July 2007 Archives (Tom A's Stock Picks)

July 2007 Archives

Strategy Lab, getting started

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Now that I have 1,000,000 to invest, with the DOW down 4.2% last week, the question is whether to start buying now or wait for the major indices to go down more. My usual answer is to buy stocks if I think the price is attractive, otherwise I continue screening for prospects. Rather than take full size positions all at once, I usually start with 40% of my maximum position size and and add two more increments of 30% as new information becomes available or buying opportunities arise. I limit my holding of any one stock to 15% of my total portfolio.

Over the past several months I have developed a list of stocks that are at very low prices relative to my preferred metrics, which are the Price/5 year average EPS or the Price/Sales, looking at 5 years of history to determine a range.

During the first week, I am planning to buy 6 or 7 stocks from my list, with each position more or less 60,000, for a total of 400,000 invested. Anticipating volatility, this approach will leave me ample funds to apply to any buying opportunities that may develop.

Buying MBI

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Tomorrow I will buy 1,000 shares of MBIA, symbol MBI. MBI is a financial guarnatee Insurance Company, Triple A rated, guaranteeing payment on government bonds and also, what is of interest given today's market concerns, on various collections of subprime mortgages. The stock is trading at attractive prices, primarily becuase of fears that the subprime problems will affect their earnings. I think the current price reflects an over-reaction and will eventually be corrected.

MBI publishes a nonGAAP metric, Adjusted Book Value per Share, which is book value adjusted by adding the net present value of expected future earnings on business which has already been booked. Over the past five years, it has traded in a range of .57 to 1.16 times Adjusted Book Value/Share. I think its normal range would be from .70 to 1.05. Adjusted Book Value has increased steadily over the past 5 years, including the most recent quarter. At Friday's closing price of 60.33, MBI was trading at .77 of its Adjusted Book Value as of 6/30/2007. I think it is a good buy because it is trading at less than its book value. Projecting Adjusted Book Value at 81.91 by the end of the year, and using the midpoint of its value range, I think 70/share is a realisitc target, with the possibility of going as high as 80.

I was able to locate a Commentary Report at S&P's website, standardandpoors.com, which provided some good information and concluded that Suprime Exposures were unlikely to cause problems for Bond Insurors. I also located and reviewed a document at MBI's website entitled "MBIA's CDO Strategy, Portfolio Analysis and Subprime Exposure." After reviewing these, I think MBIA is unlikely to be seriously affected by SubPrime issues.

The level of fear in the credit market should create improved demand for financial guarantees and should also permit MBI to achieve better pricing. MBI has been very conservative during the past few years, writing less coverage involving the 2006 Vintage of Subprime Mortgages than some of its competitors, and is well positioned to profit from the increased demand for credit enhancement products that I think will be caused by current difficulties.

Buying JNJ

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Bought 1,000 JNJ at 59.98

JNJ hit a 52 week low last week. There have been concerns about upcoming patent expirations, issues with their anemia drugs, and also with drug coated stents. I think this has created a buying opportunity - JNJ's pipeline will produce new drugs and medical devices, and their diversifacation, strong brands, and strong cash flow will maintain growth and eventually the stock will return to its normal multiples.

I was pleased when they passed on the Guidant acquisition and I think buying Pfizer's consumer products made good strategic sense.

JNJ operates in three segments: Parmaceutical, Medical Devices, and Consumer Products. Valuing the sectors separtely at multiples typical of the sectors they operate in suggests JNJ is undervalued.

This is an excellent defensive stock. With so much volatility in the market, and after major indexes have made repetitious new highs, I am very happy to pick up a nice defnesive stock at a 52 week low.

Buying BJS

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Bought 2,500 BJS at 26.27

BJS reported on 7/24, less than same quarter last year, "Canadian Breakup" cited as reason. Revenue was down 3% form the previous quarter and up 3% from the same quarter last year. This halts what had been 17% growth. They have moved some equipment from Canada to International locations and that should improve things.

Oil Services has grown profitably as energy prices have increased and companies have worked to produce more oil. I think this will resume fairly soon because of increasing global demand and limited supplies. BJS does anticipate pricing pressure in the US but they are a strong competitor and should be able to deal with it.

Looking at Price/Sales over the past 5 years, you could have made money buying this any time the Price to Sales was under 2.0 - it is 1.7 more or less which I think is a good buy point.

