Newsletter
June 24, 2006
Pieces of the Puzzle
Market & Sector Review
Fundamentally Speaking
Largest Changes This Week
This Week's Economic Reports
No newsletter next week --> Enjoy your 4th of July Weekend!
Pieces of the Puzzle
By: Vic Johnson
"Even if he fails again and again to accomplish his purpose -- as he must until weakness is overcome -- the strength of character gained will be the measure of his true success, and this will form a new starting point for future power and triumph. " – As A Man Thinketh
When most young children are given a puzzle to solve or put together that is especially challenging, most will make a good effort at solving it, but if unsuccessful will soon lose interest and abandon it. Some will even become angry at their failure to solve it and may throw a tantrum.
Contrast that with the experienced puzzle player (Editors Note: read experienced trader) who proceeds to put the puzzle together with an air of certain confidence that they will complete it. They know that they have all of the pieces of the puzzle before them so it is only a matter of finding out which pieces work where and once that’s done the puzzle will be complete. Putting a piece in the wrong place is not a cause for concern, it’s simply another step toward putting all of the pieces in their proper place.
I think of all the times in my life when I acted like a young child in dealing with the current puzzle in my life. Instead of turning over and trying the next piece, I got angry and walked away from the puzzle, seeing the puzzle as a problem instead of as an opportunity.
Napoleon Hill, author of the classic Think and Grow Rich, knew Thomas Edison and Henry Ford personally. He said of both men that the ONLY thing that was different about them from everyone else was their persistence. Which gives rise to an interesting thought. Where would our civilization be today if either man had treated his puzzles like the impatient young child?
If you don’t have all of the pieces of your puzzle on the table, then stop, identify them and get them on the table before proceeding. If, however, you’ve got them on the table, then take the approach of the experienced puzzle player (trader). When they don’t fit --- don’t quit --- try another piece or move them to another place. While you’re at it, learn another valuable lesson from great puzzle players. They don’t just enjoy completing the puzzle, they delight in putting it together.
Napoleon Hill thought Persistence was a pretty important key to success --- he used the word 97 times in Think and Grow Rich and he devoted an entire chapter to it. Some of his wisdom includes, "The majority of people are ready to throw their aims and purposes overboard, and give up at the first sign of opposition or misfortune. A few carry on DESPITE all opposition, until they attain their goal. These few are the Fords, Carnegies, Rockefellers, and Edisons. There may be no heroic connotation to the word “persistence,” but the quality is to the character of man what carbon is to steel.”
Market & Sector Review
Fundamentally Speaking
I would like to begin with a quick comment on this week's action and the June 10 newsletter discussing Accumulation/Distribution days. As I mentioned in that newsletter, this indicator requires at least a somewhat subjective analysis for its correct interpretation. I noted then that I.B.D. has over the years adjusted the advance needed from 1% to a 1.7% advance depending upon market volatility. I also noted that the program calculation on the index as well at the sector charts splits that difference utilizing 1.4% as the advance criteria and that a closer look is required on any green volume bar. Due to the increasing volatility, I was sure I.B.D. would look for a minimum 1.7% advance. On Wednesday June 21 the markets advanced sharply and on increasing volume. Late that afternoon I thought a rally confirmation day was written in the cards, and then the market proceeded to back off just enough. I.B.D.'s interpretation was this: The markets did not advance enough (NASDAQ +1.6%; NDX + 1.6%; S&P + 1.0%; NYSE +1.2%) falling just a bit short of the 1.7% mentioned in that newsletter. In addition although the volume was greater than Tuesday's volume, Tuesday's volume was below Monday's volume which was quite a bit below last Friday's volume. Conclusion: No rally confirmation day. I hope this helps in everyone's future interpretation of the index and sector charts.
Market players believe that everything they need to know is contained within a chart picture while value players believe that the fundamental condition of the economy and individual stocks will determine future value. While I can point to successes in both philosophies most traders I know are actually both; fundamental conditions for stock selection and technical analysis for entry and exit timing.
Today we'll look at some of the fundamental considerations for growth stocks contained within strong groups. Generally the strongest growth stocks are small or mid-cap issues and have a tendency to be much more volatile than the general market, however in strong market up moves these will probably out perform most other stocks. Once identified, your technical analysis skills should be utilized to time any purchases and sales. If you are more of a pure value player or are looking for dividends we will cover those in future newsletters. Today we will look quickly at one of the most popular and successful systems; CANSLIM for finding strong growth companies. There are more considerations to CANSLIM than presented here, however you can utilize this outline as a beginning tutorial upon which you should build.
- In the latest quarter earnings per share should be up at least 25 percent as compared to the same quarter last year and preferably much more.
- Earnings growth should be accelerating at some point versus previous rates of change.
- Annual earnings for the last three years should be increasing at a minimum 25 percent per year.
