Inside the Numbers: Using Wall Street Experts to Your Advantage

Anyone can get lucky once in a while. The same goes for the so-called “experts” on Wall Street. But when the overwhelming majority of experts agree on a handful of stocks, investors should take notice. When a stock has, say, 20 analysts covering it — and all 20 think the stock is a strong ‘Buy’ — it’s pretty clear that big things are expected.

Now, it’s easy to go along with the crowd and jump on a stock’s bandwagon in such a scenario. But, buyer beware. This is precisely the type of circumstance when an investor’s contrarian side should take root. Can an overwhelming bullish sentiment be a bad thing? You bet.

Naturally, you’d like to see more ‘Buy’ ratings than ‘Sell’ ratings. However, a stock with all ‘Buy’ ratings might not have any upside left. It’s certainly possible. But for every stock that sputters after a good run, there are companies like Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG) that — just when you think they’ve run up as much as possible — will still beat earnings estimates or otherwise harness a new, long-term profit catalyst that will grow profits for years to come. This is the type of stock we’re looking for in this week’s Inside the Numbers.

#-ad_banner-#For starters, we wanted to look at stocks with plenty of analyst coverage. Then, we screened for stocks with a large number of ‘Buy’ ratings. Based on the contrarian argument we discussed above, we also needed a way of filtering out stocks that have likely hit their ceilings and identifying stocks that are underpriced relative to their potential earnings growth. For this, we used a simple a simple formula: Price/Earnings to Growth (PEG). It is calculated by taking a stock’s P/E ratio and dividing it by its estimated earnings growth. (My colleague Carla Pasternak gave a terrific explanation of the importance of PEG in the February issue of High-Yield Investing.) This allowed us to find stocks that, despite their overwhelming number of ‘Buy’ ratings, may still have some long-term upside.

With these points in mind, the StreetAuthority research staff recently ran a screen for the following criteria:

— S&P 500 stocks with at least 10 analysts covering the stock
— ‘Buy’ recommendations that amounted to at least 80% of total recommendations
— PEG of less than 1, signifying that the Street is paying nothing for earnings growth

We came up with the following results:

Company (Ticker)

Total Analysts Analyst Buy Ratings Buy % of Total P/E PEG
Mastercard (NYSE: MA) 35 31 88.6% 20.4 0.91
CVS Caremark (NYSE: CVS) 23 19 82.6% 13.2 0.85
Apple (Nasdaq: AAPL) 44 40 90.9% 20.5 0.93
Qualcomm (Nasdaq: QCOM) 38 31 81.6% 21.3 0.97
Google (Nasdaq: GOOG) 40 32 80.0% 26.8 0.80

Surprise, surprise — our friends Apple and Google are on the list. The results seem to suggest that these stocks, despite being branded as “growth” stocks, may actually be underpriced. Comparing Apple’s P/E of 20 to its 5-year historical valuation of 30.5 and Google’s P/E of about 27 to its 5-year historical valuation of about 46.9 would seem to confirm this.

Another interesting name on the list is CVS Caremark (NYSE: CVS). CVS is the largest drugstore chain in the United States, with about 7,000 locations. The company purchased Caremark, a pharmacy benefits manager, in 2007. Shares took a hit in November 2009 when the pharmacy benefits division announced that it lost about $3.7 billion in contracts and that margins would be slimmer going forward. Pharmacy benefit managers use their size as negotiating power to get cheaper drug prices for customers and are a key piece of the puzzle in lowering healthcare costs.

Another profit catalyst on the horizon is the coming wave of drug patent expirations. CVS earns a fee for filling prescriptions, and more affordable drugs mean more prescriptions to fill. Not only that, but CVS actually has more bargaining power with generic drug companies than Big Pharma, so it usually earns a higher fee for generics than branded drugs. (Side note: CVS is also a big supporter of biogenerics. More on that here.)

If CVS can manage to turn around its pharmacy benefits division and reap the long-term benefits of an increasing amount of generics on the market, it will go a long way to proving the experts right on this one.