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4 great picks the smart money missed
Those who just can't fathom this 'Rational Rally' continue to be left behind. Not only are stocks rising for the right reasons, there is plenty of cheap, steady growth left to choose from.
By Jon D. Markman
Scratch an intellectual on the NYSE trading floor, and under his Brooks Bros. shirt you will usually find the hair of a bear. This is because smart people excel at criticism. They love the sound of skepticism, nitpicking and naysaying. While the unwashed masses on Main Street prefer good cheer, the ursine mossbacks on Wall Street prefer a Bronx cheer.
Thats one reason the past years rally in stocks has provoked such loathing among brainy professionals. They look at the rising personal balance sheet of the countrys swelling army of 401(k) holders and a well-bred anger wells up inside. They point to the high price-to-earnings multiples and low growth rates of the countrys biggest companies, the historic level of selling among corporate insiders, persistently poor employment growth, the remarkable number of small-cap stocks at 52-week highs and rising margin-debt levels and insist that the public is racing head over high heels into another speculative bubble that will end badly, and soon.
But is this really the case -- or is it just another one of the markets famous deceptions?
The latest bear case
Lets hear first from one of those cerebral bears. Robert Drach, a Florida trader with an enviable long-term record, says investors chasing stocks today are ignoring a fence labeled Land Mines as they jump into a field of beautiful daisies. What can look appealing can equate to jumping into the cloak of the . . . Grim Reaper, he wrote in a letter to clients last week. We have watched jumpers for a quarter of a century. Always giddy during periods of excessive speculation, at final count they are the fodder that feeds those who conduct themselves professionally. Drach has found the market so dangerous that his asset-allocation recommendation has been stuck at around 13% stocks and 87% cash for months.
He has a lot of intelligent company. My office adjoins a municipal bond underwriting and trading firm, and two of its top employees -- an investment banker and a trader -- confessed to me this month that they sat out the entire 2003 surge in equities. They missed the postwar start last spring, then were hamstrung by the powerful emotion of regret. They waited for the pullback that never came, and still have stubbornly not put their resources back to work.
Waiting for Godot to explode, too, are short-sellers at the trading partnerships for high net-worth investors known as hedge funds. Their ranks have recently risen to an all-time high, according to ISI Group research; there are now almost more of them than stocks, about 6,250.
But theyll be disappointed. To be sure, there are plenty of overpriced companies in slow-growth businesses with mediocre prospects. Food-manufacturing giant Kraft Foods (KFT, news, msgs) just announced crummy earnings and the layoff of 10,000 workers, Eastman Kodak (EK, news, msgs) has been exposed and Microsoft (MSFT, news, msgs), the publisher of this site, recently disappointed. Yet when you look at many of the top-performing stocks in the market today, those bad boys are largely not the ones hitting the 52-week-high lists -- neither are many of the profitless dot-com types that flew to the moon in 2000. Instead, you mainly see success among a lot of small- to midsized companies with reasonable valuations, grinding out growth in niche businesses nicely leveraged to a modestly improving economy.
Despite occasional fireworks from freaks like non-lethal weapons maker Taser International (TASR, news, msgs), which went from $4 to $133 in the past 12 months, the great 2003-2004 advance has been remarkably non-speculative. Perhaps its time to call it the Rational Rally.
Profitable picks that arent overbought
Without much effort, I found 700 profitable companies within 4% of their all-time highs last week that had P/E multiples below their peers and the average of the S&P 500 ($INX). (You can view the full list from our Deluxe Stock Screener here.) Many of these are under accumulation both by the sort of patient, deep-value private and public funds that are usually really early on incipient trends, as well as -- surprise -- insiders.
Consider Abraxas Petroleum (ABP, news, msgs), an independent oil and gas producer based in San Antonio. Its P/E multiple is listed as 1.20, which, if Media Generals figure is accurate, is about as low as a P/E can go. The company owns properties in Texas, Canada and Wyoming; it earned $52 million over the past 12 months on sales of $33 million, a neat trick accomplished by an asset sale. Sporting a tiny $65 million market cap, Abraxas isnt covered by any major brokerage analysts and isnt a big part of any major mutual fund. But Peter Lynch, the vice chairman of Fidelity Investments and legendary manager of Fidelity Magellan Fund (FMAGX) in its heyday, last month filed documents at the Securities and Exchange Commission showing that he acquired the largest independent stake in the company -- 3.3 million shares, or 9.3% -- on behalf of family and related charitable trusts. The stock traded as high as $5 a couple of years ago, before natural-gas prices broke down, and it could well retrace its steps if the energy group stays strong this year.