- Sales should be up 25 percent or more in one or more recent quarters or at least accelerating in their percentage change.
- After tax profit margin in the most recent quarter should be either at or at least close to a new high.
- Return on equity should be 15 percent or higher.
- The stock should have institutional sponsors; i.e. they should be increasing their holdings.
- If the company is buying back its own stock by 5 to 10 percent or more; it’s a plus.
- You must really understand the story of the company.
When people think about the sector METALS & MINING; gold and silver mining immediately comes to mind. Metals and mining however is made up of six distinct groups:
- 130 METALS & MINING (All Metals and Mining) Sector
- 131 - Steel & Iron
- 132 - Copper
- 133 - Aluminum
- 134 - Industrial Metals & Minerals
- 135 - Gold
- 136 - Silver
- 137 - Nonmetallic Mineral Mining
The current group ranking (of 209 Industry Groups) based on relative strength over the last six months, for each group in this sector is:
MG131 Steel & Iron - 2; MG132 Copper - 9; MG133 Aluminum - 20; MG134 Industrial Metals & Minerals - 6; MG135 Gold - 15; MG136 Silver - 65;
MG137 Nonmetallic Mineral Mining - 101.
From last week's letter we want to compare stocks within an industry group; this week we look at METALS & MINING- Steel & Iron (131), the picture below is just a partial output:
 
The first screen will give you a brief description of the company's businesses. You can follow through all the fundamental data by clicking the Next button on top of the picture or go directly to any category along the left column by clicking it. For now we will jump ahead to the Financial Results by clicking that button.
So that you may fill in the latest quarter: Earnings increased to $78 million, or 62 cents per share, from $71.7 million, or 57 cents per share, in the year-ago period (or 8.7%). The recent results include inventory write-offs of $28.6 million, or 23 cents per share, while the 2005 quarter included a gain of $1.5 million, or a penny per share, related to inventory. Analysts expected earnings of 70 cents per share, according to a Thomson Financial poll. Analyst estimates typically exclude one-time charges and gains.
Next we will look at Key Ratio's (by clicking on that link) of Commercial Metals vs. its Industry and the S&P500.
- In the latest quarter earnings per share should be up at least 25 percent as compared to the same quarter last year and preferably much more. If we add the $0.23 write off to the $0.57 we get $0.80 for the quarter and increase of 40 percent over the same quarter last year. If we do not add the write off back in the quarter was slightly higher than the same quarter a year ago, for myself it would require more research to determine if this write off is a one time event or not. The second quarter increase was 41% and the first quarter there was a decline of 6.5 percent. A first criterion therefore needs to be qualified but for now let’s say Yes.
- Earnings growth should be accelerating at some point versus previous rates of change. At best the growth rate of Commercial Metals appears to be slowing – No.
- Annual earnings for the last three years should be increasing at a minimum 25 percent per year. Fiscal ’05 growth was better than 100 percent, fiscal ’06 numbers are still open but if they equal fourth quarter of last year and we accept $0.80 for the third quarter then the year over year earnings growth will be 16 percent: Falls a bit short – No.
- Sales should be up 25 percent or more in one or more recent quarters or at least accelerating in their percentage change. The 5 year average growth in sales is 24 percent however the most recent two quarters show nowhere near that growth in sales: No.
- After tax profit margin in the most recent quarter should be either at or at least close to a new high: No.
- Return on equity should be 15 percent or higher. Over the last 12 months not including Tuesday’s report Return on Equity is 28.3 percent. Oddly enough this is 75 percent higher than the S&P 500 but under the industry group average: A qualified Yes.
The stock should have institutional sponsors; i.e. they should be increasing their holdings and the number of institutionsl holders increasing as well.
This data is a bit old now (as of 3/31 reports are quarterly) and should be rechecked in July. There are 253 institutional shareholders of which 62 are new holders and 21 institutions liquidated holdings. 149 were buyers and 103 were net sellers. Net change is plus 46 institutions. While the picture appears a bit mixed let's give this a qualified Yes.
CMC has been a relatively strong stock still ranking above 90. Fundamentally, while certainly sound and growing, is not quite what we are looking for if we wish to follow CANSLIM. You can find better candidates. It might be worthwhile while searching through potential candidates to make a spreadsheet (updated weekly) with the above criteria as column headings, when the time is right for your potential entry you'll have a quick view fundamentally where to go.
Add technical indicators, fundamental data, and your opinions then update the spreadsheet on a regular basis changing what needs to be changed (including opinions) add and delete stocks as you see fit. When the group or sector gives you a buy signal; a quick look at your spreadsheet will tell you which charts to bring up for timing purposes. Avoid attempts at overanalysis, keep it simple.
Largest Changes This Week
This Week's Economic Reports
Have A Great Week!
Bill
Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.
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