Cramer's Picks - 1 To Buy, 1 To Hold, 1 To Sell

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 |  Includes: ARMH, CLF, LSI, SCHL, TWX
by: The Ethical Investor

In last Monday's edition of Lighting Round on his "Mad Money" program, Jim Cramer was bullish on Time Warner (NYSE:TWX), Cliffs Natural Resources (NYSE:CLF) and LSI (NASDAQ:LSI), and bearish on Scholastic (NASDAQ:SCHL) and Arm Holdings (NASDAQ:ARMH). As always, I will only be quantitatively analyzing his bullish picks to determine if following his advice makes sense at current levels.

CLF and LSI are mid-cap stocks and have market capitalizations of approximately $8 billion and $4.5 billion, respectively. TWX is the largest firm on the list with a market capitalization of the $34 billion. LSI marginally outperformed the broader market during the last year providing a return of 4%. TWX and CLF generated negative returns. CLF in particular was a terrible performer with the stock declining 36% during the past 12-months. CLF does pay a healthy dividend of 4.5%. TWX is also a dividend payer with the stock currently yielding 2.9%.

Next, I evaluated the historical growth rates of revenue, income, and the projected growth rates. These are summarized in the table shown below:


Growth Rates

TWX

CLF

LSI

Revenue

10 Year

-3%

27%

1%

5 Year

-8%

29%

1%

1 Year

8%

45%

-20%

Income

10 Year

-

-

-

5 Year

-15%

42%

14%

1 Year

12%

59%

728%

EPS

10 Year

-

-

-

5 Year

-10%

35%

6%

1 Year

20%

53%

817%

Book Value

10 Year

-2%

45%

-12%

5 Year

-8%

43%

-18%

1 Year

-2%

45%

-14%

Growth Projections

Next Year

13%

27%

9%

Next 5 Year

12%

0.45%

17%

Click to enlarge

All the three companies reported a loss in the year 2002. TWX also reported declining growth rates during the past 10-year and 5-year periods. Its revenue and income increased by 8% and 20%, respectively last year. This trend is expected to continue with analysts forecasting a growth rate of 12% going forward. CLF has historically generated expanding growth rates; however, its long-term projected growth rate is miniscule in my opinion. LSI's book value growth rates are very disappointing in my opinion.

Having analyzed the historic and projected growth rates, I looked at the operational metrics such as margins and returns on equity and assets. These are shown below.

Margins

Averages

TWX

CLF

LSI

Gross Margins

10 Year

42%

20%

41%

5 Year

43%

28%

41%

Last Year

44%

40%

47%

TTM

43%

35%

47%

Operating Margins

10 Year

0%

15%

-17%

5 Year

9%

23%

-24%

Last Year

20%

35%

3%

TTM

20%

30%

3%

Operations

Averages

TWX

CLF

LSI

ROIC

10 Year

-5%

21%

-11%

5 Year

1%

20%

-17%

Last Year

6%

21%

28%

TTM

6%

19%

28%

Capex/Sales

10 Year

7%

6%

3%

5 Year

5%

7%

4%

Last Year

3%

13%

3%

TTM

3%

15%

3%

Click to enlarge

The three companies have either maintained or expanded their margins over the last year. CLF's margins have however declined in the trailing twelve month period. The return on invested capital has also reduced while the capital expenditure as a percentage of sales has increased. TWX and LSI are clear winners in this category. The ROIC of 6% for TWX is low in my opinion.

Having developed a good idea about the fundamentals of the three companies, the next step was to perform relative valuation. The multiples used in the analysis were based on historical analysis of individual company and industry multiples. The table below presents the valuation analysis results.

Valuation

TWX

CLF

LSI

Next Yr Proj EPS

$3.63

$10.84

$0.85

EPS Growth Rate

12%

0%

17%

Future EPS (5 Yr)

$5.05

$10.99

$1.37

Expected P/E

11.4

7

14

Price 5 Yrs Out

$57.61

$76.91

$19.14

Unlevered Beta

0.95

1.48

2.11

D/E Ratio

62%

62%

0%

Levered Beta

1.33

2.23

2.11

Risk Free Rate

2%

2%

2%

Risk Premium

6.00%

6.00%

6.00%

Size Premium

-0.36%

0.62%

0.74%

Cost of Equity

9.6%

16.0%

15.4%

Fair Value

$37.20

$38.04

$9.69

Current Price

$35.69

$56.76

$7.82

% Overvalued

-4%

33%

-24%

Click to enlarge

As shown in the table above, LSI is significantly undervalued at current levels and offers a return potential of 24%. TWX is fairly valued while CLF is grossly overvalued in my opinion. I would buy LSI, hold TWX and sell CLF.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.