A lot of the rest of the 700 companies are also in oil and gas production, petroleum shipping, regional banks or insurance industries. But since Ive covered those a lot lately, lets look at some others the brainiacs might be missing.- Parlux Fragrances (PARL, news, msgs), with a minuscule $49 million market cap, made $3.4 million last year on $69 million in sales. It designs, makes and distributes perfumes and related beauty products under licenses from the likes of Perry Ellis, Fred Hayman Beverly Hills and Ocean Pacific. Chief Executive Lekach Ilia was buying tens of thousands of shares from $3.42 to $5.06 in December and earlier this month. Its P/E multiple is around 16, its price-to-sales multiple is 0.6 and its price-to-book multiple is 0.8 -- all very low. Major private-fund complexes Pequot, Bridgeway and Brandywine own the largest independent stakes in the company, which traded as high as $15 back in 1996 and sank as low as 85 cents in 1999.
- Comfort Systems USA (FIX, news, msgs) designs and makes heating, ventilation and air-conditioning units for office buildings, malls, apartment complexes and manufacturing plants. The president and the chief executive were buying shares from $2.64 to $4.87 in the spring and winter last year, and among the three largest institutional holders are three of my favorite value spotters: Wellington Management, Royce & Associates and Heartland Advisors. The $259 million market-cap company has a price-to-sales multiple of 0.32 and a decent price-to-book multiple of 1.3. Business was challenging and profitability was squeezed the past few years, but the company has paid down debt, cut expenses and said in its last earnings report that it saw signs of improving conditions for 2004. The stock traded as high as $26 back in the 1990s, and could certainly get halfway back there in the next 12-18 months with a decent economic tailwind.
- American Capital Strategies (ACAS, news, msgs) is a buyout and merger-financing firm that provides money to small- and medium-sized companies that want to restructure, do a buyout, emerge from bankruptcy or simply grow. Its fairly cheap, with a P/E multiple of 13, pays an 8% dividend, and company directors and senior officers have steadily bought tens of thousands of shares in the open market at prices between $23 and $28 over the past year, with the latest in November. Wellington, Franklin Advisers and Capital Guardian Trust are among top institutional holders. American Capital has taken stakes in companies as far-ranging as maple-syrup maker Specialty Brands of America; ATM machine and safe-security products maker 3SI Security Systems; nSpired Natural Foods; Piper Aircraft; Electrolux; and Bumble Bee Seafoods. Since American lends to some companies experiencing weakness, its asset quality is a concern, but again, they also make it highly leveraged to the success of the global economy.
Even if the bilious bears are proved right over the next few months, and the broad market either stalls or suffers a serious setback, relatively inexpensive and well-sponsored companies like these should continue to make steady progress. Follow the money.
Fine Print
In my column listing potential surprises for 2004, I leveraged some research by trader Dennis Gartman to predict civil war in Saudi Arabia. A lot of readers thought that was nuts, but now comes word from the Singapore newspaper Straits Times that assassinations in Sakaka, power base of an important branch of the Saudi royal family, reflect nationwide anger against the monarchy. Click here for the story. . . . Reuters filed a report out of the LowCarbiz trade show last week that showed the Atkins diet craze is on the verge of being adopted by major food manufacturers. Reuters said that demand for low-carb products is outstripping supply by 30:1 and reported that grocery goliath Wal-Mart Stores (WMT, news, msgs) is not only pushing all the low-carb items it can get, but it also is planning to launch a house brand. . . . Shares of ocean freighter companies featured in my column about StockScouters top picks for 2004 have risen a ton in the past couple weeks, but still look shipshape. They include General Maritime (GMR, news, msgs), Tsakos Energy Navigation (TNP, news, msgs) and Stelmar Shipping (SJH, news, msgs).
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 controlled accounts with positions in the following securities mentioned in this column: Comfort Systems USA and Microsoft.
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