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How 2004s winning stocks were born
Even in this count-on-nothing market, investors are still rewarding innovation, turnarounds, takeovers and hidden virtues. Here are the companies I'm watching.
By Jon D. Markman
After nearly three months of the year, investors already have witnessed stocks undergo a full range of motion, from a parabolic move upward in January to a dull stretch of low volatility in February followed by a dizzying decline in March. At its best, the Nasdaq Composite ($COMPX) was up 8% in 2004, and, at its worst, it has declined 10% from peak to post a 3% loss for the year.
If the market were a washing machine, wed be ready for the rinse cycle. That makes this a good time to consider which stocks look brightest so far and what their success suggests about the prospects for these and other stocks going forward.
Lets back up a moment first and consider why stock prices go up at all. The simplest explanation is that you are buying a nanoslice of a companys future earnings power. The question is how to estimate that power.- A public company with the most modest ability to tread water with current customers ought to be able to grow earnings at the rate of growth of the U.S. gross domestic product, which this year means the stock should be able to advance 4% a year. An example is mass-market food manufacturer such as gum maker William Wrigley Jr. (WWY, news, msgs).
- A company making decent products or providing fair services in an industry with stronger-than-average demand ought to be able to double GDP growth or slightly better, so figure its stock should be able to advance 8% to 12% a year. An example is health-care products giant Johnson & Johnson (JNJ, news, msgs).
- A company selling unusually strong products or services in a popular economic sector ought to be able to triple GDP growth since it is selling more stuff to old customers, acquiring new customers and maybe even raising prices. Its shares should be able to advance 15% to 20% per year. An example is coffee retailer Starbucks (SBUX, news, msgs).
- And if a company has been doing the latter consistently well for a number of years, investors will typically pay a special premium that takes the form of an expanding price-to-earnings multiple, which could add another 10 percentage points or more to its nominal growth rate. An example is online retailer eBay (EBAY, news, msgs).
So why are some stocks already up 60% to 200% or more in 2004, and how can you judge whether the move is a fluke or likely to continue?
Trading on knowledge
The most common reason a companys shares rise a lot more than its peers' is some sort of information disequilibrium: Buyers believe they know something that sellers and bystanders do not -- some call this a variant perception -- and are willing to make intensive bets with money. The more buying power they have, and the more they can persuade others to join them, the more demand pushes shares up. If holders become increasingly reluctant to part with shares, theyll demand ever-loftier prices to let go.
In many cases, the information disequilibrium stems from a business change that the market is slow to recognize or appreciate. Shares of Southern California real-estate lender Fremont General (FMT, news, msgs) are up 60% this year: 10% in January, 25% in February and 16% so far in March. Wells Capital Management, which bought its entire 4.7% stake in the company in the fourth quarter last year, accurately forecast that the company would successfully shed its past as property and casualty insurer and morph into a profitable industrial bank.
Fremont General has virtually no analyst coverage and is owned only by a few small-cap value mutual funds so far, yet earnings doubled in the last quarter. The price gain so far is probably the result of new small-cap or midcap value buyers or an advance party of midcap growth funds.
Strangely diversified conglomerates and companies that emerge from bankruptcy, or acquire subsidiaries emerging from bankruptcy, are prime candidates for big info-disequilibrium trades. Take a look at Danielson Holding (DHC, news, msgs) and Congoleum (CGM, news, msgs).- Danielson Holding, up 223% in 2004 through March 15, has acquired holdings in marine transportation, insurance and energy production. In 2003, its American Commercial Lines subsidiary filed for bankruptcy along with related companies such as American Commercial Barge Line, Jeffboat and Louisiana Dock. Last month, the company completed its acquisition of Covanta Energys municipal waste-to-energy business out of bankruptcy. Danielsons earnings overall fell 74 cents per share in fiscal 2001, $1.10 per share in 2002, and at least $2.14 per share in 2003.
So why is this company, sporting a ridiculous price-to-book value of 10.7, according to Media General, up three times from the $2.90 where it started the year? Part of the attraction apparently is the value of its tax-loss carry forwards. Chief Executive Sam Zell and an affiliated investment company bought $6 million worth in the open market in December, and veteran vulture buyer Marty Whitman at the Third Avenue Value Fund had acquired up to 8% of the company through the end of last year. Whitman has been on Danielsons board since 1990; Zell is better known as a Chicago-based billionaire real-estate developer.
- Congoleum, the linoleum and tile flooring maker, is up 218% this year despite filing for a pre-packaged bankruptcy. Business growth certainly isnt behind the surge: Fiscal year 2003 sales of $220 million were 7% lower than 2002, resulting in a net loss of $6.8 million. And Chairman Roger Marcus detailed five big problems: large set-asides for asbestos-related legal charges; a decline in key end market manufactured housing; substantial increases in medical, energy and insurance costs; the loss of a major vendor; and the margin-slicing reduction of inventories.
But stock prices are more about the future than the past, and that might be brighter. In a press release, Congoleum said it is optimistic that 2004 results will be "significantly better" due to the company's actions to reduce its cost structure, including job cuts in 2003. After bankruptcy, some investors are clearly betting the worst is behind Congoleum.
Opportunities persist
Information disequlibria can persist for a long time, even after a company makes a full recovery from whatever ailed it, as skeptics irrationally fear a return to darkness. A typical example is TRM Corp. (TRMM, news, msgs) -- up 64% this year through March 15 -- which owns and operates a global network of 25,000 photocopiers and 3,500 ATM machines placed in grocery, convenience and drugstores. Insiders were buying hundreds of thousands of dollars' worth of company shares throughout last year at prices ranging from 75 cents to $8.98, and institutional investors at Calpers, Driehaus Capital Management, Wellington Management and Friedman Billings began to join them.
