Whenever you find yourself on the side of the majority, it's time to pause and reflect. - Mark Twain
What a great contrarian quote from Twain. Let's reflect. In regards to investing, a contrarian is one who attempts to profit by investing against the grain, to go against the crowd, because the crowd is usually wrong and always late. A contrarian believes that certain crowd behavior among investors can lead to exploitable opportunities. Pervasive cynicism about a stock or sector can drive the price so low that it exaggerates the investment's perils and belittles its future prospects. Identifying and seizing on these opportunities is a well-known investing tactic utilized by legendary investing experts such as Warren Buffett. I believe these basic materials stocks may present such an opportunity. I am not buying the global meltdown theory based on the eurozone debt debacle and a slowing Chinese economy. I have heard this story one too many times before. I have selected the five largest S&P 500 basic materials companies with PEG Ratios of less than one and EPS quarterly growth rates of greater than 25% to review in this article. We are looking for diamonds in the rough.
A company's EPS growth rate is conceivably the most important statistic to understand before investing in a stock. Each time you consider starting a position in a stock, you should prudently scrutinize its profitability EPS information.
The reason earnings are so vital to investors is that they tell you about the relative profitability of a company. EPS is the most important derivative of profitability for a shareholder. Earnings per share is defined as the net income of a company divided by the shares of common stock outstanding. With the EPS measure, you are looking at the amount of money left over for shareholders. The value is reported after taxes are subtracted.
Furthermore, these stocks are trading at bargain basement prices based on the fundamental indicator known as the PEG ratio (Price/Earning/Growth). The PEG ratio is a widely accepted indicator of a stock's prospective value. It is favored by many analysts over the price to earnings ratio for the reason that it also accounts for growth. Similar to the price to earnings ratio, a lower PEG means that the stock is more undervalued. Many investors use one as the cut-off point for PEG ratios. A PEG of 1 or less is believed to be a promising indication that significant value exists.
As Warren Buffett would say, "Price is what you pay, value is what you get." There is one caveat regarding the use of the PEG ratio though, and it's a big one: You need to perform additional due diligence and determine if the projected growth of the company is from healthy growth sources such as organic growth versus growth by acquisition or stocks buy backs, which are not necessarily bad, but may be unsustainable.
Now, simply screening for top S&P 500 basic materials stocks trading with PEG ratios of less than one and significant EPS quarterly growth rates is only the first step to finding alpha. In the following sections, we will take a closer look at these stocks to determine if the discounts are justified and these are value trades rather than traps. I will perform a brief review of the fundamental and technical state of each company. Additionally, we will discern if any upside potential exists based on sector, industry or company specific catalyst. The following table depicts summary statistics and Wednesday's performance for the stocks.
CF Industries Holdings, Inc. (CF)
CF was down over 4% Wednesday most likely on a Dahlman Rose downgrade citing fertilizer prices will be impacted from an increasingly likely large corn crop. Their price target is $155. The stock is trading down 14% from its recent 52 week high of $203 and approximately 5% above its 200 day SMA. The company has many fundamental positives. CF has a PEG Ratio of .60, a forward P/E ratio of 8.89 and an EPS growth rate of 41.64% quarter over quarter. CF has a price to book ratio of 2.43. The stock has pulled back close to its 200 day SMA which should provide support. I see the 200 day SMA as an excellent entry point.
A robust beginning to the U.S. planting season allowed CF to crush the Street's estimates by a wide margin pushing the stock to a new 52 week high. CF is the largest North American producer of nitrogen. Nitrogen is a major nutrient for corn which is predicted to have a record year this year. CF's nitrogen sales were up 37% year over year based on an unusually warm winter allowing farmers to plant earlier in the season. Nevertheless, the second quarter is when the planting season is fully underway and I don't think the story is over just yet. I see the pullback as a buying opportunity. Give CF another 5% and begin layering in to a position a quarter at a time at the 200 day SMA.
Denbury Resources Inc. (DNR)
DNR was down almost 1% Wednesday. The stock is trading down 23% from its recent 52 week high and approximately 11% down for the week. The company has many fundamental positives. DNR has a PEG Ratio of .44, a forward P/E ratio of 9.67 and an EPS growth rate of 912.77% quarter over quarter. DNR has a price to book ratio of 1.37. The stock has pulled back to 2% above its 200 day SMA which should provide support. I see the 200 day SMA as an excellent entry point for the stock.
