Screening For Stocks As The Economy Inches Forward

by: Erik Dellith

The latest GDP figures, and Friday's labor figures, suggest that the U.S. economy continues on its slow-growth path. I anticipate GDP growth will hover around 2% for this year. The question that then arises is how to hunt for stocks that should fare well in this environment.

The Bureau of Economic Analysis (BEA) reported on Jan. 30 that the U.S. economy contracted modestly in the fourth quarter, largely as a result of declines in government spending and a reversal of the inventory buildup earlier in the year. Focusing on the more substantial portions of GDP, we see that the U.S. consumer continues to chug along. Thus, the economy expanded at a relatively sluggish pace for the year. Yet, over the last 12 months or so, the Dow Jones Industrial Average and the S&P 500 Index have climbed about 10% and 14%, respectively. This leads one to wonder about the potential for richly valued or overvalued stocks. In fact, Richard Suttmeier, in a recent article, mentioned about how 63% of the stocks are overvalued. So, valuation has to be a key factor in this. We've constructed a screen for identifying stocks against this backdrop:

First, we want to focus on companies that have been growing relatively quickly. So, we focus on companies where sales and EPS growth over the last year is faster than the industry average. That narrows down our list to 630 names.

Second, we expect the general economic trend to continue. With that in mind, we want to identify companies where the growth is expected to continue, as well. Thus, we require that the estimate for next year EPS is higher than the estimate for current year EPS. This reduces our list to 473 companies.

Third, given the potential for an external shock to reacquaint investors with risk, we want a stock with a performance track record that is not too tied to the market. This is where we look at beta. Clearly, there are problems with beta (it's historical, it changes over time, etc.); however, it's likely the best measure for our purposes here, so we use it. We would like a beta that is very low. Let's set the number at 0.5. This removes many companies and results in a list consisting of only 29 names.

Finally, we want to take into consideration valuation. Again, the equity markets have had a nice rally over the last year or so, and this has pushed up the price tag on many stocks. There are many different valuation measures we could use at this point. Since we looked earlier for companies where earnings are supposed to keep growing, let's use those earnings estimates again. We will require the P/E ratio to be less than the industry average, where earnings we use are both current year and next year estimates. The result is a list of seven companies.

A quick glance at the results reveals that a couple of micro/nano-cap companies came to light.

The first of these is Acme United Corp. (NYSEMKT:ACU), with a market cap of $37.6 million. Acme is involved in making cutting, measuring and safety products that are used in schools, homes, offices, etc. Think items like utility knives, pruners, and pencil sharpeners. Acme was mentioned in an article about dividends by David Fish on Jan. 28. Acme has, indeed, fared well of late when compared with its industry peers. The company has seen its trailing 12 month (TTM) revenue climb nearly 14%, while the industry average has gained only 3.6%. The industry's soft sales translated into losses, as TTM EPS fell 3.8% for the overall industry. Yet, Acme EPS climbed 24%. Obviously, such a fast pace is unsustainable long term. Still, the shares seem to be priced at a bargain, relative to the peer norm. Based on TTM EPS, Acme shares have a P/E of 11.1 vs. the industry average of 23.4.

The next company that came to light is Old Line Bancshares, Inc. (NASDAQ:OLBK) with a market cap of $78.5 million. It operates through a series of bank branches in suburban Maryland and the Washington, D.C., area. Financial firms have not been doing so well lately, with an average top-line advance of only 3.8% over the last 12 months. By comparison, Old Line came in at 36.5%. (Note: I ran this screen on Jan. 31, so the numbers may not fully reflect the bank's earnings release on Jan. 30.) Interested investors should also take into consideration the bank's announced merger with WSB Holdings, which is expected to be completed in the next few months.

I recognize that some investors like to focus on this size of the market, but there are too many potential issues for me. I'd rather stick with larger companies with greater liquidity. This brings us to the remaining five companies on our list.

