Wednesday - February 28, 2007
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As you are well aware, stocks dropped materially yesterday. The drop was in part a reaction to the Shanghai index, as well as a weaker-than- expected durable goods report and sentiment that was just too bullish.
The good news, as our Director of Research, Dirk van Dijk, wrote on the Analyst Blog yesterday, is that earnings for the S&P 500 are still forecast to increase this year. More importantly, he suggests that now is the time to start putting a shopping list together. I have included Dirk’s blog post in today’s newsletter. You’ll find it in the Zacks Equity Research section.
Wishing you prosperity,
Charles Rotblut, CFA
1. ZACKS RANK BUY STOCKS
Zacks #1 Ranked stocks average a 31.8% annual return. Every day on Zacks.com we highlight four new Zacks Rank Buy stocks. Each individual stock is chosen based on how well they match the criteria for the four main schools of investing: Aggressive Growth, Momentum, Growth & Income and Value.
Aggressive Growth – WebMD Health Corporation (WBMD)
WebMD Health Corporation (WBMD) has easily exceeded earnings estimates in each of the past five quarters by a minimum of 22% over that time frame. Over the past week, earnings estimates have taken a big leap. This year's numbers have jumped 18 cents to 55 cents per share. Similarly, next year's estimates have risen 18 cents to 78 cents per share. Read the analysis of WBMD now!
Growth & Income – LCA-Vision, Inc. (LCAV)
The Board of Directors at LCA-Vision, Inc. (LCAV), a Zacks #1 Rank stock, exceeded analysts’ earnings expectations in 14 out of the past 16 quarters. The company recently reported solid results for the fourth quarter and full year of 2006. Analysts have been upping their profit forecasts for this year and next. The Board of Directors has returned value to stockholders through both share repurchases and dividend payments. LCAV has a current dividend yield of 1.6%. Read the full analysis on LCAV now!
Momentum – Jack in the Box (JBX)
On Feb 21, Jack in the Box (JBX) reported first-quarter fiscal 2007 earnings of $1.03, up 47% from last year and a positive 27% surprise above analysts’ consensus estimates. Sales grew 5.4% to $856.7 million. JBX has not disappointed now in 17 straight quarters. Read the analysis of JBX now!
Value – Universal Stainless & Alloy Products, Inc. (USAP)
Universal Stainless & Alloy Products, Inc. (USAP), which was last presented as a Value stock on Oct 24, is up over 66%. The company exceeded analysts’ earnings expectations in 12 straight quarters by an average margin of 19.9%. USAP reported record fourth-quarter and full-year results in mid January. Consensus estimates continue to trend higher for this Zacks #1 Rank stock. The company has a price-to-book ratio of 3.2, compared to 4.8 for the market. Read the full analysis on USAP now!
2. SCREEN OF THE WEEK
Zacks.com offers three unique weekly commentaries that all
further our mission to help you Profit from the Pros. Today is
the latest installment of Screen of the Week from Kevin Matras.
Each week, Kevin shares with you another winning screen he has
discovered using the Research Wizard software from Zacks
Investment Research. Click here to learn more about the Research Wizard.
Price Targets and Multiple Expansion
Have you ever looked at an analyst’s price target and wondered where they came up with that number?
I hate to say it, but I’ve looked at enough price targets to conclude that I shouldn’t be looking at price targets.
Some are so far out there that I couldn’t imagine how a company could even get near it.
And others are so low (and seemingly unattended) that you’re already well above it, meaning you would have gotten out just as the biggest part of the stock’s move was heating up.
It’s true that price targets aren’t meant to be set-in-stone promises, and they shouldn’t be used in a vacuum either. But it’d be great if they could make a bit more sense and be a little more realistic.
So here’s a way to create your own price targets.
(Note: I’ll show you a quick and easy way to create your own price targets at the end of this article. But first, let me explain the dynamics of how you can use a company’s P/E ratio to do this and why it makes sense.)
Many people use P/E ratios to determine a company’s perceived under or overvaluation.
But you can also use the P/E ratio to determine upside and downside price targets as well.
