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5 big themes for 2004 -- and 5 ways to play em
Its not rocket science. Just like the market pros, you can spot next years big investment themes -- and position yourself to profit from them. Heres help.
By Jon D. Markman
All this month, across the land, portfolio managers have scheduled meetings with their research teams to discuss investment themes for 2004. There is no great sorcery or insider knowledge required for private investors to do the same -- just a determination to step back to see big ideas playing out in public before your eyes, the insight to understand how to exploit them and the courage to execute in the market.
In a moment, Ill offer some conservative ways to play prospective 2004 growth themes. But first, for warm-up and perspective, lets look back at themes that worked for managers in 2003:- High-beta and base-metals stocks tied to economic growth in China, such as the Shanghai-based Internet provider Sina Corp. (SINA, news, msgs), Aluminum Corp. of China (ACH, news, msgs) and copper miner Phelps Dodge (PD, news, msgs)
- Precious metals stocks tied to a weakening U.S. dollar, such as large-cap Newmont Mining (NEM, news, msgs) and small-cap Wheaton River Minerals (WHT, news, msgs)
- Internet-based voice communications growth plays such as Sonus Networks (SONS, news, msgs)
- Broadband and wireless-equipment growth plays such as Carrier Access (CACS, news, msgs) and Westell Technologies (WSTL, news, msgs)
- Semiconductor-sales recovery plays such as Intel (INTC, news, msgs) and Amkor Technology (AMKR, news, msgs)
- Consumer medical equipment breakthroughs like Align Technology (ALGN, news, msgs) and Palomar Medical Technologies (PMTI, news, msgs)
- Consumer entertainment/electronics breakthroughs such as camera-phone chip maker OmniVision Technologies (OVTI, news, msgs) and XM Satellite Radio Holdings (XMSR, news, msgs)
The chicken way to find strong themes for 2004: Wait a couple months and focus on stocks that are first to advance 50% to 100% in the new calendar year. In April last year, in my column Investors swing for the fences, I identified 15 Nasdaq and 15 NYSE stocks of decent size meeting that criteria. All of the big 2003 themes except the metals were represented, and the Nasdaq stocks were up an average of 133% since, while the NYSE stocks were up 46% since. Only four of the 30 stocks fell in value, and just one blew up. Nine of the Nasdaq stocks went on to gain 100% or more, led by a 311% gain in XM Satellite, while three of the NYSE stocks rose triple digits, led by insurer Fremont General (FMT, news, msgs). See the whole list at my Web site here.
5 themes and 5 stocks to watch in 2004
Many 2004 themes will be continuations of 2003 themes, while others will be reversals. In February or March, I will look at strong starters with potential to finish strong. For now, Ill offer five names that have four factors in common: They are growth stocks with expanding price-to-earnings multiples; they generate a lot of cash flow; they are in the middle of big economic, cultural, financial or political themes; and they were up nine of the past 10 calendar years, through both bull and bear periods for the overall market.
Theme: U.S. military adventures overseas continue
Stock: Engineered Support Systems
For at least the next year, were stuck with a government hell bent on pursuing military adventures abroad. Engineered Support Systems (EASI, news, msgs) is a low-brow way to play this theme, as it supplies the nuts and bolts of armed conflict. The $1.5-billion holding companys subsidiaries provide a wide range of support equipment and services such as generators and water systems; tank-transport and load-management systems; equipment refurbishment; and, at the higher end, portable radar stations and avionic test equipment. About 95% of its revenue comes from the U.S. government, mostly in small contracts directly from the Pentagon or via partnerships with major contractors like Northrop Grumman (NOC, news, msgs).
Since modernization of the fighting force at a reasonable price will be a key focus of Pentagon spending in 2004, the skilled innovators at Engineered Support should do better than companies that supply big-ticket items like tanks, jets and missiles. The stock is up 115% in the past year as earnings and sales growth have reliably improved 25% to 40% annually for the past decade; cash flow is strong and rising; return on equity is a nice 21%; theres no debt; and trailing 12-month income was $37 million on $520 million in sales. This mid-cap stock is not cheap, trading for a forward price-to-earnings multiple of 29, but the company has produced the kind of reliable growth for which growth investors pay a premium. Shares were only down once in a calendar year in the past decade, -19% in 1999; price performance over the past decade is 48% annualized.
Theme: Global trade accelerates despite increasing threats of protectionism
Stock: Expeditors International of Washington
Expeditors International of Washington (EXPD, news, msgs) is the Dell (DELL, news, msgs) of transportation, as it generates mountains of cash flow without tying up hard assets or inventory. It is a Seattle-based freight forwarding company whose main role in the trade ecosystem is to cheaply buy space on air and ocean carriers in bulk and sell it dear to companies that manufacture things overseas for sale in the United States. It has grown without acquisitions to a $4 billion market cap via reliable 15% to 20% earnings and revenue growth over the past decade. It has $300 million in cash, no debt, and its P/E multiple has expanded from 17-20 a few years ago, to a premium 30-35 today.
