Stocks - Stability is Sexy Again

Thusfar, I have featured a couple of more aggressive stocks on the blog, but I think that one of the earlier entries here should be more fundamental and focused on what should be core type holdings of any portfolio. Instead of trying to pick a couple of premiere company names to analyze - AnheuserBusch, Microsoft, Pfizer, Johnson&Johnson, Wal-Mart, etc - I will reference this article from Business Week this weekend based on conversations with analysts from Standard & Poors (S&P).

Traditionally, S&P is one of the more conservative (and high quality) analyst teams around. Their star-rating (with 5-stars representing a strong buy) is usually pretty good and is featured by Business Week (particularly on BW's website). S&P uses a proprietary metric called "Quality Ranking" (QR) to help it rate stocks. The following as an exlpanation of QR from the article:

S&P Quality Rankings measure both consistency and growth of earnings and dividends over a 10-year period. The ranking was actually invented in 1956, and is used extensively by S&P and others to determine how well a company has performed historically in both good times and bad.

Rankings range from A+, our highest ranking, to C, our lowest. Generally, we consider stocks ranked A+, A, and A- as high quality, and those ranked B, B-, and C as low quality, with B+ being an average ranking.

Just because a stock is ranked A or even A+ doesn't mean that the time is right to buy it. As with all stocks, prices and valuations will fluctuate over time. However, we've also found that high-quality stocks in general have outperformed over time, with lower risk than low-quality stocks.

A recent study S&P Equity Research found that over the long term, stocks of companies with a high S&P QR outperform both low-QR stocks and the S&P 500-stock index. However, the riskier low-QR stocks have been outperforming high-QR stocks since October, 2002. This showing has caused stocks with a high QR to trade at a discount to their low-QR counterparts, vs. a historical premium.

Therefore, S&P believes:

the tide is ready to turn to high-quality stocks -- those with long-term growth and stability in earnings and dividends, says Standard & Poor's equity analyst Richard Tortoriello. The reasons: Interest rates are nearing a peak, earnings growth is slowing, and valuations of riskier low-quality stocks are starting to find themselves stretched.

Additionally, S&P's most recent Outlook report says:

Equities graduate at the top of the asset classes. S&P recommending a 65% weighting in investors' portfolios. We expect equities will make the grade as the asset class choice of 2006, thanks to healthy growth prospects.

With stocks, investors should span the globe. We favor a diversified approach to our 65% equity weighting, with 45% dedicated to U.S. stocks and 20% to international issues from both developed and emerging markets.

I think that we need to keep a lot of the names discussed in BW's article on our radar in the near future for more detailed individual analysis. I haven't looked into many of the names yet, but the following are some names that have been on my radar at some point in the last 24 months:

Automatic Data Processing (ADP), Colgate-Palmolive (CL), Home Depot (HD), Johnson & Johnson (JNJ), PepsiCo (PEP), Wal-Mart (WMT), UnitedHealth Group (UNH), Wrigley, and Pfizer (PFE).

For Your Cash - The Case for Bonds

From Wall Street Journal, April 19, 2006

The Case for Bonds: With Rates Rising, It's Time to Move Out of Money Funds

Cash may no longer be king.

Sticking with a money-market fund has been a smart strategy over the past year, as interest rates have climbed and as short-term yields have rivaled those on longer-term bonds. But with 10-year Treasury notes recently breaking above 5% for the first time in almost four years, this could be a good time for cash investors to take a little more risk.

Here's the case for tiptoeing into short- and intermediate-term bonds, while also snapping up inflation-indexed Treasurys.

• Stepping out. When interest rates climb, your first instinct should be to lengthen the average maturity of your bond portfolio, so you take advantage of the higher yields.

And interest rates, of course, have risen. At yesterday's market close, 10-year Treasury notes were paying a tad less than 5%, up from 4.4% at the end of 2005 and 3.1% in June 2003. Problem is, short-term interest rates have also climbed, pushing up the average yield on taxable money-market funds to 4.2%.

That would seem to give the edge to money funds, because they are pretty much risk-free. Bonds, meanwhile, could get hammered if interest rates continue to climb.

Remember, bond prices and interest rates move in opposite directions. That's lately been bad news for bond funds, many of which have posted modest losses this year as interest rates have spiked higher. Still, if you are hiding out in a money-market fund or a short-term certificate of deposit, you might want to step out on the yield curve.

Consider moving a chunk of your money into a low-cost, short-term bond fund that sticks with two- or three-year bonds, such as TIAA-CREF Short-Term Bond or Vanguard Short-Term Bond Index. You might move another chunk into an intermediate-term bond fund that owns bonds with five-to-10 years to maturity, like T. Rowe Price U.S. Bond Index or Vanguard Intermediate-Term Investment Grade.

