4 Guru Strategy Approved Chemical Stocks

Includes: BCPC, NEU, SCL, SSL
by: John P. Reese

We all know who makes the products that play huge roles in Americans' daily lives -- the Apples (NASDAQ:AAPL) and Coca-Colas (NYSE:KO) and Exxon Mobils (NYSE:XOM) and Hondas (NYSE:HMC) of the world. But do you know who makes the products used to make those firms' well-known products?

In many cases, the answer to that question is chemical companies. From plastics to fuel additives to food flavorings, chemical companies have a hand in many-- if not most-- of the products that you can find throughout your home or office every day. Right now, chemical manufacturers have a couple of major factors working in their favor. First, there is the rise of "fracking" in the U.S., which has made natural gas more abundant and cheaper. Natural gas is one of the key ingredients in a myriad of products made by chemical companies, and it's also a major source of power that those companies use in creating their products. Therefore, cheap natural gas can mean wide profit margins for many of these firms.

In addition, as the nascent U.S. housing recovery continues, demand for many construction products that are created with the help of chemicals -- paint, glass, and polyurethane, to name just a few -- should continue to rise.

Of course, there are concerns to consider as well. Chemical stocks tend to be quite cyclical, so the slowdown in China and potential problems with the U.S. "fiscal cliff" are risk factors. But some of those fears already appear baked into valuations, with the chemical manufacturing industry sporting an overall price/earnings ratio of just 13.5. And in terms of individual chemical plays, my Guru Strategies (computer models that are each based on the approach of a different investing great) are finding several that look very intriguing right now. Here are a few that get particularly high marks from these strategies. Keep in mind that these types of stocks should be considered within a broader, well-diversified portfolio.

Stepan Company (NYSE:SCL): Based in Illinois, Stepan makes a variety of chemicals, ranging from surfactants used in cleaning products, to polymers used in the construction and auto industries, to specialty products like natural flavorings. The firm has a market cap of about $1 billion, and gets strong interest from two of my strategies. My James O'Shaughnessy-based approach likes that it has upped earnings per share in each year of the past half-decade, and that it has a key tandem of qualities: a high relative strength (76) and a low price/sales ratio (0.55). That indicates that the stock is getting some love from investors, but hasn't yet gotten too pricey.

My Peter Lynch-based model likes Stepan's impressive 41.6% long-term EPS growth rate. (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate.) Lynch famously used the P/E-to-Growth ratio to find bargain-priced growth stocks, and when we divide Stepan's 14.0 P/E ratio by that long-term growth rate, we get a PEG of 0.34. That falls into this model's best-case category (below 0.5).

Balchem Corporation (NASDAQ:BCPC): New York State-based Balchem makes specialty performance ingredients and products for the food, nutritional, pharmaceutical and medical sterilization industries, with end-users including both humans and animals. It has a market cap just under $1 billion, and it gets strong interest from my Warren Buffett-inspired model. A few reasons: It has increased earnings in 9 of past 10 years (with the lone dip coming nine years ago); it has no long-term debt; and it has averaged a 10-year return on equity of almost 17%.

Sasol Limited (NYSE:SSL): Sasol, based in South Africa, makes a wide range of chemicals, as well as liquid fuels and electricity. It operates in more than three dozen countries around the globe. Sasol ($27 billion market cap) gets strong interest from both my Benjamin Graham- and Lynch-based models. The Graham approach likes its 2.12 current ratio, and the fact that its net current assets of $3.9 billion nearly triple its long-term debt of $1.5 billion. Sasol is also cheap, trading for 11.2 times three-year average earnings.

Meanwhile, my Lynch-based model likes Sasol's 4.8% dividend yield and yield-adjusted PEG of 0.66. (For large, slow or moderate growth companies, Lynch added dividend yield to the "G" portion of the PEG.)

NewMarket Corporation (NYSE:NEU): Based in Virginia, NewMarket ($3.4 billion market cap) began as a paper company 145 years ago. Today, it develops chemical additives that make fuels burn cleaner, engines run smoother, and machines last longer.

NewMarket has been growing EPS at a 39.7% rate over the long-term, a big reason why my Lynch-based model likes the stock. In addition, it trades for a reasonable 15.4 times earnings, which makes for an excellent 0.39 PEG ratio.

Disclosure: I am long SSL, MOS, SCL, NEU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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