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Stock Screen: Low-Risk Stocks with Above-Average Price Appreciation Potential - February 27, 2012
Investors can usually find stocks with low risk or stocks with strong expected relative price performance fairly easily. The challenge comes when you want to combine these two features, as the presence of one attribute often means that a stock lags in the other. In this screen, however, we seek to combine the best of both worlds, and search for equities that meet both of these criteria. To generate our list, we first required that all stocks be ranked 2 (Above Average), or higher, for Safety and 3 (Average), or better for Timeliness (i.e. relative price performance in the year ahead), two of Value Line’s main proprietary ranks. Then, to further reduce the relative collective risk that is usually associated with stocks that offer high returns, we limited our list to equities with a Price Stability Index (another one of Value Line’s proprietary measures) in the upper 12% of our Universe (the Index runs from 5 to 100, those equities with scores above 90 made the cut). Lastly, we only considered stocks with above-average price appreciation potential (the average was 60% as of February 27th).
Not surprisingly, the 32 equities arising from this screen are largely considered defensive in nature, and our list is dominated by established and conservatively run companies. Below we highlight two names on the list that stood out for their investment merit.
Danaher (DHR) designs, manufactures and markets professional, medical, industrial, and commercial products and services that typically possess strong brand names, innovative technology, and major market positions. The company also provides sensors and control instruments to manufacturing end markets and the electric utility industry; energetic material systems to defense systems integrators and prime contractors; and supplemental braking systems for commercial vehicles. Danaher operates in over 50 countries through five reporting segments: Test & Measurement (21% of 2011 revenues); Environmental (18%); Life Sciences & Diagnostics (29%); Dental (13%); and Industrial Technologies (19%). Sales in 2011 by country were: United States, 42%; Germany, 7%; China, 7%; Japan, 6%; All other (each country individually makes up less than 5% of total sales), 38%.
Earnings growth has been healthy at Danaher over the past two years. Indeed, the company handily bested the year before comparison again in the fourth quarter of 2011, with a gain of approximately 18%. Revenues jumped 38%, thanks largely to the presence of Beckman Coulter now being in the fold. BC was added early in 2011.
Although updated guidance has some on Wall Street trimming estimates, analyst Erik Manning believes that the company still holds strong earnings power. The BC integration seems to be moving along ahead of schedule and ought to be $0.30 accretive to share net in the years ahead. The deal is undoubtedly a catalyst, and Manning believes that it is full steam ahead from here on out. Meanwhile, the water treatment business may well get a real boost from the ratification of new rules applying to ballast water.
The stock is projected to deliver solid price appreciation over the next 3- to 5-years, with the benefits of the Beckman Coulter deal leading the way. Meanwhile, the company could be back in the acquisition game sooner than originally expected with the potential sale of its defense unit helping to replenish the coffers. The stock is a particular standout on a risk-adjusted basis, when you consider its 2 (Above Average) Safety rank.
Quest Diagnostics (DGX) is the largest independent research and testing lab in the world, holding about a 15% share of the more-than-$50 billion U.S. market. It provides insights that enable patients and physicians to make better healthcare decisions. During 2011, it generated net revenues of $7.5 billion and processed approximately 146 million test requisitions. Clinical testing accounted for approximately 91% of 2011 revenues, while healthcare information technology, clinical trials testing, life insurer services and diagnostic products made up the rest. Around 55% of testing revenue came from routine clinical testing, 14% originated from anatomic pathology testing, 27% from gene-based and esoteric testing, and the remainder stemmed from drugs of abuse testing (employer services). Approximately 94% of revenues are generated within the United States.
Despite a decline in physician office visits during 2011, due to the lackluster economy, Quest still managed to exceed earnings expectations. For the December quarter, earnings per share surpassed our estimate by 7%. The strong results were partly aided by increased demand for gene-based and esoteric testing. The recent acquisitions of Athena (neurological testing) and Celera (genetic sequencing) boosted the top line by 2.6%. Clinical Testing revenues were flat sans the new units, but did show meaningful sequential improvement. Management’s commentary suggests doctor visits are stabilizing and may improve in the near term. Overall, the company’s 2012 revenue growth guidance of 2.0% to 2.5% appears somewhat conservative, in our view.
Quest has a three-pronged growth strategy. The first part aims to establish new, innovative tests and advanced healthcare IT services. The second initiative involves enhancing the effectiveness of its sales team. The third goal is strengthening relationships with health plans and other payers. We think this will help the company record above-average long-term price appreciation.
Further, the company is in the midst of a multi-year cost reduction program. DGX is aiming for $500 million in cost cuts over the next several years. These restructuring efforts have already started to benefit the operating margin, and we expect over 50 basis points of improvement in the current year. Importantly, with key acquisitions in place, management has shifted its focus toward returning money to shareholders. In 2011, Quest returned $1 billion to investors through a combination of share repurchases and dividends. Further, the quarterly payout was recently increased by 70% and is now yielding 1.2%. We view these shares as a solid choice for the risk averse.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.