Can you name five boring industrial stocks that handed investors
triple-digit gains in the past two years or less? If you guessed
Caterpillar (CAT), you'd have one of them. I included CAT the last
time I wrote about "earnings machines" right before Apple (AAPL)
blew away the quarter last week.
That list of five companies with envious earnings
momentum that returned doubles, triples, and five-baggers also
included Netflix (NFLX), Chipotle (CMG), and priceline.com (PCLN).
Today, I give you four other industrial giants besides CAT, and I
will add the Chinese web search dominator Baidu to round out the
list.
The point of this exercise is to show you how a
system that focuses on earnings momentum, as predicted by analyst
estimate revisions, can keep you on the right side of powerful
trends for long enough to realize those triple-digit gains.
Why You Should Still Buy the Dips in These
Names
Here's more proof of the power of earnings estimate
revisions, with four industrial stocks that are generally much
sleepier -- and have value-oriented P/E's -- versus the technology
and internet names...
Deere (DE): Since August 2009, $50 to
$100
Eaton (ETN): Since September 2009, $25 to
$55
Cummins (CMI): Since October 2009, $45 to
$105
CNH Global (CNH): December 2009, $25 to
$50
Baidu (BIDU): April 2010, $60 to $160
I include Baidu because I like doing these
"backtests" in groups of 5 -- and they just reported blow-out
earnings again this quarter. Read my report "Baidu's Persistent
Search for Growth" for the details.
My "backtest" criteria for entering a long position
in the month shown for each name was this: when the stock first
became a Zacks #2 Rank (buy) after having been a Rank #4 (sell) --
plus it had to have never looked back down again below a Rank #3
(hold).
As with the first group of five mentioned above,
all these stocks experienced many weeks and months flipping between
a Rank #1 (strong buy) and Rank #2. Here’s how I explained it last
week...
"What we have found is that very strong stocks
tend to gravitate between Rank #1 and #2 for long periods over
several months or quarters. Since the Zacks Rank focuses on analyst
data only from the past 60 days, it highlights recent estimate
revisions and is intended to alert you to near-term
momentum.
But even a stock that tends to hang out in the
#1 and #2 Ranks will sometimes slip down to a #3 hold simply
because old data has dropped off, no new estimates have come in,
and earnings appear to have flat lined. But this is really just a
temporary lull, more so in analyst activity than in the company’s
real earnings power.
The five stocks I mentioned with triple digit
returns in the past 2 years or so since the recession -- AAPL, CMG,
NFLX, PCLN, and CAT -- all spent significant periods as #1 or #2
Rank stocks, often flipping back and forth as analysts moved
estimates and other stocks competed for a spot on the top
220."
EM and EER
Why would you still put money into the four
industrial stocks in my list even after the doubling most of them
have experienced? Two reasons: Emerging Markets (EM) and Earnings
Estimate Revisions (EER).
EM is the driving force of their profits as
billions of citizens and their governments clamor for the
lifestyles of the West. I have written extensively about the
massive push toward urbanization in China, India, Brazil and dozens
of other countries that is driving demand for the equipment and
technology of these firms to build infrastructure. See my
"Industrial Strength Power" for the most recent view on some of
these names.
EER are the core of the model we use at Zacks to
define those stocks with the highest return potential based on
earnings momentum. Here’s how I explained the power of this system
last week:
"The primary achievement of this focus on earnings
estimate revisions (EER) is that it precedes, and thus predicts,
what institutional money managers -- the elephants of financial
markets -- will do with their cash.
How? Because they have valuation models that tell
them what they are willing to pay for a stock today based on its
earnings tomorrow.
And what do they plug into their valuation models
to give them that answer? Forward-looking earnings estimates that
are produced by hundreds of quantitative minds in the investment
community.
Valuation Models and the Price of Tomorrow's
Profits
"Why? Because professional stock investors --
portfolio managers for pension funds, mutual funds, insurance
companies, and hedge funds -- are forward-looking by nature. They
don't care about the trailing P/E. They are focused on the forward
P/E which only comes from analyst earnings estimates.
And if estimates of futures earnings are rising in
both agreement and magnitude among the analysts, then the fair
value price that the valuation models of institutional investors
spits out will be rising. In other words, higher estimates today
equal higher stock prices tomorrow.
Are the analysts always right? Hardly, but in
aggregate, the Zacks Rank stock rating system is able to crunch and
quantify their inputs every night into a single very valuable and
historically predictive number through a proprietary formula that
sorts a universe of 4,400 stocks into five ratings.
The system alerts you immediately to earnings
momentum and this gives you time to buy (or sell) a stock ahead of
the elephants who usually take several weeks, and layers of
committee approvals, to accumulate new positions."
Continuation of Institutional Support
The four industrial stocks above -- ETN, CMI, DE,
and CNH -- are still either a Zacks #1 Rank (strong buy) or #2
(buy) based on their earnings momentum. And they all have something
else in common: a forward P/E multiple very close to 13, which is
about the market average.
But not all 500 stocks in the S&P index have
this kind of earnings power. And that's why all four of these names
will still be on the buy lists of fund managers, because a forward
P/E of 13 times looks cheap when the momentum is still up. Think of
the pauses that you see in buying as "continuation patterns" on a
price chart.
The institutions sometimes take a break from
buying, especially if stock slips back to a #3 Rank because there's
just not enough new analyst data. But as soon as the new estimates
roll in, the patterns of earnings momentum and price appreciation
tend to continue.
Long-Term or Short, Bet Aggressively on
EER
In a two year period of earnings momentum like
these ten stocks have experienced, how do you know to stay with
them when they drop occasionally to a #3 Rank? How do you know the
rapid recovery isn't over and they are headed to a Rank #4 next as
the earnings estimate revisions begin to turn downward?
Investors who believed in these stocks for the
slightly longer run than one or two quarters' earnings events could
have easily hung on with a rule that asked "Why sell a strong
earnings machine if the story and trend seem bound to continue?"
After all, a body in motion...
In this way, you are thinking long-term, yet being
aggressive with stocks that are experiencing both rapid earnings
momentum and institutional support. Now, the reality is that very
few investors buy these stocks and reap a full triple-digit gain.
Most get in too late, or out too early.
But even capturing a 25-50% move in a quarter or
two will do amazing things for your long-term portfolio results.
And this is simple enough to do when you put the low-risk,
high-reward dynamics of EER on your side.
Kevin Cook is a Senior Stock Strategist for
Zacks.com
BAIDU INC (BIDU): Free Stock Analysis Report
CATERPILLAR INC (CAT): Free Stock Analysis Report
CUMMINS INC (CMI): Free Stock Analysis Report
CNH GLOBAL NV (CNH): Free Stock Analysis Report
DEERE & CO (DE): Free Stock Analysis Report
EATON CORP (ETN): Free Stock Analysis Report
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