A Special Report from Sabrient Systems
10 Earnings
Busters to
Trade Now
10 Earnings Busters to
Trade Now
By David Brown
Chief Market Strategist and Editor of the
Sabrient Earnings Buster Portfolio
The 21st century has produced a fractured, information-dense global economy in which predicting
market behavior has become virtually impossible. Macroeconomic forces around the world push the
market around as if it were a punch-drunk fighter. When China decided to let its currency—the
yuan—float, markets around the world tossed and tumbled for weeks. When fears spread that the
federal deficits of Portugal, Italy, Indonesia, Spain, and Greece (the PIIGS) were spiraling out of
control, the markets plummeted— and then recovered as the rest of Europe, led by Germany,
stepped in to bail them out.
To put it another way: When Shanghai sneezes, Wall Street catches a cold. When Berlin blinks,
the Street rubs its eye.
For the trader, this means that the old rules no longer apply. The technical indicators you used to
depend on can’t keep up with today’s volatile global markets. The fundamentals that once guided a
company’s growth are not as dependable as they once were.
So what’s a trader to do? Determine which statistics and factors still matter; then use them to
judge the growth potential of stocks.
Earnings, for example, still matter. That’s why we’re presenting “10 Earnings-Busting Stocks”
to trade now. But before we get to those 10 stocks, let’s look at the most common mistakes in
trading earnings-busting stocks.
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10 Earnings-Busting Stocks To Trade Now
5 Most Common Mistakes in Trading Earnings-Busting Stocks.
Here’s my take on the five most common mistakes in trading stocks with high earnings growth rates.
1. Not having a system. The number one mistake made by investors is the lack of a systematic
approach to investing. Let’s say a friend tells you that ABC doubled in price today, which
making it a hot stock that you should buy. Not necessarily. You need to find out why it doubled
and whether that might be a repeatable event. Without a system, you’re investing purely on
emotion, which usually leads to trouble.
2. Paying too much for earnings growth. The next three mistakes have to do with earnings
growth rates and the price you’re paying for the current earnings, next year’s earnings, and the
earnings growth rate over the next 5 years. This is the key, really, because the expected growth
often has already been factored—and in some cases over-factored—into the current price in the
form of a too-high current P/E or forward P/E. (A free site like Yahoo Finance can provide all
the data you need on earnings growth rates and P/Es.)
a. Paying too much for current earnings. The current price-to-earnings (P/E) ratio tells
you how much you’re paying for current earnings (the current 12 months). If the P/E is
too high compared to the stock’s current earnings growth rate, there is less room for the
stock price to grow, so you could be paying too much.
What is a “too-high” P/E? To me, a current P/E that is much higher than the current
year’s earning growth is too high. For example, if this year’s earnings growth is 20% and
the P/E is 30, you’d be paying 30 times earnings. That would make me uncomfortable. If
the current year’s earnings growth rate is 30% and the current P/E is 30, that would be
fine. Even better would be a current year’s earnings growth rate of 40% and a current P/E
of 30.
Keep in mind that depending on where you are in the company’s fiscal year, the
current year’s earnings growth rate can include estimated earnings that the company
hasn’t actually made yet.
b. Paying too much for future earnings. The forward price-to-earnings ratio (forward
P/E) tells you what you’re paying for future earnings. The forward P/E ratio is even
more important than the current P/E because current earnings are more likely to be
already taken into account by the market. The forward P/E is the current price divided by
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10 Earnings-Busting Stocks To Trade Now
next year’s projected earnings. A forward P/E higher than the next year’s projected
earnings growth rate is too high, in my opinion. So a company with an expected EPS
growth rate of 25% for next year and a forward P/E of 35, based on today’s stock price, is
too expensive for my portfolio.
c. Accepting a company growth ratio that is too high. Company growth ratio (CGR) is
the annualized 5-year estimated growth rate divided by the forward P/E ratio. If the CGR
is lower than 1.0, I would take it as a warning. It’s always possible that a company’s
growth rate will accelerate making its P/E more palatable, but the opposite is much more
likely to happen—the P/E will fall to match the growth rate— and you won’t like that.
3. Ignoring the company’s accounting methods. I would not invest in a company with very
aggressive accounting practices. It could mean they may have to take a future write-down which
could slash the stock price.
How to Avoid these Mistakes
How do you avoid these mistakes? Define which factors matter to you; then quantify the data.
What matters most to me when selecting a stock are the factors I just talked about: current and
forward P/E ratios, Company Growth Ratio (CGR), and accounting and corporate governance
practices.
