6 Potential Sizzlers For A Summer Rally

by: Alan Brochstein, CFA

To me, it looks like the correction is ending. After two straight double-digit rallying quarters, it's not too surprising to consolidate. As they say, "two steps forward, one step back". In fact, that's about what happened, as the -11% move from the early April peak to the early June trough retraced about 45% of the move from early October's lows. We look to be almost back on track, and I believe that clearing 1370 on the S&P 500 will serve as the inflection point for people to recognize a "summer rally".

If you agree with me, you might want to consider investigating growth stocks that have held in fairly well, as typically these lead the way in the next expansion phase. With that in mind, I screened the Russell 3000 using Baseline to try to find some new ideas with market capitalization >$1 billion to investigate. Here is what I did (and why):

  • 1-year Price Return > 10% (Positive momentum vs. 4% S&P 500)
  • YTD Price Return > 6% (Neutral or positive momentum vs. 6% S&P 500)
  • YTD Price Return < 20% (Why chase?)
  • Price > 90% of 52-week high (Technical strength)
  • 2013 Earnings Growth > 14% (Growth stock)
  • Earnings Revisions 2012 > 0% (Stable/Positive earnings momentum)
  • Earnings Revisions 2013 > 2% (Positive earnings momentum
  • Trailing PE > 10 (If it's cheaper, something is wrong!)
  • Forward PE < 30 (Avoid speculative stocks)
  • PE < 10-year median (Avoid overpaying)

So, what I was trying to find is a group of stocks with positive price and earnings momentum with a growth orientation and reasonable valuation. This was a nasty correction: 35% of the Russell 3000 stocks sit more than 25% below their 52-week highs. For whatever reasons, investors refused to dump these growth stocks. Here are the six that made the cut:

I sorted the list by one-year return (low to high) and included a few other columns in addition to some of the info that was used to screen. Two of the stocks have cash in excess of debt (highlighted in green). I also included backwards earnings growth, which has been strong for all but LaSalle Hotel Properties (NYSE:LHO). Please keep in mind that these are not recommendations - none of these stocks is on my watchlist, though I am familiar with most of them.

LHO is a REIT focused on hotels in Boston, Chicago, Los Angeles, San Diego, San Francisco, Seattle and Washington, DC. As of Q1, they owned interests in 38 hotels (10,200 rooms). During Q1, they acquired Hotel Palomar in Washington, DC for $144mm. Q1 growth was strong, with RevPAR up 6% on a 4% increase in average daily rate and 2% increase in occupancy. Adjusted EBITDA grew 37% on a 152 bps improvement in margins. For 2012, the company is guiding to 5-7% RevPAR growth and 100-200bps margin improvement. It boosted the dividend by 82% to .80 per year (2.9% yield).

Bally Technologies (NYSE:BYI) has had a rough few years since casino construction slowed, but the whole industry appears to be regaining its footing. This stock has quietly returned close to its old high from the end of 2007. The PE then? Over 30, twice the valuation it gets today. The company has a reasonable amount of recurring revenue, and it has been increasing sales internationally. The company appears to be readying for legalized online gambling in the U.S. too. I profiled a smaller peer, Shuffle Master (NASDAQ:SHFL) a couple of weeks ago, and it pulled back to the $13 level that I had suggested was a good entry.

It's been a while since I looked at Tetra Tech (NASDAQ:TTEK). Like BYI, it is banging up against an all-time high. This company is a global provider of consulting, engineering, construction and technical services for water, natural resources, the environment, infrastructure and energy, offering full-service end-to-end solutions. In recent years, it has dramatically increased its engineering and consulting services and reduced its remediation and construction management. The former is focused on surface water, groundwater, waste management, mining, arctic engineering, and Oil Sands. Backlog grew 5% in 2011 due to acquisitions and international client orders, with U.S. dragging the growth down somewhat (especially federal government). It seems like the big drivers of growth now are international (mining/commodity-driven business) and U.S. commercial (industrial and energy projects after several years of deferral). The company has a lot of depreciation from acquisitions - free cash flow is substantially higher than net income. The company uses it to pay down acquisition-related debt, holding share-count growth to just 10% over the past seven years.

Monsanto (NYSE:MON) is the largest company on the list by far. I don't follow it, but I am aware of generic Round-Up being a problem in recent years. The company operates in two segments: Seeds and Genomics (larger by far) and Agricultural Productivity (Round-up and Harness pesticides). This is a very science-oriented company, spending 10% of sales on R&D so far in FY12 and almost 12% in FY10-FY11. The balance sheet here is significantly underleveraged, as the company has been repurchasing stock only marginally. Dividends, CapEx and share repurchases have all been relatively equal to one another over the past several years.

Susquehanna Bancshares (NASDAQ:SUSQ), based in Pennsylvania, is a deposit-rich bank that also operates other financial services, like asset management, property & casualty insurance and vehicle leasing. It trades at 1.5X TBV and a 2% dividend yield. The earnings and dividend imploded during the downturn, but both are in the recovery mode - the dividend has been boosted several times over the past 18 months. There's not a lot of insider ownership here - just 2%. I have a bank in my Conservative Growth/Balanced model portfolio that I prefer, National Bankshares (NASDAQ:NKSH). I would feel more confident recommending Cullen-Frost (NYSE:CFR) too.

LKQ (NASDAQ:LKQ) just lost the "X" in its symbol. This is a neat company that a client of mine owns. We like it better than Copart (NASDAQ:CPRT), which is a major supplier of theirs. Their CEO, Robert Wagman (47), actually worked at CPRT in the late 80s and early 90s and knows the industry well. He was promoted recently after joining the company (through an acquisition) in 1998. LKQ is focused mainly on North America, where it sells primarily used/refurbished car (and truck) parts, but the company made a pretty big acquisition in the UK last year that sounds promising. My understanding is that their IT system sets them apart from competitors. I also believe that Wagman has several growth initiatives. This one seems like a good stock for tough times!

Over the years, I have learned the importance of listening to the market. The stocks that passed this screen have held up very well in a tough market and offer reasonable valuations, seemingly good fundamentals and solid technicals. As always, I sure appreciate hearing from readers who might be familiar with these companies.

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