That way, you will pick up extra yield, possibly as much as a percentage point or more. It will also leave you in better shape, should short-term interest rates tumble.

True, there isn't much talk about that possibility right now. Instead, all the chatter is about how high the Federal Reserve will push short-term rates. But it is conceivable that today's hefty consumer debt, steep energy costs and higher interest rates will slow the economy, prompting an abrupt change in the Fed's policy -- and a sharp drop in short-term yields.

It's happened before. In 2001, the Fed orchestrated a collapse in short-term interest rates, causing the yield on taxable money-market funds to nose-dive that year to 1.6% from 5.9%.

By contrast, the yield on 10-year Treasurys barely budged during 2001, holding at just above 5%. But even if yields had fallen, bond investors would have had reason to cheer, because the decline in rates would have driven up bond prices.

"If you own six-month CDs, when you go to renew in six months, the rate could be much lower," warns Richard Schroeder, a financial planner in Amherst, N.Y. "But if you own a short-term bond fund, your yield would be protected for a while longer and you should get some capital gains."

• Inflating profits. When you buy your short- and intermediate-term bond funds, also consider putting in an order for some inflation-indexed Treasurys, formally known as Treasury Inflation-Protected Securities, or TIPS.

Inflation-indexed Treasury bonds are one of my favorite investments. They are a great way to diversify a stock portfolio, while also providing long-run protection against inflation.

The principal value of inflation-indexed Treasurys is stepped up along with the consumer-price index. You also earn a small amount of additional interest. This "real" yield reflects your gain above inflation -- and right now the rate is pretty attractive.

For instance, if you buy 10-year inflation-indexed Treasurys today, you can lock in a yield above inflation of just under 2.4 percentage points a year. That's some 2.6 percentage points less than the 5% yield on conventional 10-year Treasury notes.

In other words, if annual inflation turns out to be higher than 2.6% over the next 10 years, inflation-indexed Treasurys will outperform conventional Treasury notes. That strikes me as a distinct possibility.

But even without a pickup in inflation, the yield on inflation bonds looks pretty appealing. The average historical, after-inflation return on conventional intermediate and longer-term bonds is roughly 2.3%, notes investment adviser Larry Swedroe, co-author of "The Only Guide to a Winning Bond Strategy You'll Ever Need."

With inflation-indexed Treasurys, "you should be willing to accept a lower return, because you're getting insurance against unexpected inflation," he argues. Indeed, when 10-year TIPS hit 2.15% late last year, Mr. Swedroe started buying individual inflation-indexed Treasury bonds, and he has continued to buy as rates have climbed.

If you prefer mutual funds, check out offerings like Fidelity Inflation-Protected Bond or Vanguard Inflation-Protected Securities. One warning: Like other taxable bonds, inflation-indexed Treasurys can generate big tax bills. To postpone those bills, hold your inflation-indexed bonds or funds inside a tax-sheltered retirement account.

LOGI: Logitech International (LOGI)

Logitech International engages in the design, manufacture, and marketing of personal interface products for personal computers and other digital platforms.

You recognize their stuff. The company’s products include Web-cameras, mice, trackballs, and keyboards for the PC; interactive gaming controllers, multimedia speakers, headsets, and headphones for the PC and for gaming consoles; headsets for mobile phones; headsets, headphones, and speakers for mobile entertainment platforms; advanced remote controls; digital writing solutions; and 3D control devices. It sells its products to both original equipment manufacturers and to a network of retail distributors and resellers, principally in Europe, North America, and Asia Pacific.

A few months ago, LOGI was recommended by Jim Cramer on Mad Money. It piqued my interest and I kept it mind. This week, The Wall Street Journal ran a SmartMoney Stock Screen focused on strong returns on equity.

The WSJ's screen said:

ROE divides a company's profits by its net worth. In doing so it shows how efficiently its managers are using the plants, equipment and other resources they've been entrusted with. A variety of factors affect ROE: brand strength, pricing power, expense control, sales volume and more. Generally speaking, companies with sizable internal returns in the form of high ROEs are more likely than not to produce generous external returns in the form of share-price gains.

In October we listed eight survivors of our Efficiency Experts screen. They've since gained 34%, more than triple the S&P 500-stock index's increase.

The screen looks for companies whose returns on equity and on invested capital are in the top 25% for their industries. Return on invested capital, or ROIC, works just like ROE except it measures earnings relative to everything a company owns and the money it has borrowed. In doing so it makes up for ROE's key weakness: ROE tends to flatter companies whose heavy debt loads have shrunk their net worth, making it look like they're generating heaps of earnings with little resources.