The Big Three Ratios. These three factors—company growth ratio (CGR), current P/E ratio,
and forward P/E ratio—tell you how much you’re paying for a company’s earnings. In order to do a
proper comparison, you’ll also need the company’s earnings growth rates for the current year, next
year, and next 5 years. You can find the current and forward P/E ratios and earnings growth rates
for any public company at many financial websites. I use Yahoo Finance and CNBC.
The company growth ratio (CGR) is not readily available, but it’s easy to calculate. Divide the
estimated next 5 years growth rate (per annum) by the forward P/E.
Corporate Governance. A company’s accounting and governance practices relate to the
company’s integrity. If these practices are rated as aggressive, I would think twice about buying their
stock. There’s too big a chance that they’ll run afoul of the Securities and Exchange Commission
(SEC) and have to restate a bunch of numbers, which could damage the stock badly.
Several companies study the corporate governance of public companies and issue reports on the
level of risk related to the company’s accounting and governance practices.
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10 Earnings-Busting Stocks To Trade Now
Risk Metrics publishes a “Governance Risk Indictor “(GRI ®)1 through Yahoo Finance. You can
find this on the stock’s Profile page. Here is the Risk Metrics’ assessment of GameStop Corp
(GME), one of the earnings-busting stocks:
GameStop Corp.’s Governance Risk Indicator (GRI®) as of Jan 1, 2011 is: Board (Medium
Risk), Audit (Low Risk), Compensation (High Risk), and Shareholder Rights (High Risk).
AI quantifies those risks that relate to company stock price, securities litigation, and major
restatement probabilities and issues an “Accounting and Governance Risk” rating (AGR® score)2.
The AGR score is a percentile score ranging from 0 to 100, with corresponding ratings from Very
Aggressive to Conservative. Here is Audit Integrity’s assessment of GameStop Corp:
GameStop Corp. is currently rated as having Average Accounting & Governance Risk
(AGR). This places them in the 71st percentile among all companies, indicating higher
accounting and governance risk than 29% of companies.
The Risk Metrics GRI score is free to users through Yahoo Finance. Audit Integrity was recently
merged with GovernanceMetrics International, and the AGR scores are now available only through
subscriptions.
Sabrient Systems, one of the leaders in quant information, quantifies hundreds of pieces of
data, rather than just the ones I’ve mentioned here, and they use it to rank more than 5,800 stocks. I
used the Sabrient quantitative rankings to find these ten earnings-busting stocks to trade now.
NOTE: At the end of this report, I’ve included a table of these quantifiable data for the 10
earnings-busting stocks. In a future posting on this blog, I’ll lay out a step-by-step procedure for
quantifying the data.
1
GRI is a registered trademark of Risk Metrics.
2
AGR is a registered copyright of Audit Integrity, Inc.
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10 Earnings-Busting Stocks To Trade Now
Earnings-Busting Stocks to Trade Now
NOTE: Stocks #1 - 6 were originally selected in late November 2010, but their
fundamentals still qualify them as earnings busters. All prices, ratios and earnings
data are current as of April 20, 2011. This report will be updated from time to time.
1. GameStop Corp (GME) ($26.35)
Remember Babbages, that cool software store in the mall where you hung out as a teenager looking
for computer video games? Well, over the past decade, Babbages morphed through several
identities, ended up as GameStop Corporation, and is now providing video games to your kids and
grandkids, both in the mall and online.
GameStop is the largest video game and entertainment software retailer in the world, with almost
6,500 stores in the U.S. and 17 other countries. It ranks No. 255 on the Fortune 500. This year it
acquired kongregate.com, whose 10 million members play online games for free. Little wonder it
made our list of earnings-busting stocks.
Why GME is an Earnings Buster: GME’s earnings have grown at +36.8% per year over the
past 5 years and are projected to continue at a milder pace of +12.4% per year over the next 5 years.
Right now you can buy those earnings at a pretty good discount. The current P/E is 10.0, but the
projected P/E is just 8.2. The price peaked in late 2008 at about $62; it is now selling for about a
third of that, so it has a lot of room to grow. Its CGR is 1.51, and it is rated a Strong Buy by
Sabrient.
2. Trina Solar, Ltd.
(TSL) ($27.59)
China’s targeted clean energy policies are positioning it to become a major player in the global
renewable energy market—Trina Solar is at the forefront of that effort.
Headquartered in Changzhou, China, Trina Solar is the largest solar photovoltaic (PV)
manufacturer in the world, marketing PV modules to a number of European countries (Germany,
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10 Earnings-Busting Stocks To Trade Now
Spain, Italy, the Netherlands, France, and Belgium). In August of last year, the company signed an
agreement to supply PV modules to Southern California Edison.
