By Stockpickr Guest Columnist Doug Hall
Stock selection requires an investor to consider quantitative and qualitative factors. That is, you analyze a company's numbers, and then you interpret what those numbers and other pertinent information mean for the stock.
Take steel companies, for example.
Investors have been pummeled for the last two months as stocks for Steel Dynamics (STLD), Nucor (NUE), U.S. Steel (X), AK Steel Holding (AKS), Reliance Steel & Aluminum (RS) and Schnitzer Steel (SCHN) have dropped almost 50% since their peaks in midsummer. These companies aren't serving identical markets, but all produce steel -- some from scrap, some from ore. Their futures are closely tied together.
Consider that all of these companies have reported annual growth ranging from 14% to 48% over the last five years. But selling for seven to 11.5 times trailing earnings, their current prices reflect growth rates of 1% to 5%. That just doesn't seem right.
My seasonal forecast accounts for 85% to 95% of the variability in these revenues. That's pretty good, so I'm fairly confident that my future forecast will be pretty good. Unless the bottom falls out of the economy, these companies are likely to do better than their current prices imply. Look at the quantitative results in the following table:
But that's just number-crunching, computer-generated information. The revenues are predicted by statistical analysis of the last 20 quarters' worth of data. The net income figures are those revenues times the reported profit margins, and the price target is from a formula credited to Ben Graham. Are these stocks "safe" to buy now? The quantitative analysis indicates a large margin of safety, as Graham called it.
Qualitatively, ask yourself the following questions: How long can Steel Dynamics, Schnitzer Steel and Reliance Steel grow at more than 30%? Will the economy go down the drain? Will Russia invade Georgia -- the one Sherman marched through? Will these stocks reach these targets? Can my portfolio do well even if they don't?
We can't answer any of these with certainty, but if the trends these companies have firmly established over the last five years continue, steel is a steal. Down the road, long-term investors may look back on this summer as "time spent in the forge."
Disclosure: My family currently owns shares of Steel Dynamics, the company I thought was fastest-growing and most-undervalued before I wrote this column.
Posted on Sept. 9, 2008
