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Jubak's Journal
Recent articles:
• High returns in a low-interest-rate world; 5 keys, 6/13/2003
• A fourth-quarter earnings surprise? Don't bet on it, 6/12/2003
• Has your stock become a lottery ticket?, 6/10/2003
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| | Jubak's Journal
5 stocks that could soar if rates stay low
Last week I outlined the profile of stocks that will thrive if the Fed keeps interest rates low. Now let's screen for the particular stocks and turn up some unfamiliar names.
By Jim Jubak
Low interest rates as far as the eye can see. Inflation in what seems to be a deep, deep freeze. Slow economic growth that keeps the pressure on company profits. Theres a good chance thats the environment that investors will have to live with for the next couple of years or more.
Its quite a contrast with the high-growth, high-margin decade that came to a crashing end in 2000.
And its certainly not the kind of monetary and economic environment that sends all stocks soaring. The Federal Reserves medicine may be just what an ailing economy needs. Yet the possibility remains it will also produce lingering pain and perhaps fatal damage to companies in industries struggling to eliminate marginally profitable excess capacity.
What to look for
But that doesnt mean a low-interest-rate environment would be bad for all companies. In my last column, I laid out what to look for in a company and a stock if you believe the Feds promise to keep interest rates low for as long as it takes to get the economy rolling.
Look for the stocks of companies that:
- Face as little pricing pressure from excess capacity at competitors as possible . . .
- with strong balance sheets that can raise capital cheaply . . .
- that have lots of opportunities to put that cheap capital to work on . . .
- new projects that will earn returns as high as possible over the cost of the new capital that funds them, and . . .
- whose new projects show returns that are not significantly lower than those for the companys existing businesses.
(For more detail on these five rules, see my column, "High returns in a low-interest-rate world.")
Now its time to put those general rules to work. Ive built a screen that captures the logic of those rules, and I have put our Stock Screener to work to come up with stocks that have the potential to outperform in a low-interest-rate world. Among the top 100 candidates pulled up by that screen, youll recognize names such as Berkshire Hathaway (BRK.B, news, msgs), Pfizer (PFE, news, msgs) and Viacom (VIA.B, news, msgs) that are already members of Jubaks Picks. Others such as Western Digital (WDC, news, msgs), Stryker (SYK, news, msgs), Electronic Arts (ERTS, news, msgs), Perrigo (PRGO, news, msgs) and Whole Foods Market (WFMI, news, msgs) may be familiar from past columns.
But the purpose of screen-building isnt to confirm an investors existing picks, although its reassuring when that happens. And it's not to come up with a list of the usual suspects. The time that goes into building a screen is well spent because of the unfamiliar names that it brings up that seem worthy of further research. And here this screen has done a solid job. I found five stocks that the screen has surfaced that are worth researching and watching: Chicago Bridge & Iron (CBI, news, msgs), Echelon (ELON, news, msgs), Engineered Support Systems (EASI, news, msgs), Steris (STE, news, msgs) and Talisman Energy (TLM, news, msgs).
Six simple steps to screen
Heres how to build this screen using our Stock Screener.- Under Company Basics set market capitalization to greater than $500 million.
- Under Investment Return set recent return on invested capital to 20% greater than the five-year average return on invested capital. (The last term should read 1.2*ROI 5-Year Avg.)
- Under Financial Condition set debt-to-equity ratio to less than industry average debt-to-equity ratio.
- Under Growth Rates set year-to-year revenue growth rate to greater than 0.
- Under Profit Margins set net profit margin at 20% greater than the five-year-average profit margin.
- Under Profit Margins set net profit margin at 20% greater than the industry average profit margin.
Heres my screen.
Five that fit the bill
Heres my reasoning on five stocks I find interesting:
Chicago Bridge & Iron is building the next generation of the worlds energy infrastructure. That includes work from the front-end engineering and design for the build-out of the Russian natural gas industry in Siberia for companies such as BP (BP, news, msgs) to the back-end work on the liquefied natural gas terminals necessary to get natural gas to the undersupplied U.S. market. Cheap capital funds the projects that keep Chicago Bridge & Iron busy, and the company has been using its strong balance sheet to snap up smaller energy design and engineering competitors. Recent return on invested capital is about 14%, well above the 7% average for the last five years or the recent industry average of 3%.
Echelon is using its strong balance sheet to drive the market for its hardware and software systems that allow devices such as air conditioners, lighting systems and thermostats to communicate with each other and with centralized control systems across the Internet. Example: Echelon recently acquired automated electric metering technology from Metering Technology. Echelon intends to use the new technology to build complete solutions for utility customers interested in reaping cost savings from intelligent electric meters. At the end of January, the company had about 7 million meters installed. Return on invested capital has recently run at about 9%, up from the five-year average of 2.2%.
