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Jubak's Journal
Recent articles:
• How to profit in a stuck-in-a-rut market, 4/16/2004
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10 winning stocks for a stuck-in-a-rut market
If you're looking for a defense against looming inflation but still don't want to give up growth, here are ways to play both angles.
By Jim Jubak
If investors were paying close attention last week, they could have glimpsed the kinds of stocks that will do well if inflation indeed is rekindling.
The Consumer Price Index surged ahead at a preliminary but still scary annualized rate of 6% in March. So, its little wonder that the Federal Funds futures market is now giving 50/50 odds to a Federal Reserve interest rate increase of half a percentage point in an attempt to damp down inflation fears.
But are those fears justified? Most of the CPI increase was concentrated in lodging (up 3.8% for the month and 46% annualized) and clothing (up 0.9% for the month and 11% annualized). Those sectors typically show big jumps in March, and both are coming off periods of price discounting because of weak demand. And despite Marchs strong growth in jobs, 360,000 new claims for unemployment, about 30,000 more than Wall Street and economists had expected, were filed in the week of April 5-9, according to the Labor Department. And on April 16, the Fed reported that industrial production in March fell a surprising 0.2%, ending a pattern of months of gains. Capacity utilization (a measure of how much of the nations manufacturing potential is actually in use) fell 0.2% as well, to 76.5%.
Not surprisingly, the stock market has stalled as the prevailing counterforces of growth and inflation slug it out. Technical analysts call this a trading range; I call it stuck in a rut. In my last column, "How to profit in a stuck-in-a-rut market, I described the big forces at play in the economy and stock market, and I suggested a growth/inflation barbell portfolio strategy that balanced out the opposing trends.
This week, Im recommending specific stocks to consider for that portfolio, and theres no better place to begin looking for inflation-beaters than last Tuesdays market action.
Looking for defensive stocks
Last Tuesday (April 13), the Dow Jones Industrial Average ($INDU) dropped 134 points, and the Nasdaq Composite ($COMPX) fell 35. Investors were running for cover on fears that inflation and interest rate increases were just around the corner. Still, 113 stocks managed to hit new highs for the day. The list is dominated by defensive stocks. These include energy stocks such as Anadarko Petroleum (APC, news, msgs), Burlington Resources (BR, news, msgs) and ChevronTexaco (CVX, news, msgs); natural resources stocks such as Boise Cascade (BCC, news, msgs), Weyerhaeuser (WY, news, msgs) and Texas Pacific Land Trust (TPL, news, msgs); and food stocks such as PepsiCo (PEP, news, msgs) and ConAgra Foods (CAG, news, msgs).
And these are the sectors that Ill draw from to make up the inflation-fears end of my barbell. Fortunately -- and not by chance -- Jubaks Picks is already heavily weighted in this direction. Ten of the current picks fall in this category. Energy stocks include BP (BP, news, msgs), Shell Transport & Trading (SC, news, msgs), Schlumberger (SLB, news, msgs), and Teekay Shipping (TK, news, msgs). Natural resource stocks include Freeport-McMoRan Copper & Gold (FCX, news, msgs), Noranda (NRD, news, msgs), Newmont Mining (NEM, news, msgs), The St. Joe Co. (JOE, news, msgs), and Tejon Ranch (TRC, news, msgs). Food stocks are represented by PepsiCo.
But what if youre still adding to this group or even just thinking about your first inflation stock buy?
The danger inherent in a group that has rallied as strongly as this one (while the market as a whole has moved in the opposite direction) is that youll wind up buying these stocks at a peak. And that would be just before the uncertain stock market decides to swing back in the other direction. PepsiCo is closing in on my May 2004 target price of $57. Id call this one a hold now and wait until the market swings away from this group before buying new PepsiCo shares. Same with Schlumberger at $62 and Noranda at $17.
But fortunately, thanks to speculators who built leveraged positions in gold and industrial metals stocks in anticipation of this moment and are now unwinding those positions, stocks in those two inflation-sensitive sectors have corrected to the point where some are now reasonable. If youre looking to add to your inflation-fears group, my suggestions would be metals stocks Southern Peru Copper (PCU, news, msgs) and Inco (N, news, msgs), and, because drillers have lagged energy producers, oil drilling stock National-Oilwell (NOI, news, msgs).
