The market closed with authority on Friday, after the S&P 500 crossed 1,600. In a true bull market, bad news is overlooked and good news is celebrated. Currently, it seems as though our markets have transitioned to a bull market, and with the S&P 500 still trading around 15 times earnings, this can be a very lucrative period for investors. Therefore, the question becomes how to play this new market? In my opinion, the markets will feed on the great employment figures we saw on Friday and continue to trade higher. With that said, I am continuing my series with five stocks to watch next week in this "bull market".
A Continued Rally Following A Quarter of Great Improvements
Last week, shares of American International Group (NYSE:AIG) exploded through resistance at $41.00 and created new 52-week highs at $44.90. The catalyst for this move was earnings, which then pushed shares higher by 5.67% and led to a near 9% gain for the week. But here's the thing, AIG is still cheap, and I expect that it will continue to trade higher with the market now that it is trading in a new level.
I've been following AIG for about a year now, post-recession, and it seems as though two areas of the business are watched or criticized- more so than others: Property & Casualty and its combined ratio. Last year when the stock fell 5% after earnings, it was in part because its combined ratio reached 105; anything over 100 means there are more claims than premiums.
In this current quarter, the company saw its ratio fall from 102.1 to 97.2, which shows great progress. Furthermore, Property & Casualty insurance is a massive business and has lagged over the last year. Hence investors were delighted to see a 60% gain in operating income within the business. Overall, I see a massive company trading at a deep discount that is now starting to make believers out of even the most skeptical of investors. I think this last quarter solidified a lot of people who were on edge and with the stock trading $15 below its book value per share, I expect a lot of buying pressure in the week ahead.
An Underperformer to Now Outperform the Market
Since 2011, the auto industry has been the bread-and-butter of the U.S. economy with strong growth producing new jobs from manufacturing to sales in all regions of the country. Yet despite this fundamental performance, it has been the most underperforming industry. For example, General Motors (NYSE:GM) has continued to improve in units sold year-over-year, yet since July 2011 it had traded flat compared to the S&P 's 18% return during the same period. However, with strong earnings and solid sales data, the stock has broken through its range, creating new 52-week highs, and is now outperforming the S&P 500.
GM currently trades at 7.40 times next year's earnings with a price/sales ratio of 0.28, meaning it's cheap. The biggest problem for GM, and the auto industry, has been Europe, as quarterly losses have piled up with no end in sight. But during its quarterly report last Thursday, the company posted a loss in Europe of just $300 million (suggesting light at the end of the tunnel) but saw an 8% rise in North American sales (far beyond the growth of GDP). Therefore, with the stock being cheap, Europe stabilizing, and with it reaching new highs, I think we could see a continued rally next week with investors slower to sell and quicker to buy.
Awaiting the Second Post-Earnings Pop
Last week I suggested that Restoration Hardware (NYSE:RH) would trade higher during this last week, but instead it traded about even with the S&P 500. Theoretically, I shouldn't choose RH two weeks in a row. However, I believe that because of how strong it performed during its last quarter that it is fast approaching a post-earnings breakout. Hence I am adding it to the list once more!
Just in case you missed last week's version of "5 Stocks to Watch", I'll give you a quick rundown of why I think Restoration Hardware will see a post-earnings rally. First, it's trading at a 30% discount to Home Depot (NYSE:HD) with 26% growth in same store sales compared to Home Depot's 2% improvement. Next, it has not added any new retail stores but is growing rapidly, thus suggesting that with expansion expected in the immediate future that earnings will grow even faster. Finally, the stock has maintained its post-earnings 12% gain and has found a trading range.
In the last article, I did say that it is very difficult to predict a second post-earnings pop, but when fundamentals are tremendous relative to valuation, it almost always occurs. In this bull market, I am very confident that Restoration Hardware, trading in a very bullish home improvement space, will unleash at some point soon. But if not this week, I promise not to include in the next "Five Stocks to Watch".
A High-Flyer to Continue Outperforming the Market
If you want an example of a second post-earnings pop, as I described with Restoration Hardware, then look at Delta Airlines (NYSE:DAL). The stock jumped from $15 to $16.50 after earnings and then saw seven trading days of flat performance before breaking out into a new level last Friday, to $18.00. The stock is now trading at its highest level since 2008, having returned an 85% gain in the last six months. The company's improvements have been across the board, as it has fundamentally capitalized on lower fuel prices and growing volume.
Aside from posting a quarterly report where domestic revenue grew 6.10%, passenger revenue per mile increased by 4.10% and overall efficiency improved with declining fuel prices, recent data suggested a boost in global traffic (higher by 6%) as well. This is a company that is also trading very cheap, much like AIG and GM, with a price/sales ratio of just 0.40 at 5.70 times next year's earnings with room to improve its margins. The transportation sector has become a favorite in this new bull market, with Delta a favorite in the sector. Thus I expect the stock to remain strong and continue trading higher as long as the market is trading higher.
Small-Cap Growth Company Could Appreciate Before & After Earnings
So far I am one-in-one with my small cap selections. Last week I chose OncoSec Medical (NASDAQ:ONCS) and it returned a gain of 14% as investors anticipate upcoming data, giving the stock a six week 32% gain. This week I am looking ahead to earnings for my largest holding, XPO Logistics (NYSE:XPO). Last year the company posted revenue of $44.56 million in Q1, but on Wednesday, XPO is expected to post revenue of more than $100 million for the quarter.
XPO Logistics is one of the greatest growth stories in the market (in my opinion), and is the quintessential value investment. In 2011, it had revenue of $177 million, in 2012 it had $278 million, for 2013 it's expecting $600 million, and in 2014 the company will be on a run-rate of more than $1 billion. Yet despite this growth, some still question the margins of the company and the vision of its CEO Bradley Jacobs.
Jacobs was the founder of four billion dollar companies including United Waste and United Rentals. XPO Logistics will be the fifth. His strategy has always included acquisitions and cold starts. Once the company becomes "large" by his metrics, efficiency then becomes the focus. For the last three quarters, XPO Logistics has announced at least one acquisition, and although I am not sold on the fact that it will occur in this quarter, I do think the anticipation will push shares higher prior to earnings. Then, based on my conversations with Jacobs and his statements, that organic growth is occurring, and that recent acquisitions are actually increasing EBITDA, I think margins may show some improvements (for those few bears out there).
I'll conclude by saying that XPO Logistics is trading at just 0.50 times 2013's sales, yet has more than 100% growth. Sooner or later a company with this level of growth, which supersedes anything else in the transportation sector, will appreciate to reflect fundamentals and growth. It's just a matter of the company being noticed, Jacobs' vision and success being explained, and the company's $250 million in cash being put to good use in producing industry leading growth. Hence I would definitely watch this stock ahead, during, and after earnings with it being $3 off its all-time high.
In this article I have tried to focus on value, trends, and stocks that I believe will perform well in a bull market. Already, we are seeing money being taken from cyclical names and being put into those that have underperformed the market for a set number of quarters, thus presenting immediate upside. However, as a fundamental investor, the suggested upside for these stocks is based on long-term trends and my belief that each stock is attractive over a longer period of time. I urge you to explore your portfolio and also to assess stocks following earnings or other catalysts. I think you'll be surprised to find the level of value that is scattered throughout this market despite all-time highs.
Disclosure: I am long ONCS, XPO, AIG, RH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.