Buying OLN

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Bought 3,000 Olin, OLN, at 20.41

OLN operates in 3 segments, Chlor-Alkali, Metals, and Winchester. My interest is in the Chlor-Alkali, which is a commodity chemicals business and very cyclical, characterized by periods of over supply. In recent years, this industry has undergone what participants describe as "capacity rationalization," meaning a number of plants have been shut down. OLN has an agreement to acquires Pioneer, PONR, which operates only in the Chlor Alkali industry. They see substantial synergies and cost savings in the acquistion.

While the combined entiry will be 3rd in Chlor Alkali, it will be a substantial factor in Bleach, which has generally shown higher and more stable margins. OLN regards itself as a low cost producer of Chlor Alkali products. Taking all of this together, I think that if and when Chlor-Alkali demand increases, the business will be very profitable, because supply and demand will be very closely matched.

OLN has addressed the underfunding of its Pension Obligations, and is reducing inventory in its Metals (brass) segment, creating inventory profits.

Metals and Winchester have low margins, while Chlor-Alkali has high margins. This makes it a little difficult to do a segment analysis. I tried a number of approaches and think OLN is worth somewhere between 25 and 33 per share.

Buying AMAT

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Bought 3,000 AMAT at 21.71

AMAT is the leader in the Semi-Conductor Equipment industry, from that position they have moved into making equipment for Flat Panel (Display) Manufacturers, and they are now expanding into the Solar Power arena.

At a P/E of 17.8, AMAT is less expensive than other members of the industry in which it is a leader. On a Price/Sales basis, in the past it has been profitable to buy AMAT at 3 or less - it is now at 3.04.

My interest is in the Solar initiative. Given current energy prices and government subsidies, the solar power industry should grow and become economically rational as costs are driven down in the same way they have been in semiconductors. AMAT has the financial strength and R&D capabilities to become a significant factor in this business. From my standpoint, it is more effective to invest in Solar by buying AMAT than it would be to try to pick from among a host of startups and IPOs in an effort to select the winners. The solar is a kind of free plus to the Semiconductor Equipment.

Buying UPS

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Bought 700 UPS at 75.74.

UPS is trading on the low side of its range based on either Price/Sales or Price to 5 Year Average EPS, the reason being growth has slowed quite a bit in recent quarters.

UPS has a strong cash flow, which they have applied very effectively in expanding their sorting facilites. I think their capex has enabled them to improve their systems and efficiency which has helped support margins. They are building a hub in Shanghai which is expected to become operational in 2008 and should promote growth in China, compensating for the slower growth in the US.

Based on the company's goal of increasing EPS in a range of 6-10%, and additional growth in the China market, I look for UPS's shares to increase to the midpoint of their historical value range, 93 as I figure it, over a period of 1 to 2 years.

In the meantime, the dividend yields 2.36%.

Buying CTAS

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Bought 1,500 CTAS at 36.75

CTAS is a leader in the uniform rental business and has grown steadily and profitably, with a continuing stream of acquisitions of smaller players. The slowdown in US manufacturing, where most of their customers are, has caused a slowdown in growth and put pressure on margins. The stock is now trading on the low end of its historic ranges of Earnings/5 Year Average EPS or Price/Sales.

Management has addressed the problem by branching out into Other Services,such as first aid, fire safety, and document storage. The size of their existing customer base offers opportunites to sell new services. Also, they are in the process of reorganizing sales to develop more internal growth and to expand the sales of ancillary products. This reorganizaion has taken longer than they anticipated.

I think growth will improve over the next two years, as the benefits of the sales restructuring develop and internal growth increases. The Other Serivces Segment grew 16.5% in fiscal year 2007 over 2006, and 18.6% in 2006 over 2005, and now generates 26.2% of their revenue. I regard this as evidence that they still have room to expand. Based on this, I think the stock should increase to 45-50 within 1 to 2 years.

Buying PG

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Bought 1,000 PG at 62.44

Proctor and Gamble is on the low side of its historical Price/5 Year Average EPS range, and I like it as a defensive stock. I bought it on that basis, and after the fact I have been asking myself, it is cheap by historical standards, but why is it going to go up this year? A downgrade by Lehman Bros planted the seeds of that question, I added the article to my notes and forgot about it.

I will plan to review the financials and other material to see if I can develop a more positive rationale for this trade.

Tom A's Stock Picks

Tom Armistead

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