A rare combination of smart growth stocks
Now on to the other half of the barbell, the growth end.
Here the markets recent action isnt going to give us much help. Growth stocks have been out of favor ever since investors started focusing on inflation and interest rates. That out-of-favor status makes this a good time to buy shares in this group, but it also makes it harder to find them.
What am I looking for? A very rare two-part combination:
- Stocks that will deliver solid earnings growth as long as the economy is growing at even a modest rate and no matter what inflation and interest rates do
- Stocks that also are trading at relatively modest valuations in comparison to that growth rate
The problem, of course, is that most of the obvious candidates that meet my first requirement are trading at very hefty premiums to the market.
But you can still find stocks like these if you dig deep outside of the popular sectors. A stock that I added to Jubaks Picks recently, Engineered Support System (EASI, news, msgs) fits the bill. It trades at a trailing 12-month price-to-earnings ratio of 27.3, and analysts project fiscal 2004 earnings growth at 52%.
Three other stocks in Jubaks Picks -- Oshkosh Trucks (OSK, news, msgs), Donaldson (DCI, news, msgs) and Canadian Pacific Railway (CP, news, msgs) -- also fall into this group. Price-to earnings ratios are 21, 24.3 and 12.5, respectively, and projected fiscal 2004 growth 37%, 14%, and 18%. (All three are still buys at current prices.)
But I am definitely underweight at this end of the barbell. So let me give you three candidates that Ill be adding over the next week or so to Jubaks Picks:Ive written about all three of these stocks in the last few months. You can find more details on Wolverine and PETsMART in my March 10 column Turn to cheap, growing consumer stocks. SCP Pool was one of the stealth blue chips I wrote about in my Oct. 14 column "8 great blue chips youve never heard of.
Wolverine clearly fits the bill with its 12-month trailing price-to-earnings ratio of 19.4 and projected fiscal 2004 earnings growth of 12.8%. But SCP Pool and PETsMART are trading at price-to-earnings ratios of 28.2 and 29.7, respectively, on projected earnings growth of 16.6% and 21.1%. Arent these stocks too expensive and thus too risky to be adding to a portfolio now?
Low volatility has value for investors
That brings me to beta, another measure of a stocks risk and one thats central to the inflation fears/growth hopes barbell strategy. Beta is a measure of the volatility of a specific stock compared with the stock market as a whole. Thus, the market as a whole has, by definition, a beta of 1. Stocks that are less volatile than the market get a beta of less than one: the lower, the less volatile. Stocks with a beta of more than 1 are more volatile than the market: Ask Jeeves (ASKJ, news, msgs), for example, which has traded between $40.70 and $7.41 in the last 52 weeks, has a beta of 4.74.
A low beta doesnt equal low gains in a stocks price: PepsiCo has a beta of just 0.4, but the stock has returned 39% in the last 12 months. A low beta does, however, equal a history of steady growth without big downside surprises. (You can find a beta value for any stock on our Company Report page. Here it is for Pepsico.)
To make my strategy work, the two groups at the end of the barbell should have different betas. For the inflation fears group, Im looking for betas below 1. That I think maximizes the strength of this group: Steady, if sometimes slow, gains and very limited downside volatility. For the growth group, Im looking for higher betas, maybe as high as 1.5. Those higher betas effectively leverage the potential good earnings news from these stocks, making them likely to move up more on good news. Yet, by keeping beta below 1.5, Im not taking on the kind of risk that comes with an Intel (INTC, news, msgs) with its beta of 2, Mercury Interactive (MERQ, news, msgs) with its beta of 2.3 or Nvidia (NVDA, news, msgs) with its beta of about 3. In the current market, I think thats just potentially too much downside risk.
From a beta perspective, then, PETsMART and SCP Pool are exactly what Im looking for. SCP Pool has a beta of 1 and PETsMART a beta of 1.4.
OK, youre now quite possibly asking, where do I get the money to implement this strategy since I dont happen to be sitting on a pile of cash?