The first of these larger companies is semiconductor firm Cirrus Logic, Inc. (NASDAQ:CRUS), which has a market cap of about $1.8 billion. It's been a tough year for semiconductor companies, as the industry average revenue growth rate fell 3.7%. By comparison, the company's revenue growth advanced 75%. Not only has revenue climbed, but the company's profit margins have expanded, hitting nearly 27%, up from a five-year average of just under 14%. By comparison, its peers have seen margins narrow from a five-year norm of 10.5% to 9.9% in the TTM time frame. The company is priced below its peers when based on earnings. Its P/E, incorporating TTM EPS, stands at 12.2, well below the industry average of 23. The story becomes a little different, though, based on sales, where CRUS is priced at 2.8 relative to the industry average of 2.2. Yet, keep in mind the differences in those margins.

Next we have CYS Investments, Inc. (NYSE:CYS), with a market cap of about $2.3 billion. CYS is a finance company that invests in agency residential mortgage-backed securities. With revenue growth in excess of 40%, the company easily outshines its industry, where the average is only 12.3%. The company's advantage at the bottom line is not as great, but is still substantial: 29.4% vs. 24.8%. Based on P/E, CYS shares at 3.7 are priced at a fraction of the industry norm of 41. It is at this point that I am quite happy to admit that there are two types of companies that I have willingly stayed away from, and the REITs category is one of them. However, John Lewis recently discussed CYS in his article on Agency mREITs, and investors looking for more information on this area may want to look there.

Next on our list is Consolidated Edison (NYSE:ED). The utility company that provides power to New York City has a market cap of about $16.6 billion. I ran this screen before the database had time to update to reflect ConEd's latest earnings. (The most recent release can be found here.) That stated, the company's top line slipped by about 5%, amid declines across key segments. One of the reasons why ED came across our screen was because of better-than-industry-norm revenue growth. This hasn't changed. In the TTM period, industry-wide revenue fell 6.6%. Going forward, according to Reuters, analysts had been looking for ConEd to post EPS of $3.83 this year. This at the upper end of the company's guidance of $3.65 to $3.85. Interested investors might want to consider how analysts are going to digest the latest earnings release, and thus, adjust their estimates, before committing here.

Earlier I mentioned that there are two types of companies that I have happily stayed away from. Tobacco is the other (though not for the same reason). I mention this because Lorillard Inc. (NYSE:LO) is the next company that appeared on the screen. The tobacco giant has a market cap of about $15.3 billion. Historically, the company's revenue growth has slightly outpaced the industry average. Its five-year top-line growth rate comes in at 7.8% vs. the industry norm of about 6.6%. EPS growth has also been faster over this period, hitting nearly 11% vs. the average of 9.9%. Furthermore, stock is priced at a relative bargain. LO's P/E, based on TTM EPS, is 14, against a peer norm of 17.3. According to Reuters, the company has beat earnings estimates in at least each of the last five quarters. Watch for the company's 2012 earnings release on Feb. 13.

The last company on our list is Questcor Pharmaceuticals Inc. (QCOR). The company has a market cap of just under $1.5 billion. The company focuses on treatments for multiple sclerosis, among others. The general market environment for biopharmaceutical companies has been challenging, as industry revenue fell 3.5% in the TTM period. By comparison, Questcor posted revenue growth in the triple digits. It has an operating margin of 58% vs. an industry norm of 21.5% in the TTM period. Despite the decline in revenue, the company's peers managed to post EPS gains of nearly 11%. Again, Questcor saw growth in the triple digits. Obviously, such a fast pace is unsustainable longer term. And, as mentioned in this Jan. 31 article, the company faces some hurdles, which may restrict near-term price appreciation. The recent downward pressure on the stock, which fell about 2.6% while the industry on average climbed 6.4% over the last four weeks, has further contributed to QCOR's cheaper price tag: It has a TTM P/E of 9.7 vs. an industry norm of 21. Here, too, look for the company's earnings release on Feb. 13.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.