First, the P/E ratio is simply price divided by (/) earnings. For example, if a stock’s price is $30 and its earnings are $1.25, then its P/E would be 24. ($30 price or ‘P’ / $1.25 earnings or ‘E’ = 24 P/E ratio)
If that stock’s earnings rose to $2.00, then the P/E would now be 15. ($30 price / $2.00 earnings = 15 P/E)
The most logical conclusion would be to see the stock’s price rise until its most recent multiple (or P/E ratio) of 24 was hit again. Why is this so ‘logical’? Because people had just been willing to pay 24 times a company’s earnings and they probably still are, if there’s reason to believe the company’s earnings will continue to improve.
So $2.00 (earnings) x 24 (the previous multiple or P/E ratio) = $48 (price). So the price target I’d have for that stock would now be $48. (And you could do the same thing on the downside as well.)
However, P/E ratios will often times increase or decrease based on macro-economic reasons, and not just on the stock’s own numbers. By macro-economics, I’m referring to the economy, the indexes (broader market) and the industries, etc.
For instance, as the economy gets better, companies will do better, and vice versa. So as things get better, an increase in earnings can be anticipated.
This being the case, people will be willing to pay more for earnings because they believe earnings will continue to rise and maybe even more aggressively. So people who were willing to pay 24 x earnings before ($30 price / $1.25 earnings = 24 P/E) may now be willing to pay 25 x earnings ($1.25 earnings x 25 P/E or multiple = $31.25 price target). Or may be as much as 30 x earnings ($1.25 earnings x a 30 earnings multiple = $37.50 price target), etc. This is all done in anticipation that earnings will be meaningfully higher down the road. And they’re willing to pay up for them now before the earnings arrive, since these higher earnings should push prices even higher still.
One of the keys to this forecasting, however, is gauging the stock’s historical P/E ratios of the past in order to get a better idea of the potential multiple expansion (or contraction) in the future.
Let’s say stock ABZ’s current price is $31.25 with $1.25 in earnings, for a P/E of 25. And let’s say its five-year average P/E is 30. Moreover, let’s also say the stock’s industry has started to move and is creating lots of interest. You could begin your evaluation by going back and seeing under what conditions stock ABZ scored its highest multiple (P/E) and see how the industry’s multiple had behaved as well. (You might even want to see how the market’s average P/E has changed too.)
Once you’ve determined that multiples are expanding for instance -– and based on past multiples, you’ve decided that another 5 points for your industry is reasonable -- you might conclude that another 5 points should be added to the future multiple of your stock too.
To come up with a price target, I’d take ABZ’s earnings ($1.25) and multiply it by the new multiple of 30 (25 + 5 = 30) to get my price target of $37.50.
And as earnings estimates climb, I’d continue to reevaluate my target price by reevaluating its multiple and etc. And assuming everything was the same, if earnings were now estimated at $1.50, I’d multiply $1.50 x my multiple of 30 for a new target of $45.
Of course, when predicting multiple expansions (or contractions), you should continue to pay attention to the market, the industry, its peers and of course the stock itself to avoid having your targets get stale.
Besides determining price targets, you can also use these ideas to find stocks on the move with potential multiple expansions.
The screen I’m running today finds stocks with P/E’s under the average for their Industry and are under their average P/E over the last five years. But it must also have shown an increase in its P/E over the last quarter to demonstrate its responsiveness to higher earnings, which is also a part of the screen.
The Parameters are:
And for good measure:
This screen produces plenty of great stocks to consider with the potential for continued multiple expansion. Here are a few of them:
This type of screening requires access to historical P/E ratios and forward P/E ratios. Most screeners don’t have this. But the Research Wizard does!
"Tip: Another way to quickly and easily determine your stock’s estimated potential price target is to multiply the stock’s price by the equation: (current P/E [using 12 month actuals] / divided by its forward P/E [using 12 month forward EPS Est.].
The calculation would look like this:
Price * ((current P/E) / (forward P/E)) = future price (or price target)
In other words: let’s say a stock’s price was $50 and its current P/E was 20. Let’s also say its forward P/E was 15. Take 20 divided by 15 and you get 1.33 (i.e., 15 goes into 20, 1.33 times). Anyway, multiply the stock price by 1.33, and you get $66.50.
