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What if I told you about a group of companies
that operated at a 50% profit margin and yet are more than 50%
cheaper than the broader market?
Interesting, right?
Indeed. But here's what's even more interesting: These four
companies are among the most undervalued firms on the market
today. I know you're thinking I'm about to tell you
about a bunch of banks. I'm not. None of these companies'
businesses have anything to do with lending or finance. And
even though they are in a sector that's not in need of a
bailout, their shares have been punished, and by a far wider
margin than much of the market. My four favorites among the
screen's result would need
to experience a price increase of +550.4% just to reach
their average historical valuation for the past five years.
How's that for upside? Not bad!
Now, you probably want to know how they've fared so far this year.
Fair question. After all, the market -- which tumbled -37%
last year -- is already down more than -20% this year.
Well, believe it or not, all of these companies are beating
the S&P. Two are in positive territory; the
worst performer of the four is still ahead of the market by
11 percentage points.
I started watching these companies a month ago. I've personally
owned them through an ETF for even longer. So when I ran
across them doing some unrelated research, my curiosity was
piqued. Let me tell you about it.
I'll warn you now, though: If you keep reading, you're going to want
in on these companies. Because these year-to-date returns,
as great as they've
already been, are just the start. I know there is a lot of
pessimism and doom and gloom out there, but these are
companies that you should be excited about. They're just getting warmed up. They've only
started to notch the gains they're going to see this year.
My prediction? This is the only sector of the economy
that can lead a rally.
The Screen
As I said, I wasn't looking for these companies when I ran
across them. Really, I didn't know what I was going to find. I
wanted to look for companies that were extremely profitable. If
revenue is falling for most companies, my thinking was, then
I wanted to get a look-see at the companies that get to keep the biggest
share of the revenue they were able to bring in.
I set the bar pretty high. I demanded a U.S. company with a 25%
minimum profit margin. Then I excluded any company trading
at more than 15 times earnings or worth less than $500
million.
There were some interesting names. Microsoft (Nasdaq: MSFT), for one. And Merck
(NYSE: MRK),
the drug maker. Then I narrowed my focus to the companies
whose stock was in the plus column for the year. And of
these 12 companies, eight were energy-related. Two of the 12 were offshore oil drillers
-- and two other offshore outfits made the initial screen
but have seen their shares slip so far this year.
When four closely related
companies make their way into a narrow stock screen -- I'm
interested. I have to know why. And when I found out, I
realized that I had stumbled across the most exciting screen
I have seen in years.
Crude Obeys (OPEC's) Law of Supply and Demand
Oil has fallen out of the headlines. With gas prices below
$2, the mainstream media is paying attention -- and
rightfully so -- to far bigger economic issues. But, at the
same time, experts don't think the price of oil is going to
stay low for long. Oil has risen from the mid-$30's to
the mid-$40's in the past month. But the rise doesn't look
like it's going to end, at least not according to the
positions investors are taking. The April contract values a
barrel of crude at $45 -- about
a third of its $147 high -- though traders have pegged the price
of crude at $50 in six months and +17.5% higher in a year.
These recent price increases -- in addition to the continued
strength going forward upswing -- have actually prompted major investment houses
to lease oil tankers, fill them with crude and let them sit
in port. When oil prices rise, these cagey traders will ship
the oil and sell it at a massive profit.
You see, oil has fallen because many people are fearful that demand
is going to plummet because of the recession. But though the
world has been in recession for some time, global demand
has, in fact, slipped only marginally. It has, to be sure, fallen by a
million barrels a day. While that seems like a lot, the
world is still using 84.7 million barrels of oil a day.
That's a decrease, yes, but only -1.1%.
Now, if prices of oil and oil companies had fallen by that amount, then
we could conclude markets are efficient and
logical.
But they're neither, as the chart dramatically
illustrates. Markets are reactionary and
panicky -- that's a good thing: That's why there's
such a raft of opportunity. The fact is that oil
remains tremendously oversold, and so
are oil companies. That's why these companies are
holding their value as the market slides -- and why the future price
of oil is so much higher than the current
front-month contract.
Most industry experts envision a target price between $60 and $80 a
barrel. Plenty of analysts think $100 a barrel oil
is in the offing. |
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Investors Don't Have Time to Waste
There is a critical element to these stocks, and that's time.
Investors don't have much longer to snap up these shares at
discounted prices. Here's why:
OPEC, the cartel that controls most of the world's oil supply,
announced Feb. 10 that its members still had not made good
on their promises to cut back on oil. These countries are
still 1.695 million barrels a day behind their target.
For years, OPEC rattled its saber about cutting production, but it
never honored the quotas. They didn't need to, because the
price of oil was so high. But now, with the price so low,
OPEC -- whose members countries' budgets are based entirely
on oil -- are heeding their production targets. Mark my
words: OPEC is going to make additional cuts and decrease
production to its 24.8 million barrels per day. This will
cut supply and buoy prices.
This will take some time -- weeks rather than months -- and it is
beginning to happen. Here
at home, inventories have begun to decline after months of
increases. Today's inventories report surprised the market
by recording another decline. Here's the only way this
can play out: Refiners will draw down on this massive supply of
crude just as OPEC clamps down even further on production.
And that's when the magic will happen. Demand will rise as
supply has been cut back. We all know what that does to
price.
It's key to remember that while the small producers can go find oil
anywhere in the world, OPEC members are constrained within
their borders, where they have a finite supply of oil. They
don't want to sell it any cheaper than they have to, and
they will ultimately prove successful at manipulating the
price. The clock on cheap oil is ticking: The oil ministers
meet March 15.
Now's the Time to Buy
Offshore oil companies, as I mentioned, have gargantuan
price-appreciate potential. They're still
cheap, but that won't last long, not for the offshore
drillers, and not for the oilfield service providers and not
for exploration and production companies. Now's the time to buy.
Many happy returns.
-- Andy Obermueller
Co-editor
StreetAuthority Investor Update
P.S. I almost forgot. Twelve companies met the screen's
criteria and had positive returns year-to-date. The two
offshore drilling outfits with the most upside potential are
Diamond Offshore (NYSE: DO) and Noble Corp. (NYSE: NE).
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