October was certainly a month for the ages, as equity investors across the globe found there was nowhere to hide from this crisis, which quickly progressed from a housing issue to a credit issue to a leverage issue to a global recession.
But for all the negatives, the world financial leaders have arguably responded better than at any time in history, adding crucial liquidity to frozen markets, backstopping loans and lowering interest rates. Markets have begun to price-in a recession in the United States and elsewhere, but its depth and breadth are two big unknowns, and this compels us to seek out only the best-positioned companies in their industries. Key traits are strong cash flows and balance sheets, and the ability to operate for a long time without significant access to the credit markets.
Sector-wise, there were no winners last month. The S&P 500 as a whole was down 17% in October, and the best-performing sector was healthcare with a return of -9.5%. But there were success stories amongst individual companies, and even a few that were positive for the month. Today we'll highlight three diverse companies - a pharmaceutical company, a stock exchange, and a retailer - each of which rebounded well to finish the month, and may have the strength and stability to grow earnings in this most difficult of environments.
My Filter - A Necessity In This Market
These days we have to be much stricter in our fundamental considerations for stocks. Simple P/E ratios or earnings growth rates won't cut it anymore - we should be including metrics for debt loads, current assets, and operating margins. For the latter I chose to filter out companies with lower than 5% operating margins; in this market all margins are up for a good squeeze, and low-margin businesses may quickly find themselves in the red.
Each of these three survivors of October's gauntlet also score well on three key metrics:
- Debt/Equity ratio below 0.5 - this means that the company has at least $2 in equity for every $1 in long-term debt;
- Forward P/E under 15 - this ensures that earnings stability exists into 2009;
- Current Ratio above 1.0 - this means the company has more in current assets than in current liabilities (due in less than one year)
Bristol Myers Squibb (NYSE:BMY)
This "Big Pharma" stalwart recently reported third quarter revenues up 15%, and booked a huge $2 billion gain on the sale of a business unit in August. Bristol now has over $7 billion cash on the balance sheet plus over $1 billion in nicely-appreciated ImClone Systems (Nasdaq:IMCL) shares following the failed takeover attempt of the biotech outfit. Bristol grew its operating margin, net margin, and return on equity in the third quarter, and the stock also pays a very satisfying 5.9% yield. (To learn more about margins, read The Bottom Line On Margins.)
NASDAQ OMX Group (Nasdaq:NDAQ)
The exchange operator has a unique service to offer at a time of heightened uncertainty. Higher volatility usually leads to higher trade volumes and activity, which means more money for Nasdaq and other gatekeepers. The company has great electronic trading platforms, which have allowed it to come in and swoop up massive volumes previously executed on other exchanges. Nasdaq's share of NYSE-listed stock volume was up nearly 200% year-over-year, reaching over 1.5 billion shares in September. Meanwhile, average daily volumes for U.S. equities reached a record 3.3 billion shares in September, and by all accounts October tracked even higher judging by aggregate trading volumes across the world.
Nasdaq reports earnings on November 6, and I look for management to indicate that they are done acquiring for now (Nasdaq purchased the Philadelphia Stock Exchange last year), and are focused on growing their existing platforms in the U.S. and Europe, while focusing on cutting costs, and creating synergies.
Dollar Tree (Nasdaq:DLTR)
This company may win the award for the most simplistic business model: "Everything in the store - $1". As such, the value proposition is easy to understand; the consumer is weak, and by all accounts getting weaker. And Dollar Tree, along with peers like Family Dollar (NYSE:FDO) and 99 Cents Only Stores (NYSE:NDN) cater to that highest of budget ideals - when all else fails, shop as cheap as you can. (Learn more about Retailers at Analyzing Retail Stocks)
In the company's second quarter reported in August, total sales rose 12.5% while comparables rose an impressive 6.5% and net income was up 15%. And that data tracks back to the summer, when the consumer was, at the margin, much more confident. As 2008 plods on, look for these deep discount retailers to continue turning in strong comps growth. While I'm not crazy about the slight premium multiple that Dollar Tree shares are getting to the broad market, it is currently justified given the catalysts to earnings growth in the coming quarters.
Final Thoughts
Many investors have long lists of stocks that they feel are trading at great values, and to be certain there are many signs of an oversold market. But until we can digest what kind of earnings growth (or decline) to predict in 2009 and beyond, predicting the "E" in the P/E ratio is like trying to pin the tail on the donkey. Until the blindfolds come off, take extra steps in your research to find fundamentally strong companies with ample short-term cash flow.
Do you have a favorite penny-pinching stock? Will the economy pick up in 2009, or are we destined for deep recession? Join me in the Investopedia Community (EpiphanyOne) to discuss your views and make your stock picks for all to see.