Our screen also looks for operating margins and debt/capital ratios that have improved vs. their five-year averages, and five-year sales and earnings growth of at least 15% apiece. The nine companies on our list met these criteria, have more than $200 million in trailing 12-month sales and trade at least 100,000 shares on an average day. As always, please remember that stock screens produce research lists, not buy lists.

Thursday's "Efficiency Experts" list included Logitech and it brought it back to my mind.



Fortunately, and unforunately - timing is everything. LOGI ended this week at $42.44 after trading as low as $37 on Tuesday, posting a 14.7% gain in three days on a great earnings report highlighted by the company's 30th consecutive quarter of double digit sales growth!

Fourth-quarter net profit rose 27 percent to $51 million, or 52 cents per share, compared with $40.2 million, or 41 cents per share. Analysts had been looking for profit of $49 million.

For the full year, the company said net income rose 21 percent to $181 million, or $1.84 per share, compared with $149 million, or $1.53 per share, in the same period a year ago.

Gross margin for the year was 32 percent, compared with 34 percent last year.

Thirteen analysts polled by Reuters had on average expected the company to report a 20-percent rise in net profit for its financial year to end-March 2006 of $179 million.

Logitech has been benefiting from increased popularity of communication over the Internet, which is boosting sales of speakers, headsets and webcams.

In addition, "operational efficiencies and successful management of our working capital resulted in a record high in a single quarter for cash flow from operations of $137 million," Guerrino De Luca, Logitech's president and chief executive officer, said in a statement.

Fourth-quarter sales rose 16 percent to $466 million, while full-year sales rose 21 percent to $1.8 billion.

Looking ahead, Logitech said it expects sales and operating income to grow 15 percent, year over year. Gross margin is expected to be at the low end of its long-term targeted range of 32 percent to 34 percent, but slightly higher than for the previous year.

This week's run up boosted LOGI's P/E from 18 to 24.5. The company's 52wk high is $51.41.

It may not be the most opportune time to buy LOGI...but, feeling as good as I do about the company's future prospects (and strong consistent historical financial performance), this may be a great one to buy on some future pullbacks.


Other information:

(1) MSN's Stock Screener: LOGI is a 9 of 10

(2) Forbes article from 2000: Logitech, the little mousemaker that roars

Funds That Play The Field

Related to the spirit of the Buffet-esque mutual fund comes "Funds That Play the Field" from Business Week.

Funds That Play The Field
All-caps have their pick of equities, and are beating more focused peers
March 6, 2006

For nearly two decades, equity mutual funds have been boxed in. That's because marketers have been packaging funds by investment styles such as small-cap value or large-cap growth at the behest of pension consultants and financial advisers who want to fine-tune their asset allocations.

Yet a small group of funds can pick and choose securities from all corners of the equity universe. Now these funds, which are called all-cap funds, are outperforming their style-specific peers and attracting attention from both individual and institutional investors. "People are looking outside the box," says Don Cassidy, senior research analyst at Lipper (RTRSY ), the fund-tracking unit of Reuters (RTRSY ).

The numbers are compelling. All-cap funds, also known as multicap or go-anywhere funds, beat their U.S. diversified-equity peers during the one-, three-, five-, and 10-year periods ending Jan. 31, 2006, according to Lipper. The outperformance is most dramatic in the 12 months ended on Jan. 31, when all-cap funds gained an annualized 16.9% vs. 14.4% for U.S. diversified-stock funds.

What gives all-caps the performance edge? Cassidy likens them to the sort of hedge funds that let managers run with their best ideas, "giving the portfolio manager a wider playing field," he says. That flexibility often results in steadier returns and lower volatility.

To find a good all-cap fund, check out BusinessWeek's Mutual Fund Scoreboard (bwnt.businessweek.com/mutual_fund/), which identifies more than 140 all-cap portfolios from a universe of more than 4,000 mutual funds. Using five-year performance data from Standard & Poor's (MHP ), funds are ranked by their risk-adjusted returns from A (superior) through F (very poor). All-cap funds is a small fund category, so there are only seven that are rated A.

DIVERSIFICATION TOOL
Because all-cap managers can shop up and down the market-capitalization spectrum, portfolios are often eclectic. Case in point: the A-rated Hodges Fund (HDPMX ). Holdings in the $365 million portfolio, which gained an annualized 14.5% in the past five years, include lumbering giants such as General Motors (GM ) as well as tiny companies such as Life Time Fitness (LTM ), a small health-club chain. "One minute we may be buying a small company in a value situation. The next minute we are buying Apple (AAPL ), which is a large-growth stock that sells at a ridiculous multiple," says Don Hodges, manager of the Dallas-based fund.

