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J. Stephen Castellano steve@ascenderellc.com
This week, 63 stocks make the "high-quality" list, in line with 63 last week, but with 8 additions and 8 deletions. 32 stocks make the "low-quality" list, up from 26
last week with 7 additions and 1 deletion. We have not seen any solid Healthcare names on our list for quite some time, but this might be changing with the
addition of the most interesting new "high-quality" name this week, biotech company Biogen Idec Inc. (BIIB).
Examples of just a few recent sell side actions that we have preempted since November 30, 2010
12/9/2010: United Continental Holdings (UAL) -- Morgan Stanley named the stock a long Research Tactical Idea.
12/9/2010: Freeport McMoRan (FCX) -- Credit Suisse raised its price target to $130 from $110, making it the highest price target on the Street.
12/9/2010 Waddell & Reed (WDR) -- Barclays upgraded the stock to Overweight from Equal Weight, and raised its price target to $41 from $30.
12/3/2010: RPC, Inc. (RES) -- Canaccord Genuity raised its price target to $37 from $30.
12/2/2010: Ares Capital Corporation (ARCC) -- was named a long Research Tactical Idea at Morgan Stanley.
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Ascendere Associates LLC December 10, 2010
J. Stephen Castellano Page 1 steve@ascenderellc.com
Highlighted Stock Ideas
We define quality as relative to four key factors: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision Momentum; and 4) Fundamental Quality.
Stocks that make it to our "All-5 List" are those that have the highest possible scores for each for each of these four key factors.
Rankings can be somewhat volatile as companies file additional financial data and as relative valuations change; this is especially true during earnings season.
Much of the volatility is noise, which is why frequent rebalancing based on the latest rankings can actually hurt performance.
About 1/3 of these stocks make it to our model portfolios that turnover monthly, but we think some of these stock ideas could work well with average 12-month
holding periods as well. Our opinion is based on a backtest we conducted back to 12/31/2004 through 9/30/2010, which showed that 12-month returns from
stocks on refined list averaged about 11%, with the highest 12-month returns averaging +95% and the lowest 12-month returns averaging -42%. Deeper
fundamental analysis of stocks on this list might reveal some of the stronger, longer-term ideas.
High-Five List
New to the "High-Five List" relative to last week include East West Bancorp, Inc. (EWBC) and LyondellBasell Industries AF S.C.A. (LYB). Stocks staying on the
High-Five List include TRW Automotive Holdings Corp. (TRW),Tyson Foods Inc. (TSN) and Freeport McMoran Copper & Gold (FCX). Leaving the list this week is
CIT Group, Inc. (CIT) due to a lower relative operating momentum.
Super Growth
Stocks that maintain the highest possible rankings for every factor but relative value may be well on their way to super growth. Stocks that have previously on
our screens but were removed at much lower stock price levels because of poor relative value include Netflix, Inc. (NFLX), Chipotle Mexican Grill, Inc. Co (CMG)
and Apple Inc. (AAPL). Currently fitting this profile is Ford Motor Co. (F) and Smithfield Foods Inc. (SFD).
Biogen Idec Inc. (BIIB) is a $15.8b market cap biotechnology company that "discovers, develops, manufactures and markets biological products for the
treatment of serious diseases with a focus on neurological disorders." Biogen Idec was formed in November 2003 when IDEC Pharmaceutical Corporation closed
its purchase of Biogen Inc. in an all-stock $7.5b deal. It currently markets four products: AVONEX, RITUXAN, TYSABRI, and FUMADERM, for the treatment of
multiple sclerosis (MS), non-Hodgkin’s lymphoma (NHL), rheumatoid arthritis (RA), Crohn’s disease, chronic lymphocytic leukemia (CLL) and psoriasis. It has an
agreement in place with Genentech with regards to the development and commercialization of a MS drug and a NHL drug.
What catches our attention about this company is not only its solid rankings in four key factors, scoring 4 out of 5 for 1) Relative Value; 2) Operating Mometnum;
3) Analyst Revision Momentum; and 4) Fundamental Quality, but also due to the fact that it appointed a new CEO this past July that is "evaluating the company's
strategic priorities and examining additional means to maximize shareholder value." New management teams are usually looked upon favorably by investors
since they can breathe new life into an enterprise.
The new CEO, George Scangos Ph.D., was previously the CEO of Exelixis, Inc. (EXEL), a $720m market cap biotech company involved in the treatment of cancer,
metabolic and cardiovascular disorders. Scangos was the CEO at Exelixis from October 1996 to June 2010, and was the President of Biotechnology at Bayer for
the three years prior to that. Unfortunately, taking a look at the stock price chart for EXEL is not at all that inspiring, however.
The company just completed a $1.5b buyback of stock which was first announced in April 2010; in all, the company repurchased approximately 29.8m shares of
common stock which reduced the number of common shares by 15% through September 2010. It does not pay any dividend but does generate a very attractive
level of free cash flow, estimated to increase from $1.2b on a trailing 12-month basis in the latest quarter to $1.6b by December 2011. Economic profit and ROIC
are also forecast to improve. Not being experts in biotech, we can only imagine that the board wants a more creative use of its cash flow than another 15% buy
back of stock. Biogen already looks quite attractive, and Exelixis does not appear the paramount example of operational success, so we assume Scangos was
brought in to use all of that excess cash flow to make a smart acquisition. In any case, BIIB looks like it might be a nice addition down the road to a high turnover
portfolio such as our long-only model, and deserves further study as a longer-term holding.
In our opinion, cash flow growth and return on invested capital are the key drivers of any stock's valuation. By focusing on various proxies for these data points
and other factors such as relative value, we have been able to generate some terrific investment ideas and avoid some significant value traps over our career in
sell side and buy side equity research.
For those interested in learning more about determining a company's value as it relates to ROIC, we recommend reading McKinsey & Company's "Valuation:
Measuring and Managing the Value of Companies" or "The Value Sphere: The Corporate Executives' Handbook for Creating and Retaining Shareholder Wealth."
We also find the newsletters produced by Michael Mauboussin, the Chief Investment Strategist at Legg Mason Capital Management, an excellent source of
information as it relates to determining the value of companies.
Ascendere does not rate stocks on any scale, but does offer individual stock commentary and valuation opinions. With regard to Ascendere's portfolio
strategies, "long" or "high-quality" baskets should generally be considered buys, unless otherwise noted. Stocks in our "short" or "low-quality" baskets should
generally be considered sells, unless otherwise noted. While exceptions may occasionally occur, typically stocks in the high-quality basket are expected to
outperform the S&P 500 over a month's time and stocks in the low-quality basket are expected to underperform. A more relevant benchmark would comprise
of all stocks and ADRs that trade on major U.S. stock exchanges with a market cap above $2 billion.
Ascendere adheres to professional standards and abides by codes of ethics that put the interests of clients ahead of its own. The following are specific
disclosures made by Ascendere:
1) Ascendere may have a financial interest in the companies referred to in this report ("the Companies"). The research analyst covering the Companies
and members of the analyst's immediate family have a financial interest in one or more of the Companies.
2) Ascendere generates revenue from research subscription revenue and portfolio management fees. At any given time it may be long or short any of
the Companies.
3) Ascendere does not make a market in the securities of any of the Companies.
5) Ascendere has not managed or co-managed a public offering for any of the Companies.
6) Neither Ascendere nor any of its officers or any family member of the covering analyst serve as an officer, director or advisory board member of any
of the Companies.
7) Neither Ascendere nor any of its officers or any family member of the covering analyst beneficially own 1% or more of any class of securities of any of
the Companies.
8) The covering analyst certifies that this report accurately reflects such analyst's personal views.