Monday, July 13, 2009

5 Superball Stocks

'Don't catch a falling knife' ... The idea of buying a former superstar stock at a discount price certainly has its attractions, but you've got to make sure you catch the haft -- not the blade."

So runs the thesis of my recurring Fool column "Get Ready for the Bounce," in which we search among the wreckage of Mr. Market's overturned cutlery drawer, hoping to find future winners in a pile of 52-week losers. But do we really need to sit around for a whole year, waiting for a potential bouncer?

I say nay. Sometimes, stocks fall far in far less time than a year -- and like a superball dropped from the balcony, the harder they fall, the higher they bounce. Today, we're going to look at a few equities that've suffered dramatic drops over the past week. With a little help from the 135,000 members of Motley Fool CAPS, we hope to find an opportunity or two for you:

Stock

How Far From
52-Week High?

Recent Price

CAPS Rating
(out of 5)

McDermott International  (NYSE: MDR)

(71%)

$16.89

*****

CME Group  (NYSE: CME)

(39%)

$263.18

****

Rio Tinto  (NYSE: RTP)

(71%)

$124.56

****

Potash Corp (NYSE: POT)

(63%)

$85.07

****

Elan Corp (NYSE: ELN)

(82%)

$6.78

****

Companies are selected by screening on finviz.com for abrupt 10% or greater price drops over the past week. 52-week high and recent price data provided by finviz.com. CAPS ratings from Motley Fool CAPS.

Five super falls -- one superball
For four weeks running, Mr. Market has maintained a foul temper. In a similar mood, many of us might grouch at the spouse or kick the dog (not really!), but he took his anger out on some of the biggest names in investing. Commodities companies in particular felt the brunt of it, as Potash and Rio Tinto tumbled (along with the marketplace that draws its revenues from trade in commodities, CME Group).

Motley Fool Rule Breakers recommendation Elan also took a hit, for no reason I can fathom. (To the contrary, the firm recently attracted $1.5 billion in investment from Johnson & Johnson (NYSE: JNJ), which looks to me like a positive.) Likewise, McDermott -- an engineering shop that does a fair amount of oil & gas work -- seems to have been hammered based on little more than jitters over where the price of oil might be heading.

So far, Fools are keeping the faith, endorsing all five of these stocks by wide margins. But the one we really love is the last one named above. Here we go with ...

The bull case for McDermott International 
Make no mistake -- a lot of Fools really like McDermott. Out of nearly 1,350 votes cast on CAPS, only 30 investors expect the stock to underperform the market from this point on. Still, what interests me most about these ratings is not so much their quantity, but their quality.

Specifically, my first clue about where this stock is going comes from the quality of the investors who've been singing its praises most recently. Meaning no disrespect to the Fools who've gone out on a limb to tell us what they think about this stock, their reputations precede them and ... those reputations aren't so hot. Each of the CAPS members who penned the pitches shown below "boasts" a CAPS rating in the bottom quintile of the investors we track, beginning with:

  • GreenChileKicker, who argued in May that McDermott has: "a lot of room to grow with dependence on energy and oil."
  • hillcity2110 adds that McDermott has plenty of: "cash on hand! hiring 250 new people in this economic down turn. record work back log! large US and international revune!"
  • And Xitopie echoes the point that McDermott is: "Loaded with cash. Infrastructure play. A multi-bagger without the risk."

Compare and contrast
Forgive my restating the obvious, Fools, but every stock has risk. It just varies from company to company. To gauge McDermott's relative riskiness, let's compare it to one of the shops I profiled last week: Foster-Wheeler (Nasdaq: FWLT).

Like F-W, McDermott is in the construction biz. Like F-W, it's expected to maintain a respectable growth pace over the next five years -- a bit shy of 11% per year on average. Finally, like F-W, McDermott has gobs of cash loading down its balance sheet -- $600 million in net cash, to be precise.

Yet these companies are not identical twins -- and I'm sorry to report to McDermott shareholders, it's their company that fares the worse by comparison. At the most basic level, Foster-Wheeler's 6.6 P/E easily trumps the 10.2 times earnings valuation on McDermott. More important, though, is the fact that F-W generated more than $250 million in cash over the last 12 months, while McDermott burned cash ($280 million worth).

True, it has not always been so. From 2004 through 2008, McDermott averaged $218 million per year in annual free cash flow. But giving McDermott every possible benefit of the doubt, here's what I come up with:

  • A $3.9 billion market cap, minus $600 million in net cash, gives McDermott a $3.3 billion enterprise value ...
  • ... Divide that by the amount of free cash flow this firm generated back during the boom times, and its enterprise value-to-free cash flow ratio works out to a little over 15 ...
  • ... Which is simply too high for an expected 11% grower. Simple as that.

Foolish takeaway
I'd love to be able to tell you that I agree with my Foolish peers, and that McDermott's a deal. But it's not. The numbers are clear here, and what they tell me is: Foster-Wheeler's cheap; McDermott isn't.

 
 

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