So again, that’s: $50 * (20 / 15) = $66.50
This makes sense because if investors are willing to pay 20 times earnings now; assuming the company’s earnings forecast looks good, why wouldn’t they be willing to pay at least that in the future.
Get the rest of the stocks on this list and start looking for new stocks on the move. And then start creating your own price targets. Sign up now for your free trial to the Research Wizard and start finding better stocks today.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
3. ZACKS EQUITY RESEARCH
Valuations got significantly better today than they were yesterday. Not only are stocks off the most since the reopening of the market after 9/11, but the yield on the 10-year T-note has dropped sharply. While I’m not sure you want to jump in the market first thing tomorrow morning, it might be wise to get your shopping list together. You probably will want to buy on Monday.
The sell-off today is being driven by a sell-off in China, where the market had doubled in just a few short months. The authorities there were getting concerned that that market was getting overheated and moved to restrict credit going into the market. The other big factor is the ongoing imposition in the sub-prime mortgage market. I would avoid the sub-prime market still. Looking at banks, look for those that earn more of their money from fees, including investment banking fees, and avoid those that make their money from spread income. Spread income is the traditional bread and butter for banks. It is likely that there will be more loans going bad, and it is hard to make money borrowing short (i.e. taking in deposits) and lending long when the yield curve is inverted.
More. . .
Despite the relatively good existing home sales number today, I still think the worst of the housing market decline is ahead of us, not behind us. However, look to some of the Consumer Staples and Health Care names. They have very solid earnings growth expectations, and are less sensitive to a slowdown in the overall economy. Many of them also earn a substantial portion of their money from overseas, and the weakness of the dollar will give them a tailwind. For both of these sectors, positive estimate revisions for 2007 have been recently outpacing estimate cuts by more than two to one. On a total expected earnings basis, the earnings in the Health Care sector are expected to be 11.24% higher in 2007 than they were in 2006; for Consumer Staples, total earnings for S&P 500 firms are expected to be 11.21% higher.
For the S&P 500 as a whole, total earnings are expected to be up 7.85%. The world is not coming to an end. The future of the republic is not in doubt. This is a long-overdue correction. However, it is very rare for a correction to run its course in a single day. Start making your list and check it twice.
Dirk van Dijk, CFA is Director of Research for Zacks.com.
Real-time market insights from Zacks Equity Research Analysts. Stocks featured recently include Washington Mutual (WM), Cabela’s (CAB), Double Eagle (DBLE) and Cell Therapeutics (CTIC). To see their latest posts, click here.
4. ZACKS WEALTH MANAGEMENT
Every week, Zacks Wealth Management provides informative articles on how to build and protect wealth. Today’s topic is:
Life insurance – some consider it a waste of money, but it can be an invaluable way to provide for your loved ones and to diversify your assets. The purpose of life insurance is to replace the lost income your family needs if you were to pass on. The amount of life insurance will vary from person to person, depending on the family’s lifestyle and finances. So the question is, how much coverage do you really need?
The general rule is to buy insurance that is a multiple of your salary, from three times upwards to 20 times. I don’t like general rules because you end up buying too much or not buying enough coverage. The amount of life insurance should take into account the amounts of assets you have to cover expenses. The expenses can include estate or inheritance taxes, probate and funeral costs, uninsured medical costs, debt repayment, which includes your mortgage, and college funds for any children you may have. The expenses should also take in account your family’s future monthly expenses, such as child care and living expenses, college expenses and expenses for retraining or education for your spouse. Here a two ways to calculate the coverage you need:
Capital Utilization Method
In English, this method helps you calculate income you need for the future and leaves no money at the end of that future period. Let’s say you have specific needs like the ones below:
Payoff mortgage: $200,000 College funding: 300,000 Spouse and children’s needs (under 18 years old): 300,000 Spouse needs life expectancy: 200,000
Total needed: $1,000,000
If you have $500,000 in current coverage, then you’ll need to purchase another $500,000 of coverage. At the end of your spouse’s life expectancy, all the insurance proceeds will be utilized with nothing left over.
