Author: Robert Gay (GEARS)
Disclaimer: Robert Gay owns owns DHI, PHA, TBL, BRKS, IVAC, POWI, PLXS, ATMI, SLAB, FARO, DIOD, VSH, CYMI, FCS, and TLAB in his Covestor Luxury Liner Model.
September 7, 2010: The collection and analysis of the second quarter 2010 financial statements is largely complete now and a broad based acceleration in corporate wealth is clearer. The average annual sales growth rate of the GEARS total market index is now positive and, over the past year, staged the sharpest “V” shaped improvement in the data record. Even with that unprecedented reversal, the average sales growth rate has recovered only to the cycle trough level of 2002.
Concern about the sustainability and magnitude of the improvement may have had an influence on the stock market decline in recent months. I have taken that market weakness as an opportunity to take the Luxury Liner Model to a fully invested position and significantly net long. That strategy was designed to increase the market sensitivity of the model and the weak performance of the model during the market decline in August is testimony to the success of the change.
American public corporations are now more clearly in acceleration mode and the pattern is familiar. Historically stocks produce better investment returns than bonds when both sales growth and profit margins are rising. That dual strength in fundamentals appeared in the second quarter for the first time in many years.
Traditionally American cyclical recovery is lead by companies in the consumer cyclicals sector where evidence of a powerful improvement continues to build. The strong and broad improvement in the sales growth and gross profit margin of the consumer cyclicals group is of particular interest because of the high level of operating and financial leverage of the group. SG&A expenses and interest expenses continue to rise in the group during the second quarter. That has the effect of slowing the bottom line improvement relative to the top line and sets up a positive earnings surprise pattern in the sector average. That pattern of stronger top line and high and falling costs is more fully developed in the small company group of the consumer cyclicals sector where share prices have been especially weak. More buy ideas have immerged in that group in recent weeks.
The Home Builders and Building Materials Industry has been a hot topic in the recovery debate and share prices were weak in August. The Luxury Liner Model made buy transactions in August for D.R. Horton Inc and Pulte Corp. where the combination of strong fundamentals improvement and depressed share price appeared to provide the better opportunities. The Retailers Industry showed a further improvement in the second quarter and added lower SG&A expenses/sales and a higher profit margin to the year-long sales growth improvement. I added Timberland Company to the Luxury Liner retailers list during the quarter.
The Basic Industrials Sector is another important group in the traditional cyclical recovery pattern of U.S. public companies. Here fewer opportunities presented in August as the sector average share price and valuation advanced to a new high. Buy opportunities were more frequent in the small companies group of the Basic Industrial Sector and the Luxury Liner model made new buy transactions in Brooks Automation Inc and Intevac Inc.
In the past decade the Technology Sector has added a new component to the American cyclical experience. Since the steep share price decline of the technology group in 2000 through 2002, shares on average have been flat and recently weak taking valuation to near the 2008 low and near to the lowest valuation level since 1998. In the second quarter, sales growth was broadly strong and the profit margin advanced. The Luxury Liner added to technology positions with new buy transactions for Power Integrations Inc, Plexus Corp, ATMI Inc, Silicon Labs Inc, Faro Technologies Inc, Diodes Inc, Vishay Intertechnology Inc, Cymer Inc, Fairchild Semiconductor and Tellabs Inc.
Experience shows that investment decisions should be made as the market presents opportunities and in the last three months, with share prices weak, most opportunities were buy decisions. That has taken the Luxury Liner model to a fully invested net long position and enhanced the sales growth characteristics of the model on average. If the stock market continues to advance in September, I intend to shift my focus to sell decisions. The Luxury Liner average gross profit margin declined in the second quarter and is now lower than the GEARS Total Market index average. This needs attention and market willing, I will be able to increase the frequency of rising gross profit margins in the model as the month progresses with the sale of stocks of lower profit margin companies.
To create a successful stock portfolio requires attention, consistency and discipline. Most of all, it requires an information edge. Years of research have shown that shares of companies that are profitable with rising shareholder wealth perform better. The Luxury Liner and all GEARS models are managed with that information edge.
I have created ISPACE-Investors Space for Truth, located on the GEARS Website where I make available a detailed, accurate, consistent, reliable and verifiable financial statement analysis for all companies in the GEARS coverage population and for industry, sector and index populations. I invite you to take advantage of our free registration.
