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Investment Ideas

The New Year is now upon us with renewed hopes and dreams. The turn of the year also usually signifies a dedication to self-improvement through resolutions or fun goals that we set for ourselves to accomplish in the coming year. Some of mine include: 1) finishing those hand-stitched buckskin pants I've been working on for the last two years, 2) reading three Russian novels, 3) playing the djembe drum more often and, as always, 4) improving my stock-selection methods.

In past articles, I've discussed research tools, testing ideas and ways to pick stocks. In this article I'm going to put it all together and provide a stock focus list for 2012. While I'm not advocating a "buy-and-bury-your-head-in-the-sand-for-eternity" approach, I do believe these stocks have potential for good profitability if held for the next year or more, which will also help tax-wise since they'll be considered long-term gains.

To build a one-year focused screen, I'm going to use the Research Wizard's data and software to find some of the best ideas that test well over a 52-week holding period. Once I have this basket of individual factors, I'll put them together to form a comprehensive strategy.

The list of factors that I tested included valuation ratios (P/E, P/S, P/Book, etc.), margins (Net, Operating, & Pretax), growth (earnings & sales), profitability (ROE, ROA, ROI, etc.), analyst earnings estimate changes and recommendations, and the Zacks Rank. In this study I simply tested each idea, e.g., P/E, on multiple 52-week periods from the beginning of 2000 through the end of 2011. Then I selected the five best factors, making sure that each factor came from a different style category to diversify the point of view.

The five factors that I chose were Return on Equity (ROE), Price/Sales (P/S), Operating Margin, rating change and the Zacks Rank. Of the 30+ factors I tested, I feel these five have good performance and are complimentary to each other. They also come from a diverse set of documented stock anomalies: Fundamental, Value and Analyst. In fact, a combination of these anomalies creates what's called a Multi-Anomaly approach. Check it out.

Testing a strategy made up of these five components, which selected only twelve stocks in each testing period, resulted in an average compounded annual return of 11.3% from 2000 – 2011. That's significantly higher than the S&P 500's 0.7% per year over that same period. I don't even have to ask if you'd rather make 11% or 1% per year. We all know the answer to that.

But, what is really interesting is that I was prepared to warn you that with only twelve stocks in this strategy, it would have been much more volatile that the S&P 500. Yet the results indicate otherwise. The average losing stretch for the S&P 500 was 2.3 years, while it was 1.3 for this strategy. Furthermore, the average maximum drawdown was -40.4% for the S&P while -39.3% for the strategy. Finally, the average losing period was -18.0% for the S&P 500 versus -20.2% for the strategy. These results show that the historical risks were similar. So would you like to invest in a strategy that has a similar risk profile to the market yet makes more than ten times the annual market return? Indeed, another rhetorical question.

Here's a method for finding highly-rated and upgraded stocks with good profitability and margins at a reasonable price:

  • First, start with only US common stocks.
  • Next, create a liquid, investible set of the stocks with the largest 3000 market values and average daily trading volume = to 100,000 shares (if there's not enough liquidity, it’ll be hard for you to trade it).
  • Add another filter by selecting those stocks with a Zacks Rank = 1. (Let's stick with only the best rated stocks.)
  • Select only those companies with a positive percentage change in analyst ratings over the last 4 weeks. (We're looking for stocks with mostly upgrades over the past month.)
  • Keep only those 50 stocks with the highest Return on Equity. (ROE is a great measure of a firm's profitability.)
  • Pick the 25 stocks with the highest Operating Margin. (Turning revenue into income is the key to a business.)
  • Select the top 12 stocks with the lowest price-to-sales ratio. (Lower means you want to pay less per unit of company revenue.)

Here are 12 stocks for 2012 based on this method (1/13/12):

(ADS - Analyst Report) - Alliance Data Systems Corporation

Alliance Data Systems, which probably tops this list, provides data-driven and transaction-based marketing, and customer loyalty solutions primarily in the United States and Canada. The stock price of this company has been appreciating, it is a Strong Buy on the Zacks Rank, the company is highly profitable and it remains a good value based on its price-to-sales ratio.

(RYN - Snapshot Report)– Rayonier Inc.

Rayonier, a Jacksonville, Florida-based company, engages in the sale and development of real estate and timberland management, as well as the production and sale of cellulose fibers in the US and Australia. This company is financially strong with solid profitability and margin ratios. This company's stock has also seen some good price appreciation. The upswing should continue since the company pays a nice dividend, which is highly desired in this low-yield market environment.

(RL - Analyst Report) – Ralph Lauren Corporation

This New York-based designer has experienced solid growth and profitability over the past year and is expected to continue as the company increases its global brand awareness. The stock price of this retailer has been jumping, yet remains an excellent value. Zacks Rank considers this company a Strong Buy and I do too.

GDI – Gardner Denver, Inc.

Gardner Denver designs, manufactures, and markets industrial machinery and related parts and services throughout the world. This company has it all: a Strong Buy Zacks Rank, analyst upgrades, good profitability and margins, and the stock remains a good bargain.

(GNRC - Snapshot Report) – Generac Holdings Inc.

Generac designs, manufactures, and markets backup power generation products for residential, light-commercial, and industrial markets in North America. This company makes the 2012 list due to its great Zacks Rank, great profitability and operating margin, and its P/S ratio.

VPHM – Viropharma Inc.

Viropharma, which engages in the global development and commercialization of therapeutic products that address serious diseases, is guiding higher-than-expected sales for the year, which has sent the stock price soaring even higher. As a result, analysts have upgraded their recommendations for this company's stock, which also holds a top Zacks Rank. Profitability and margins remain strong and the annual sales should make profits higher as well.

(MKSI - Analyst Report) – MKS Instruments Inc.

MKS Instruments is a great bargain for the level of sales and profitability it offers at its current price. The stock is also a Zacks #1 Rank and the company has good operating margins, with a solid Cash Flow. MKS provides instruments, subsystems and process control solutions that measure, control, power, monitor and analyze parameters of manufacturing processes worldwide.

(SGY - Analyst Report) – Stone Energy Corp.

Stone Energy is an independent oil and natural gas company that engages in the acquisition, exploration, development and operation of oil and gas properties in the Gulf of Mexico and the Appalachian region. The stock of this company is a good value based on its inexpensive price, good profitability, strong operating margins, and great Zacks Rank.

(WU - Analyst Report) – Western Union Co.

Western Union, which provides money transfer and payment services worldwide, makes the list because of its bargain stock price, great profitability and Zacks Rank. The improving economic situation will benefit payment services companies fairly well.

(PAY - Analyst Report) – VeriFone Systems, Inc.

VeriFone is another payment services company that is poised to do well as the economy improves. Analysts have already begun upgrading the stock of this profitable and still inexpensive company.

(MNTA - Snapshot Report) – Momenta Pharmaceuticals Inc.

Momenta is a biotech company that specializes in the characterization and process engineering of complex molecules. This company is up and coming with strong profitability, a clearly inexpensive stock price relative to its industry, increasing sales and income and analyst stock upgrades.

(STBZ - Snapshot Report) – State Bank Financial Corporation

Community-based banks offer an attractive alterative to customers versus the big banks, and this small cap fits the bill perfectly with its fantastic Zacks Rank, good profitability and attractive price.

So should we make it a baker's dozen and add one more? No, I'll give you the chance to work the Research Wizard's magic to come up with your own lucky number 13. The more you are involved in your investment process, the better investor you'll become and your portfolio will reflect it. Click here to learn more!

Here's to a Happy and Profitable 2012!

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