The TRM turnaround story: After several years of losing money as it built out its network, the company had declared profitability as a goal and achieved it last year, earning $5.5 million in 2003 after losing $4 million in 2002. The business obtains recurring income from the basic insight that despite much high-tech hype, we live in neither a cashless world nor a paperless world. Instead, there is a regular need on the part of consumers to have cash and make photocopies, and they will pay a small premium to do so at a convenient location. Retailers refill the copiers and ATMs with paper and cash and receive a revenue cut; TRM services them with a branded sales force. The company has grown so far without making acquisitions, but said it may pursue some this year to grow its market share.
In addition to these oddball microcaps, several medium-sized and large companies have outpaced their peers this year. AT&T Wireless (AWE, news, msgs) and Sepracor (SEPR, news, msgs), up 69% and 87%, have done it through the irreproducible feat of buyout offers; Sprint PCS Group (PCS, news, msgs), +52%, has done it through the knock-off belief that it could attract a buyout.
More memorable is Elan (ELN, news, msgs), a horribly beaten-up big Irish biotech -- down to around $1 in 2002 from $65 in 2001 on accounting concerns -- that has returned from the dead. The stock is up 136% this year, as investors came to appreciate its credible new management and focus more on its terrific drug pipeline than its big long-term debt. The stock is not as cheap as it was, obviously, but is still somewhat undervalued for a major biotech.
Another great story this year among midcaps is Research in Motion (RIMM, news, msgs), the Canadian maker of the popular Blackberry wireless e-mail devices, which is up 39%. The stock is wildly pricey now, but instructive in that shareholders have benefited from one of the few persistent technology innovations of recent memory. (Companies are buying them for traveling employees as an inexpensive substitute for laptops.)
In summary, the best stocks of the year are either special situations in which new shareholders are betting on hidden virtues; dramatic turnarounds; acquisition candidates; or blue-ribbon technology innovators. Well keep an eye on all of them as the year continues.
| Highlighted top stocks of 2004 | | Stock | % chg YTD | Price/sales | March 16 price | Market cap | | Danielson Holding (DHC, news, msgs) | 217.87 | 1.12 | $9.25 | $283 million | | Elan (ELN, news, msgs) | 144.99 | 7.49 | $16.88 | $5.8 billion | | TRM Corp. (TRMM, news, msgs) | 68.46 | 1.01 | $14.37 | $100 million | | Sprint PCS Group (PCS, news, msgs) | 51.42 | 0.72 | $8.51 | $8.9 billion | | Fremont General (FMT, news, msgs) | 59.43 | 2.63 | $26.96 | $1.9 billion | | Research In Motion (RIMM, news, msgs) | 39.32 | 15.59 | $93.11 | $7.3 billion | | Congoleum (CGM, news, msgs) | 210.29 | 0.08 | $2.11 | $17.5 million | | | | | | | Other top names of interest | | | | | | Rica Foods (RCF, news, msgs) | 333.91 | 0.41 | $4.99 | $59 million | | Viewpoint (VWPT, news, msgs) | 273.33 | 7.44 | $2.80 | $98 million | | Terra Nitrogen Co. (TNH, news, msgs) | 157.13 | 0.57 | $12.34 | $228 million | | Tenneco Automotive (TEN, news, msgs) | 82.96 | 0.14 | $12.24 | $527 million | | Ultralife Batteries (ULBI, news, msgs) | 61.79 | 3.95 | $20.03 | $314 million | | Veritas DGC (VTS, news, msgs) | 83.49 | 1.29 | $19.23 | $662 million | | | | | | | Top gainers -- StockScouter 10s | | | | | | CompX International (CIX, news, msgs) | 99.53 | 0.95 | $12.77 | $215 million | | NovaStar Financial (NFI, news, msgs) | 37.06 | 4.08 | $58.88 | $1.4 billion | | IMPAC Mortgage Holdings (IMH, news, msgs) | 28.50 | 3.19 | $23.40 | $1.2 billion | | NuCo2 (NUCO, news, msgs) | 27.53 | 2.2 | $16.26 | $171 million | | Harrington West Financial Group (HWFG, news, msgs) | 22.35 | 1.75 | $16.83 | $87 million | | Commerce Bancorp (CBH, news, msgs) | 23.91 | 4.09 | $65.04 | $4.9 billion |
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Fine Print
To see more analysis of the best stocks of 2004, visit this page at my personal Web site. . . . SuperGen (SUPG, news, msgs), the stock mentioned in my last mailbag column for its cancer drug candidate Dacogen, has risen 19% since on the strength of a study showing impressive preliminary results from the therapy. . . . Have you ever wondered why ATM machines are showing up in places as small as the local teriyaki shop or corner grocery? An ATM is really nothing more than a computer with a money drawer. The teriyaki guy can fill it with the $20s from his register at the end of the day instead of hauling them down to the bank at midnight and paying the bank for the privilege of keeping his money there. Out of every $2 withdrawal fee, the teriyaki guy gets $1.50 and the ATM network provider gets 50 cents. If the teriyaki guy gets about 30 withdrawals a day at his machine, he can pay off the $4,000 cost in a year. After that, he gets a nice little extra revenue stream, and his customer has more money to spend on meals. To learn more about TRM, visit its Web site.
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 jdm68@lycos.com. At the time of publication, Markman had personal or professional positions the following securities mentioned in this column: TRM Corp., Fremont General, Tenneco Automotive, Starbucks.
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