Author: Robert Gay, GEARS
Model: Luxury Liner
Disclosure: Long LYTS, COHU, VECO, NSM
With the most recent quarterly financial statements from the large majority of the capital value of the stock market now accounted for, I see a continued powerful and now leveraged acceleration in corporate wealth. The capital-weighted average sales growth rate of SEC-filing companies increased for the fifth consecutive quarter.
The strongest and fastest recovery in sales growth on record keeps getting stronger. Average sales growth is well above average, and consistent with the great bull markets in the record – 1995 to 1999 and 2002 to 2007. The frequency of rising sales growth fell, as we knew it must, but we remain with a higher frequency of improving top line then in any other pre-crisis period since 1995. Our data for these figures and our updated macro report on equities vs. long bonds is here.
Gross profit margins rose less frequently in the annual period, but the average gross margin advanced for the first time in a year. Corporate fixed costs (SG&A to sales) fell and now lower interest costs are adding operating and financial leverage to a strong top line.
Companies are producing accelerated cash flow and recently, with the huge flush of liquidity, are accumulating cash. More dividends, more aggressive share repurchase and acquisitions are sopping up some cash, but many companies are accumulating securities. I am looking for the capital expenditures cycle to kick in soon, but so far capital expenditures continue to fall relative to sales.
Among smaller companies the capital expenditure cycle is more evident, with CapEx relative to sales up in the smaller company Russell 2000 index for the first time in two years. Our macro report on the Russell 2000 index is here.
Stocks have advanced broadly and strongly, so the population of share prices trading at a premium to their historical volatility range is large. That broadly extended share price makes this a good time to focus on sell decisions. As the recovery becomes less unanimous, stock selection becomes more important and the companies with stable or falling growth will perform poorly. Many of those companies trade now at premium prices and should be sold.
I have been taking a more conservative approach with the Luxury Liner portfolio in recent months, as shares have broadly moved to premium prices. The cash balance has come up due to sell decisions for companies with deteriorating fundamentals and extended share prices.
Sell decisions for retailers Timberland Co (TBL) and CVS Caremark Co. (CVS) were partially balanced with a buy for Cohu Inc (COHU). Most retailers report their financial statements a month later than other companies, so I am still anticipating those financial statements.
My small exposure to housing was changed with a switch from DR Horton Inc. (DHI) to LSI Industries Inc. (LYTS). The Consumer Cyclical Sector continues to look strong, with sales growth high and up last period. Gross profit margins are rising, and lower inventories suggest that the improving margin trend of the past year will continue. The strength in consumer cyclicals is important since, historically, this sector has been a useful leading indicator of the direction of the broader industrial and technology sectors.
The Basic Industrial Sector produced another powerful acceleration in the recent period, with sales growth up and now near the highest level on record, gross profit margins rising for the eighth consecutive quarter, and lower financing costs adding bottom line leverage to the top line strength. In response the new fundamentals in annual financial statements, I made a sell decision for AK Steel Holding Corp.(AKS) and a buy for Veeco Instruments Inc. (VECO)
The Technology Sector continues to produce powerful acceleration, with sales growth strongly up. The average gross margin improved for the first time in a year and lower costs (SG&A expense to sales) produced a leveraged bottom line improvement. I made sell transactions for International Business Machines (IBM), Dot Hill Systems Corp (HILL), Atmi Inc. (ATMI), Power Integrations Inc. (POWI), Nvidia Corp (NVDA) and Silicon Labs (SLAB), balanced partially with a buy decision for National Semiconductor Corp. (NSM)
There is more work to be done and the larger cash position and larger hedge in the Luxury Liner reflect caution. Corporate growth and commodity prices have become so strong that a tightening of global credit conditions seems imminent. That would likely produce a drop in the value of long term investments and produce more buying opportunities.
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.
I have created ISPACE–Investors Space for Truth. I invite you to take advantage of our free registration.
Sources:
“GEARS Total Market” Robert Gay, GEARS. http://www.the-gears.com/pdf_files/igetpdf.aspx?pdf=ddow
“GEARS Consumer Cyclicals Sector” Robert Gay, GEARS. http://www.the-gears.com/pdf_files/igetpdf.aspx?pdf=sccz
“GEARS Basic Industry Sector” Robert Gay, GEARS. http://www.the-gears.com/pdf_files/igetpdf.aspx?pdf=sbiz
“GEARS Technology Sector” Robert Gay, GEARS. http://www.the-gears.com/pdf_files/igetpdf.aspx?pdf=stkz
