto lending business. (Subprime is Wall Street jargon for loans to customers with less-than-stellar credit histories. In general these customers have a higher rate of defaults on their loans during economic downturns.)
Implementing my broadening rally strategy is a two-step process.
First, dust off your list of economically sensitive sectors that do well in the early stages of a recovery. Examples would include financials, energy, chemicals, paper, advertising -- all those sectors that turn up quickly when the economy does.
Second, identify late bloomers in each attractive sector.
A stock can be a late bloomer in a sector for two general reasons: because it has more economic risk than the average company in its sector, or because the companys business historically has recovered slightly later than its rough peers in the sector.
Two types of late bloomers
Let me give you two examples of each kind of late bloomer.
First, Ill start with those that bloomed late because of perceived economic risk. (Capital One also fits this group.)
In the financial sector, AmeriCredit (ACF, news, msgs) is a prime example of a stock that lagged because of excess risk yet is now rallying because the belief in an economic recovery has reduced the perception of that risk. The subprime auto loans that AmeriCredit issues through car dealers are no longer seen as bombs waiting to explode.
Clear Channel Communications (CCU, news, msgs) also belongs in this class because of worries about what an extended economic downturn would do to the companys balance sheet. An aggressive acquisition campaign had driven debt up to about $9 billion, and the company just reported its fifth losing quarter in a row. But with advertising revenues set to tick upward as the economy recovers, investors are more willing to look past the companys books.
As for stocks that bloomed late because the companys business historically recovers later than its sector as a whole, Id put Lamar Advertising (LAMR, news, msgs) in this category. The third-largest billboard company in the United States, Lamar Advertising shares typically hold up longer than the bulk of its sector because billboard revenues are among the last part of the advertising market to slump in a recession. On the other hand, billboard revenues typically recover more slowly than do TV or radio advertising revenues when the economy turns. Lamar Advertisings business recovery will lag a quarter or two behind the recovery at radio advertising companies such as Clear Channel or radio and TV advertising companies such as Viacom (VIA, news, msgs).
Merrill Lynch (MER, news, msgs) belongs in this group, too, on the basis of its performance this year if not on the historical record. After past recessions, brokerage stocks such as Merrill have led the market out of its slump. Not this time, however. Thanks to severe downturns in investment banking business -- mergers and acquisitions and initial public offerings are both down to a trickle -- the brokerage houses with investment banking arms have lagged the retail brokerage specialists. Shares of Merrill Lynch havent done all that badly from Feb. 25 through March 8, climbing 9% in the period. But in the same two weeks, E*Trade Group (ET, news, msgs) soared 25% and Charles Schwab (SCH, news, msgs) is up 16%. Having an investment banking arm -- and one with exposure to Enron -- hasnt been a plus this year.
Of these two kinds of late bloomers, I much prefer the second -- the business-cycle late bloomer. If the economic recovery proves to be more delayed than expected -- or if investors temporarily lose faith in the recovery -- these stocks will stall and then retreat without a doubt. But since the issue is one of timing -- when these fundamentally sound businesses will rebound -- I dont expect panic selling.
Investing in the other type of late bloomer -- the high economic risk late bloomer -- does expose an investor to fear-based selling. The fear that an extension of the economic downturn could lead to major financial problems -- whether accurate or not -- could easily return if investor sentiment swings back toward a belief in the economic downside.
At this stage of the market Im better trading off some potential return for some potential risk. Im adding Lamar Advertising and Merrill Lynch to Jubaks Picks with this column. As the other part of my cyclical rotation strategy, Ill be selling Fannie Mae and Rohm & Haas. In addition Ill be selling Electronic Arts (ERTS, news, msgs) because the stock is near my target price for March.
New developments on past columns
Watch the skies to see if stocks will soar
Airlines, and Continental Airlines in particular, should be a major beneficiary of the economic stimulus package passed by Congress last week. The Job Creation and Worker Assistance Act speeds up the rate at which companies can write down investments in business equipment. First, corporations will now have the ability to write down 30% of the value of any investment made after Sept. 10, 2001, and before Sept. 11, 2004, in the first year of that investments life. That should have an especially big impact on companies that invest in long-lived assets -- such as airplanes. Second, companies will now be able to deduct net operating losses from any profits earned over the previous five years instead of the current two years for tax purposes. That makes the huge losses airlines racked up at the end of last year and at the beginning of 2002 more valuable -- if the airline paid substantial taxes over the last five years.
Buy Merrill Lynch
I think the fourth quarter of 2001 marked a bottom for Merrill Lynch (MER, news, msgs) . The company took a huge, $1.7-billion, after-tax charge against earnings to cover the costs of its restructuring, and then disappointed Wall Street by delivering lower than expected cost savings from that restructuring. But that sets the stage for a pickup in the stock as investment banking activity gradually increases in 2002 and improving retail trading volumes move through the leaner Merrill Lynch brokerage operation. The stock now trades at just 17 times projected Wall Street consensus 2002 earnings per share of $3.09. Im adding the stock to Jubaks Picks as of March 12 with a target price of $64 a share by December 2002.
Buy Lamar Advertising
The billboard segment of the advertising market was the last to slide into recession in 2001 and its trailing other ad segments as the economy comes out of the recession in 2002. So Lamar Advertising (LAMR, news, msgs) , the No. 3 billboard company in the market, trades at a sizable 25% discount to its close peers in the radio advertising sector. The company has been busy buying billboards in the rapidly consolidating sector -- and thanks to the rapid depreciation charged against such assets, that will keep the company in the red for all of 2002 and 2003. Earnings before taxes, interest, depreciation and amortization -- a conventional way to track media companies such as Lamar Advertising -- grew 15% in the fourth quarter of 2001. Im adding the stock to Jubaks Picks as of March 12 with a target price of $49 a share by December 2002.
Sell Electronic Arts
Im selling my position in Electronic Arts (ERTS, news, msgs) because the stock has climbed to near my target price of $62 a share in the current rally. This amounts to a very modest $3 gain on the shares since I added them to Jubaks Picks on June 12, 2001, at $58.99. But with the stock and the Nasdaq market in general at the top of its recent trading range, I think its wise to lock in even this small gain and look for more modestly priced shares. Electronic Arts currently trades for 72 times projected earnings for the fiscal year that ends in March 2002.
Sell Rohm & Haas
I think its time to take some profits in these shares after the strong recent rally in cyclical stocks. Shares of chemical maker Rohm & Haas (ROH, news, msgs) are up about 11% since I added them to Jubaks Picks on Jan. 29 at $34.45. At around $39 a share, the stock is still better than 10% below my target of $44 by December 2002, but this market is moving up in fits and starts so Ill take profits here and look to re-enter the stock or the chemical sector after the next pullback.
Sell Fannie Mae
As the economic recovery becomes more established, I think its a good idea of rotate out of the safest stock in a sector and into those with a little more economic risk. Thats why Im selling Fannie Mae (FNM, news, msgs) here. The stock is likely to remain an extremely solid long-term holding, and it remains one of my 50 Best Stocks in the World, but with the recovery picking up steam I think other more economically sensitive financials will outperform these shares. Fannie Mae is down about 3% since I added the shares to Jubaks Picks on Oct. 5, 2001, at $82.49.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Apache, AOL Time Warner, E*Trade Group and Charles Schwab.
|