Denbury had a fantastic first quarter. The company earned 41 cents per share versus the Street's estimate of 38 cents. Top line revenues of $645.1 million also impressed besting the Street's estimates of $634.4 million. DNR has beat EPS estimates consecutively for the past four quarters. One of the top Bakken players, DNR had record Bakken sales volumes for the quarter providing a 29% increase year over year. In March, Barclays Capital reiterated its Overweight rating on the stock and upped its price target to $26. This suggests the stock has an approximately 50% upside from here. The stock looks undervalued here.
EOG Resources, Inc. (EOG)
EOG was up over 1% Wednesday after reporting a blowout quarter last night. The company reported Q1 EPS of $1.17 beating the Street's estimates by $0.03. Revenues of $2.81B were up 47.9% year over year beating estimates by $590M. EOG raised its 2012 total company liquids production growth target to 33% from 30% and raised the total company production growth target to 7% from 5.5%. The Chairman and Chief Executive Officer of EOG Resources Mr. Mark Papa stated on Mad Money last night,
Simply put, we believe the Eagleford Shale is the largest oil field found in the United States since Prudhoe Bay and that was in 1968. Not only is it the largest oil field found since then, we believe it yields the best reinvestment rate of return of any current oil and gas investment that we know of in the industry right now for large assets.
The stock is trading down 12.5% from its recent 52 week high and approximately $119 per share. The company has many fundamental positives. EOG has a PEG Ratio of .65, a forward P/E ratio of 15.50 and an EPS growth rate of 112.53% quarter over quarter. EOG has a price to book ratio of 2.24. The stock has pulled back to 6% above its 200 day SMA which should provide support. I see the 200 day SMA as an excellent entry point for the stock. The stock is being held down due to the belief that oil prices will drop due to a global recession. I'm not buying it. This stock is undervalued and primed to rally.
National Oilwell Varco, Inc. (NOV)
NOV was down over 2% Wednesday. The stock is trading down 23% from its recent 52 week high and approximately 9% down for the week. The company has many fundamental positives. NOV has a PEG Ratio of .97, a forward P/E ratio of 9.85 and an EPS growth rate of 47.85% quarter over quarter. NOV has a price to book ratio of 1.57. Technically, the stock is weak. The stock has recently dropped six percent below its 200 day SMA which is bearish.
Nevertheless, the company has beat earnings estimates three quarters in a row. Analysts have recently raised consensus estimates for fiscal years 2012 and 2013. NOV earned $4.77 in fiscal year 2011. Analysts project earnings of $5.94 per share in 2012 and $6.88 in 2013. I believe this stock is undervalued for the same reason as EOG. The market is focused on macro issues currently. Nevertheless, it always reverts back to fundamentals. This stock is a buy, but I'd wait until it rises above the 200 day SMA and confirms an uptrend before starting a position.
Chesapeake Energy Corporation (CHK)
What more can I say about CHK? The stock has been crushed to a point where the fundamentals look great. The problem is ... it's a value trap. When I stated previously to stay away from the stock as more shenanigans were sure to be forthcoming; even I had no idea of how much more was looming. Just today three additional news bytes were released.
First, Moody's lowered its outlook on Chesapeake to negative from stable, reflecting growing risks from CHK's massive capital expenditure plan. CHK's cash flows are vulnerable to further declines in natural gas prices, Moody's says, and it remains dependent on completing asset sales to maintain liquidity to fund its transition toward higher liquids production. Second, Reuters sources say in the weeks before CEO Aubrey McClendon was stripped of his chairmanship, he arranged an additional $450M loan from a longtime backer which was simultaneously arranging a $1.25B round of financing for Chesapeake itself. And finally, Wednesday morning a shareholder lawsuit accused Chesapeake of understating the cost of personal jet travel provided to top executives and directors by as much as $10M per year. Chesapeake had claimed personal use of company aircraft was "limited," with jets used "primarily" for business travel.
The only ray of hope for CHK is Southeastern Asset Management's involvement in the debacle. With a 12% state in the company they have taken an active role. They are a great company and may be able to put together a package to increase shareholder wealth, but I can't hang my hat on this one bright spot. I say avoid it.
A contrarian view combined with courage in your convictions is one of many ways to make money in the market. Our innate instincts encourage us to depart a sinking ship. This survival tactic impacts the way we invest. When market panic creates opportunities to buy stock in solid companies with sound prospects, hopefully you have powder dry and take advantage. The market is clearly at an inflection point. To open a position you must have courage in your convictions. A market correction provides opportunity to buy great names at a discount price. You must do your due diligence to find the diamonds in the rough.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly basis to reduce risk and setting a 5% trailing stop loss order to minimize losses.