Expeditors has been a leader in corporate governance before it became trendy: Everyone in the company is paid a low base wage augmented by a bonus tied to individual branch offices profits; and the chief executive pays for his own parking at corporate headquarters. The companys already-solid return on equity will improve as industry consolidation and its own growth lead to greater economies of scale. Corporate documents are refreshingly candid, and the colorful CEO, once asked if he would make acquisitions, said, Why buy what you can kill? Canny fund-management company Ruane Cunniff is the leading, longtime institutional owner with 15% of outstanding shares. Shares are up 20% this year; they were only down once in the past 10 years (-3.6% in 1993); 10-year annualized return is 33%.
Theme: Weakening dollar and the rise of consumers in Eastern Europe, India and China
Stock: William Wrigley Jr.
William Wrigley Jr. (WWY, news, msgs), one of the most underappreciated consumer-products companies in the country, produces what you might call the healthy alternative to cigarettes. Chewing gum is a non-harmful, somewhat addictive discretionary food that gets the best display in any grocery or convenience store, right next to the cash register. The $10 billion company earned $445 million in the past 12 months on $3 billion in sales, up 11% and 15% from the previous year -- brisk gains for a food company.
Wrigley has a 58% market share in gum in this country and a 90% share in the United Kingdom and Germany. But what really grabs your attention is that this high-cash flow, no-debt, family-run outfit is the low-cost producer in all its markets and a powerful innovator in everything from flavor agents to gum-wrapping technology. Since 60% of sales are overseas, a weaker dollar will improve earnings considerably. The company is moving tentatively but steadily into new areas of potential growth, such as teeth-whitening gum (Orbit White), antacid gum (Surpass), breath-freshening gum (Eclipse), breath-easing gum (Airwaves) and throat-lozenge gum (Alpine). Also, its expanding into new territories such as Eastern Europe, China and India, where it gets to train billions of consumers on the benefits of gum chewing. Shares have fallen just once in the past 10 years (-5.95% in 1999) and are up 15% annualized over that time; theyre up just 2.2% this year, plus a 1.6% dividend. If you are worried about stocks in 2004 but need to own something, Wrigley could be your stick.
Theme: Aging baby boomers and their bum knees
Stock: Stryker
This weekend, about 10,000 men and women ran in the Seattle Marathon near my home, and a slew of them were over 40 years old. Thats great news for Stryker (SYK, news, msgs), as it is the nations leading maker of orthopedic implants -- the artificial joints, spinal rods, screws and bone cement these folks may eventually need as they cross into their 50s and 60s. Stryker earned $425 million on $3.5 billion in sales in the last 12 months, and investors have rewarded its reliability over the past decade with a P/E multiple of 37 and a market cap of $15 billion.
This is a stock that is rarely cheap, as it has pulled down 18%-22% revenue growth, 20%-30% earnings growth, loads of cash flow and a 21% return on equity seemingly forever. The stock is up 22% so far this year, has offered a 22% annualized return over the past 10 years, and has only faltered once in the past decade -- a 26.7% decline in 1993. In addition to the new orthopedic-implant market, Stryker also counts on replacing a lot of the implants installed 10-15 years ago and also makes all the specialized drills, saws, cement mixers and stretchers that doctors rely on to do their work. The company is threatened by new non-surgical methods of fixing bones and joints, but it has gone on the offensive by developing a biotech division focused on products that help grow bones.
Theme: Regional/small bank consolidation
Stock: First BanCorp.
Yeah, I know. Youve heard this one before. But its not going away. There are a lot more banks than necessary in North America, and ongoing consolidation puts a rising bid under all their stock prices. I could have picked just about any small bank, but chose First BanCorp. (FBP, news, msgs) because it is the second largest in Puerto Rico and thus would make an ideal purchase for a Citigroup (C, news, msgs) or Bank of America (BAC, news, msgs) that wishes to make a larger play on the island. It has been in business 55 years, regularly registers 15%-20% earnings growth on better-than-average profit margins, sports a relatively modest P/E multiple of 14 and has a 1.5% dividend yield.
Puerto Rico has higher population density than any U.S. state (1,100 people per square mile) and demand for housing -- the key focus of any regional banks lending department -- is growing. Puerto Rico does have an unemployment problem, but its value as a travel destination has risen in proportion to Americans fear of traveling far overseas. Shares are up 33% annualized over the past 10 years, and 69% this year; the only decline in the past decade came in 1999. Other Puerto Rican banks to consider are W Holding Co. (WHI, news, msgs), up 65% this year, and Doral Financial (DRL, news, msgs), up 82% -- two stocks that have been StockScouter favorites since we launched the system in June 2001.
Some investors are concerned that higher interest rates will kill the rally in small banks and thrifts, but rising rates could actually benefit them as they will continue to mostly pay out 1%-3% in passbook accounts while lending more dearly at 7% to 8%.
All of these are expensive; anyone interested should consider purchasing on inevitable pullbacks. Ill watch them over the next couple of years and report back. If you have suggestions on themes or stocks to watch in 2004, e-mail them to me at jdm@oddpost.com and put the word theme in the subject line.
Fine Print
To learn more about Engineered Support, click here; to learn more about Expeditors International, click here; to learn more about William Wrigley, click here; to learn more about Stryker, click here; to learn more about First BanCorp, click here (if you read Spanish). . . . Thanks for all your 2003 turkey suggestions. Later this month, Ill write a column that will list them all and try to forecast which have the greatest potential for turnaround next year.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, Markman did not have a position in any securities mentioned in this column.
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