Engineered Support Systems saw orders soar 90% in its most recent quarter over the year-earlier period. Not especially surprising, since the companys business is concentrated right where the U.S. defense and security budgets are growing most rapidly. Engineer Support Systems supplies military electronics and support equipment designed to increase the speed with which U.S. forces can be deployed into the field. In addition the company is receiving orders from the Department of Homeland Security and the Department of Defense for its air-handling and heat-transfer equipment for use in the containment of potential biological and chemical attacks. That fast growth provides plenty of opportunities to put cheap capital to work. The companys recent return on invested capital is about 19%
Steris has the broadest collection of devices and equipment for preventing infection in its industry: everything from high-temperature sterilization equipment to the supplies used by washing and decontamination systems. Steris growth is linked to the rate at which new hospitals and ambulatory surgery centers come on line. And its that link that makes Steris a potential outperformer in a low-interest-rate environment. Capital expansion in the health-care industry is directly related to the cost of capital for hospitals and other health care companies. Cheap money makes expansion and the addition of new services the easiest way for a hospital to balance its books when the government and insurers are looking to cut reimbursement payments for medical procedures. The companys recent return on invested capital has been near 13%, way above the five-year average of 7%.
Talisman Energy is drilling for oil and gas in some very expensive places. While Canada accounts for about 50% of Talismans current production, the companys growth prospects come from an offshore gas discovery project in Papua New Guinea and the gas reserves now under development in Indonesia, Malaysia and Vietnam. The geological and geopolitical risks in those areas make Talisman particularly susceptible to fluctuations in the price and availability of capital. On the upside, of course, that increases the companys leverage if interest rates stay low and capital remains abundant. Production at Talisman is projected to start ramping up this year.
Market in need of a rest?
Whats missing from this screen and these capsule descriptions? Anything on valuation.
Some of these stocks have run up strongly in the recent rally. And some show huge spikes. Chicago Bridge & Iron, for example, moved up from $20 a share on May 30 to hit $24.50 on June 11 before retreating to $22.50 on June 13. That puts the stock above the target price some analysts have set for the end of 2003.
Talisman Energy and Engineered Support Systems are similarly above the targets Ive seen from some Wall Street analysts.
These analysts may be wrong on their projections, of course, but right now this market is showing signs that it might be in need of a rest. Volume has started to fall in the last week, for example, after a week where trading volume increased with each move upward. The number of new highs in the market had been inching ahead each day, as well. In the last week, however, while substantial numbers of stocks are still hitting new peaks, the number of new highs for the market as a whole has dropped.
Does that mean the market is in for a decline? A 5% to 7% correction? A bigger retreat? No one knows. But to me it feels like a good time to be cautious about the price an investor pays to put new money to work.
While the market sorts itself out and gives me a better read on its near-term trend, Im going to put my time to use researching ideas like these and give the money I have on the sidelines a rest.
In my next piece, based on my regular 5:45 p.m. (Eastern Time) TV appearance on CNBCs Business Center, Im going to talk about some potential low-interest-rate winners in the natural resources sector that just missed making this screen. Youll be able to find a transcript of that TV appearance here on Thursday if you miss the broadcast.
New developments on past columns
One way to invest for four different futures
Shares of Pfizer (PFE, news, msgs) are showing some life. In the last three months, shares are up 8%, but that still lags the 9% climb in the Standard & Poors 500 stock index. However, for the last month, the stock is up 4% versus a 3% rise in the S&P 500 index. Some of that performance has come as investors buy in anticipation of the companys June 17 meeting for Wall Street analysts. Look to see whether the stock keeps up its relative out performance after the meeting or if this is just one of those one time speculative bumps.
Changes to Jubaks Picks
Sell Comcast
Shares of Comcast (CMCSK, news, msgs) have run up 44% so far in 2003 as more investors understand that the management at Comcast will be able to wring substantial profits out of the cable systems that the company bought from AT&T (T, news, msgs). But the stocks relative strength has declined recently, dropping from 82 over the past six months to 45 for the last three months. With shares climbing close to my target price for December 2003, I think its time to take some profits, at least temporarily. Im selling Comcast out of Jubaks Picks with a 44% gain since I added it on December 10, 2002, at $22.59 a share. (Full disclosure: I will be selling my personal position in Comcast three days after this column is posted.)
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Berkshire Hathaway, Comcast, Pfizer and Whole Foods Market. He does not own short positions in any stock mentioned in this column.
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