That far-reaching, go-with-your-gut approach is what appeals to Gary Webb, chief executive of Webb Financial Group, a financial advisory firm in Bloomington, Minn., who started using the Hodges Fund as a core holding for his clients last year. "For smaller clients, it's a good diversification tool, and for bigger clients, I put it in their portfolio strictly because it's a good fund," Webb says.

While all-cap fund managers have the flexibility to buy all kinds of securities, their portfolios are often concentrated. The A-rated Fairholme Fund (FAIRX ) only owns about 20 securities, including Berkshire Hathaway (BRK ) and EchoStar Communications (DISH ). "There's a big advantage in being able to go anywhere and concentrate," says co-manager Larry Pitkowsky. Indeed, the $1.8 billion fund deftly rode out the bear market, thanks to a portfolio laden with steady insurance stocks. Even with a 2% loss in 2002, its five-year annualized return is 14.3%.

At the A-rated Heartland Select Value Fund (HRSVX ), one of co-manager David Fondrie's favorites is Oregon Steel Mills (OS ), which makes steel for railroad tracks and natural gas pipelines. Fondrie has held on to the stock even though it has almost doubled since the fund bought it last spring. All-cap managers can "hold on to their winners, and are not forced to sell when a stock they like has moved outside of a designated market range," Fondrie says. Translation: He's not boxed in.

EPL: Energy Partners Limited

EPL: Energy Partners Limited
Sentiment: Bullish
Current Price: $24.35
Est Market Cap: $925M
Est P/E: 13.6
52 Week Range: $19.06 - $32.98

Instead of wading into the waters with some slow, value plays...why not jump right into the hot topic of the last 18 months? Energy

Energy Partners Limited (EPL) has popped up on a couple of radars recently - both on Fox's Saturday morning business show and just last Thursday on Jim Cramer's Mad Money.

Cramer said:

Cramer said that Energy Partners is one of the greatest buy opportunities since he started "Mad Money."

Energy Partners is a company that is most levered to finding new oil, and there's nothing more important than getting to new oil.

It's a risky business, but it can be a lucrative one, he said. Not only is there a tremendous demand for companies finding fresh oil, but also this stock is cheap and can give you the most upside.

The company has been deepwater drilling in the Gulf of Mexico, and it was successful finding new oil, which could add almost 10% to the reserves, Cramer said.

Energy Partners had an 88% success rate last year, completing 52 projects. If the company is able to keep this output up, "the stock should soar."

Hurricanes Katrina and Rita did not permanently damage Energy Partners' operations in the Gulf of Mexico, but the stock is trading exactly where it was 12 months ago.

Cramer said Energy Partners may be a ripe, attractive target for a takeover at a big premium.

Of course, we shouldn't buy anything just because Cramer recommends it. In fact, you probably should never touch anything Cramer recommends in the first few days after his comments. But, EPL does meet my criteria of popping up on my radar screen from multiple directions.

Morningstar, of course, is no Cramer when it comes to risk. So, their March 6, 2006 release that cited EPL as one of their 5 Energy Stocks to Watch was also promising:

Energy Partners (EPL)
Eric Chenoweth, CFA
Fair Value Estimate: $34.00
Consider Buy: $21.70

From the Analyst Report: Energy Partners sees potential in a place that many others consider mature: the Gulf Coast. The firm is planning to spend a record $360 million in 2006 on exploration and production. Given the big jump in spending, the success or failure of next year's drilling program could have a large effect on Energy Partners' value. While many of its projects hold low to moderate risk, several could have a much bigger financial impact. Denali, in the East Bay off the southeastern tip of Louisiana, is particularly important. The well will cost close to $20 million and require drilling to a depth of around 22,000 feet, making it one of the riskiest projects on Energy Partners' plate in 2006. But the potential reward is also estimated to be quite large, ranging from hundreds of billion cubic feet to 1 trillion cubic feet.

Founded in 1998, EPL is an independent oil and natural gas exploration and production company based in New Orleans, Louisiana. The Company's operations are focused along the U. S. Gulf Coast, both onshore in south Louisiana and offshore in the Gulf of Mexico. It has interests in 38 producing fields and 5 fields under development located in the Gulf of Mexico Shelf and the Gulf Coast onshore regions. As of December 31, 2005, the company had estimated proved reserves of approximately 166.9 billion cubic feet of natural gas and 31.5 million barrels of oil.

EPL is currently trading at $24.35. The markets were closed on Friday, and were therefore unable to react to Cramer's comments.