From selling those stocks that dont fit this strategy. For example, even though Freeport-McMoRan is in the right industry, its high beta of 1.3 makes it a bad fit with the low risk I need from the inflation group for this strategy. Im going to replace it in the inflation group with Southern Peru Copper and its beta of 0.6. And I'm going to fund my purchase of Wolverine by selling my shares of 2.4 beta Western Digital (WDC, news, msgs).
Next column: Ways to implement an inflation fears/growth hopes strategy without tearing up your existing portfolio using the new kid on the block, exchange-traded funds or ETFs.
Changes to Jubaks Picks
Sell Freeport-McMoRan Copper & Gold
The stock market overall is getting more volatile as investors worry about interest rate increases from the Federal Reserve. Plus the gold and basic metals sector is getting riskier as traders unwind hedges and sell to reduce their leverage. Freeport-McMoRan Copper & Gold (FCX, news, msgs) carries more individual stock risk than Id like. So Im selling these shares and switching the money into Southern Peru Copper. Im selling the shares with a 6% profit since I added them to Jubaks Picks on Sept. 23, 2003. (Full disclosure: I will be selling my shares of Freeport-McMoRan Copper & Gold three days after this column is posted.)
Buy Southern Peru Copper
Shares of Southern Peru Copper (PCU, news, msgs) have been hammered this year as traders who had borrowed cheap money to create leveraged positions in copper and copper stocks moved to take profits and cover their loans. The stock, which traded as high as $49.50 on Jan. 20, hit a 2004 low of $36.30 on March 24. Since then, it has behaved like a stock that has found its bottom. I like the shares of basic metals producers as inflation hedges and because of increasing demand from China, especially for copper and nickel. Im adding Southern Peru Copper to Jubaks Picks with a September 2004 target price of $45 a share.
Sell Western Digital
We could get a short-term bounce after the selling in the sector, but I expect technology stocks to show weakness until June. Part of that is seasonal: This is usually a rough period for technology stocks as companies come off their third- and fourth-quarter sales and earnings peaks. Part of it is interest rate fears. With their high multiples, technology stocks are, along with financials and utilities, likely to bear more than their share of punishment as investors decide to head for safety. I still like the underlying long-term trends in the disk drive business, as the devices get smaller and smaller and show up in more and more products. Im not willing, however, to sit through this period of weakness in such volatile shares. I'm selling Western Digital (WDC, news, msgs) with an 11% loss since I added it to Jubaks Picks on November 21, 2003. (Full disclosure: I will be selling my shares of Western Digital three days after this column is posted.)
Buy Wolverine World Wide
Wolverine World Wide (WWW, news, msgs) continues to build on the success of its Merrell shoe line in the casual shoe market by acquiring new brands, most recently Sebago, and reviving its classic Hush Puppy and CAT brands. Net sales picked up by 8% in the fourth quarter, and Wolverine increased gross margins by 1.7 percentage points. The company generated $100 million in operating cash flow in the most recent fiscal year and saw its order backlog grow by 20%. The stock trades at 19.4 times trailing 12-month earnings per share. Im adding the stock to Jubaks Picks with a target price of $28.60 by October 2004.
New developments on past columns
8 stocks to watch in a wandering market
PepsiCo (PEP, news, msgs) reported earnings of 45 cents a share, about 7% better than Wall Streets projections of 42 cents a share, on April 15. Revenue grew by 11% to $6.13 billion. The driver, as it has been in recent quarters, was the companys salty foods division, Frito-Lay, which succeeded in launching new products Lays Stax and Lays Classics that gained additional shelf space in grocery stores. Later this year, PepsiCo will roll out a new line of lower-carbohydrate Doritos and Tostitos chips designed to capture a share of the low-carbohydrate diet market. The new chips will have 60% fewer carbohydrates than the existing versions. As of April 20, Im upping my target price to $59 by June 2004 from the recent $57 by May. (Full disclosure: I own shares of PepsiCo.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: BP, Donaldson, Freeport-McMoRan Copper & Gold, Newmont Mining, Noranda, Pepsico, Oshkosh Trucks, The St. Joe Company, Schlumberger, and Tejon Ranch. He does not own short positions in any stock mentioned in this column.
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