The stock market staged a technical follow-through day on Tuesday which tells investors that the market's bias has changed to a confirmed uptrend. However, history has clearly shown us that 3 out of 4 follow-through days fail and Tuesday’s follow-through day has the ingredients of one that will fail.
Still, no stock market rally has ever started without a follow-through day and sometimes quiet follow-through days, like the one in March 2009, can launch impressive rallies.The key factor in all follow-through days is leadership. How do the top industry groups leading this market higher based on price performance over the past six months look? Are there a handful of stocks with strong fundamentals and technicals to confirm the strength of the follow-through day in these industry groups?
These two questions are more important than anything else I look at when considering if a market has put in a real bottom or not. Before Tuesday, gold, silver, and gem stocks were the leading stocks and if the market staged a follow-through day it appeared they would enjoy the fruits of the future gains. That, clearly, is not the case after Tuesday and Wednesday and now there are only two top industry groups with top quality stocks in them with strong fundamentals and technicals.
Sadly, those two leading groups only have two stocks each that have both criteria that history proves can lead to big stock market gains over an intermediate term time-frame. Let’s take a look at these four stocks, starting with the Chemicals-Agriculture industry group followed by the Beverage-Non Alcoholic industry group.
In the Chemicals-Agriculture group we can see that two stocks are responsible for putting this group on top. CF Industries (CF) and Terra Nitrogen (TNH) are both high quality merchandise as indicated by their share price. Unlike many new investors, I prefer to deal with quality, and when you deal with quality you deal with high-priced stocks. You can’t buy a Mercedes Benz for the price of a Ford Focus and if you can you shouldn’t buy that Mercedes Benz as there is definitely something wrong with it.
The greatest stocks during any uptrend have the same key characteristics. They all sport strong EPS and sales growth, show a strong profit margin and return-on-equity, are liquid, are leaders in their industry, show strong relative strength compared to the overall market, and are being accumulated by big institutional funds. Every one of these stocks meet these requirements, minus TNH on the liquidity issue.
CF Industries (CF) is a Deerfield, IL manufacturer of nitrogen and phosphate fertilizers including urea, ammonium nitrate in North America. EPS growth the past six quarters have shown impressive growth of 104%, -40%, 13%, 84%, 52%, and 174%. During the past five quarters sales growth has gained 32%, 113%, 144%, 134%, and 38%. EPS estimates for 2011 are for a gain of 130%. This is the kind of growth smart money managers look for.
While the company may have a debt-to-shareholder ratio of 48% it sports a return-on-equity of 19% with a cash flow of $13.44. It also sports a 0.9% dividend yield and has a relatively low P/E ratio of 12 which is around the mid-range of its five year average between 3 and 23. These numbers above are the main reason mutual fund ownership has grown from 1168 to 1345 funds during the past four quarters. The smart money loves quality and we can see that is definitely the case here.
Terra Nitrogen (TNH) is a Deerfield, IA (not IL) manufacturer of fertilizers including urea ammonium nitrate and ammonia used by farmers to improve crop yield and quality. EPS growth the past six quarters have the same impressive growth we saw in CF Industries with gains of 19%, 8%, 119%, 114%, 102%, and 78%. Sales growth for those past eight quarters came in at 17%, 34%, 46%, 65%, and 19%. Right now, there are no future EPS estimates.
Terra Nitrogen sports zero debt, a return-on-equity of 115%, a cash flow of $11.70, and an 8.7% dividend yield. The P/E ratio might be near the upper end of the five-year historical range of 4-21 at 14 but if EPS growth continues at this pace that number will come down. Mutual fund managers like what they see as fund ownership has increased from 29 to 34 funds over the past four quarters.
Over in the Beverage-Non Alcoholic group we see the same thing with our two leaders Hansen Natural (HANS) and Diamond Foods (DMND) that we see in our two stocks from the Chemical-Agriculture group.
Hansen Natural (HANS) is a Corona, CA manufacturer of alternative beverages including energy drinks, fruit juices, smoothies, and natural sodas. EPS growth the past eight quarters have come in at 11%, 328%, -20%, 15%, 20%, -7%, 69%, and 30%. During that same time sales growth was 8%, 14%, -2%, 22%, 24%, 10%, 50%, and 26%. YOY EPS estimates for 2011 and 2012 are for gains of 32% and 18% respectively. Hansen Natural holds zero debt, has a return on equity of 30%, a cash flow of $2.52, and a P/E ratio of 31. The P/E ratio is near the upper end of its 12-45 five-year range.
However, Hansen has always traded at the high end of its range the entire time since its move started back in 2003. Since then it is up 16,000%, proving once again P/E ratios do not matter at all when it comes to finding monster stocks in the stock market. Numbers like the above are why mutual fund ownership has increased from 704 to 764 funds the past four quarters. These fund managers did not care about the P/E ratio and they are currently being rewarded with higher stock prices.
Diamond Foods (DMND) is a San Francisco, CA manufacturer of culinary, ingredient, food service and in-shell nuts and other snack products. EPS growth the past eight quarters have come in at an impressive 56%, 28%, 30%, 88%, 36%, -24%, 90%, and 73%. Sales growth during this time has been 1%, -8%, 22%, 25%, 55%, 40%, 40%, and 61%. YOY EPS estimates for 2011 and 2012 are for gains of 32% and 23% respectively. Diamond Foods does have a lot of debt with debt-to-shareholder equity at 136%. Still the recent EPS and sales growth along with a return-on-equity of 13% and a cash flow of $2.46 should help chop away at that in the future.
Mutual fund ownership is not that impressive but it is growing from 357 to 365 mutual funds during the past four quarters. However, we must keep in mind that it has fallen from 377 to 365 quarter-over-quarter. Normally, you want to see the numbers increase every quarter for the past four quarters. Fundamentals are the most important thing, for me, when I consider purchasing a stock. Technicals, however, tell me where to purchase these stocks. In that regard, I am already long Terra Nitrogen with the bounce off the 10 day moving average, on Wednesday, on volume stronger than any down volume during that time. My final cut loss is a close below the 20 day moving average if the stock does not move higher immediately.
To go long CF Industries I will need to see it pull back to either the 10 or 50 day moving average before considering a new long. For Hansen Natural, since I passed on the cup with handle breakout on Tuesday, I will have to find a spot at the 10 and 50 day moving average. For Diamond Foods I will need to see it bide more time sideways building a better base to break out from. The base is currently too V-shaped for me to be interested in going long here.
Disclosure: I am long TNH.