Capital Retention Method
In this scenario, you would use the interest on the proceeds and your original capital would still be there at the end of your spouse’s life expectancy. Let’s say you are married with child making $120,000 per year. If you die, you know your wife will receive $20,000 from social security. How much money is needed to provide an equivalent income while you were still alive? Since your spouse is getting $20,000 from social security, your family needs $100,000 more to get the equivalent of your salary. At a 5% return on investment you will need to have $2,000,000 of coverage. How did we arrive at that amount? Simple, $100,000 divided by 5%. It’s the same way as saying 5% of $2,000,000 equals $100,000. Keep in mind that you need to add $100,000 to this amount for total coverage of $2,100,000. That extra $100,000 is needed at the time of your passing because your family can’t wait until the end of the year to earn the 5% then start taking in that income.
Please be mindful of these calculation methods when figuring out your insurance needs. If you get too much coverage, you are paying unnecessary premiums that you could be investing, giving to charitable causes, or even leisure. If too little, your family pays the price. A great and trusted insurance pro will help you asses your needs and recommend the right amount
Jonas Zamora is a Certified Financial Planner™ professional.
This article is provided for informational purposes only and does not constitute legal or tax advice. Zacks Investment Management, Inc. is not engaged in rendering legal, tax, accounting or other professional services. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel.
CFP Board, a nonprofit regulatory organization, fosters professional standards in personal financial planning so that the public values, has access to and benefits from competent and ethical financial planning. CFP Board owns the certification marks CFP®, Certified Financial Planner™ and federally registered CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements. CFP Board currently authorizes more than 50,000 individuals to use these marks in the United States. For more about CFP Board, visit www.CFP.net.
MITCH ZACKS ON THE MARKETS
The stock market should begin to benefit from flows of assets out of other investment classes. More...
5. Best of the Zacks $100,000 Challenge
Zacks is conducting a nationwide talent search to find the very best stock pickers. The winner gets a $100,000 dream job with Zacks! . Sign up for free to join the competition, or just read what stocks the leading players are trading on the Zacks Challenge Player Blogs.
Here's what the leading players are saying this week:
Java J (Ranked #1 with $504,597)
MOMENTUM TRADING. HOW DO YOU DO IT ? WHAT TOOLS DO YOU USE ? These are some of the basic tools and techniques I use to do my trading...I have found over many, many years of experience that keeping things simple and pretty straightforward is the best approach...
Shoelessjoe (Ranked #2 with $291,787)
HOLD'EM OR FOLD'EM????? (TRMM) If you do your homework and buy good, solid stocks and they go down 5 or 10% on a day like this, are you going to sell and admit you must have been wrong? "Heck No" I am scooping up the value someone else is discarding because they got scared of the market.
Momotrader12 (Ranked #1065 with $102,722)
TIP OF THE DAY: DIVERSIFY- DON'T OWN TOO MANY CHINA STOCKS The market opened blood-red this morning. Ouch. Really big OUCH! Not only do I have several China stocks, I even hold a China ETF in my IRA (FXI). I am taking a beating. What do I do?
Beris (Ranked #25 with $126,414)
UTILITIES BRING NUCLEAR AND COAL POWER BACK TO THE TABLE! REVERSAL ON THE WAY? (ACI, ANR, JRCC) Nuclear plants are taking too long to build or power up. Natural gas prices keep rising through the roof, and wind and solar power are far from being available. Coal still appears to be the best solution.
OTHER TOOLS FROM ZACKS
At the heart of Zacks Investment Research is the Zacks Rank investment philosophy that continues to vastly outperform the market. Our Zacks #1 Ranked (Strong Buys) have produced the following results for investors:
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To truly take advantage of the Zacks Rank, you need to first understand how it works. That's why we created the free special report: "Zacks Rank Guide: Harnessing the Power of Earnings Estimate Revisions". Download a free copy now to prosper in the years to come.
Or view the full list of Zacks #1 Ranked stocks.
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The Zacks Performance Rank performance is the total return of equal weighted simulated portfolios consisting of those stocks with the indicated Zacks Rank net of fees. Results reflect the reinvestment of dividends and other earnings. Simulated results do not represent actual trading and may not reflect the impact that economic and market factors might have had on decision-making if an adviser were actually managing a client's money.
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