Why TSL is an Earnings Buster: Trina Solar has grown at +76.9% over the past 5 years, and is
projected to grow at +16% per year over the next 5 years. Based on this year’s earnings, its P/E is
7.6; based on next year’s earnings, the projected P/E is only 6.6. Its CRG is 2.44, which makes it a
good buy considering the projected growth rate. TSL is rated a Strong Buy by Sabrient.
3. Apple, Inc. (AAPL) ($342.41)
If you don’t know who Apple is, you’ve been living in a cave in the Australian outback for the past
30 years—and even that’s probably not beyond the reach of the company that Steve Jobs built.
Apple is one of the companies that has changed the way we live, beginning with the Apple II
in 1977 (I was User # 91 of the Apple II) and segueing to the Mac, the iPod, the iTunes media
browser, the iPhone, and most recently the iPad and Apple TV. It was the growth stock of the 1980s,
and it began a new surge of growth in 2001 with the introduction of the iPod and has grown at about
50% per year for the past 5 years.
Why AAPL is an Earnings Buster: Last year Apple’s earnings grew +52%. This year they’re
expected to grow approximately +60%, with a current P/E of 18.9 and a projected P/E of 12.4.
Apple is expected to grow at +19.6% a year over the next 5 years, which gives it a CGR of 1.58.
Some analysts feel that Apple’s accounting is a bit on the aggressive side, but the stock comfortably
meets all of our other criteria. AAPL is rated a Strong Buy by Sabrient.
4. Jazz Pharmaceuticals (JAZZ) ($34.22)
Jazz is an interesting name for a company that makes drugs . . . but according to its website, the name
was inspired by jazz, the musical form because the company uses “innovation and collaboration” to
improve patients’ lives.” Well, okay.
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10 Earnings-Busting Stocks To Trade Now
JAZZ develops prescription medicine for patients with psychiatric and neurological disorders.
Current products include Xyrem for the treatment of narcolepsy LuvoxCR, an antidepressant. On
October 11, 2010, the Food and Drug Administration rejected JAZZ’s application for its JZP-6, a
treatment for fibromyalgia, and requested more trials. However, the market seems to be ignoring the
rejection; the stock was up more than 5% the week of the announcement.
Why JAZZ is an Earnings Buster: JAZZ is probably the most speculative of our earnings
busters. The company made its first earnings in 2010 of $1.50, which is 677% more than it made in
2009 (outrageous gains tend to appear when a company transitions from the red to the black).
Expected earnings for 2011 are $2.82, which sends the expected growth rate to 88%. We’re paying
41.2 times this year’s estimated earnings, but assuming those earnings are achieved, the forward P/E
is only 6.8. With a 5-year estimated growth rate of 25% per year, JAZZ has a solid CGR rating of
3.68. But keep in mind the word “speculative” and the rejection by the FDA in October, 2010.
Sabrient rates JAZZ a Strong Buy.
5. Arrow Electronics, Inc. (ARW) ($42.74)
A Fortune 200 company with 12,700 employees worldwide, Arrow Electronics made Fortune’s
annual list of the World’s Most Admired Companies for the 11th year in a row. ARW is a global
provider of products, services, and solutions to industrial and commercial users of electronic
components and enterprise computing solutions. Headquartered in Melville, N.Y., Arrow serves as a
supply channel partner for over 1,200 suppliers and 115,000 original equipment manufacturers,
contract manufacturers, and commercial customers through a global network of more than 340
locations in 52 countries and territories.
Why ARW is an Earnings Buster: Arrow’s 2011 earnings are expected to increase
+18.62% from last year and to grow at a rate of 14.5% per year for the next 5 years. What’s more,
the earnings are cheap—the current P/E is 10.4 and the projected P/E, only 7.9. Arrow’s CGR is a
healthy 1.84 and its accounting and governance practices are rated low risk by Risk Metrics.
Sabrient’s earnings quality rank is a bit below average, but the growth metrics make that risk
tolerable. ARW is rated a Buy by the Sabrient.
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10 Earnings-Busting Stocks To Trade Now
6. Amtech Systems, Inc. (ASYS) ($22.40)
Amtech is a technology company that provides products and services to the semiconductor and solar
industries, the latter establishing it as a player in the alternative energy field. A small-cap company,
ASYS sells its products primarily in the United States, Asia, and Northern Europe. The company
was founded in 1981 and is headquartered in Tempe, Arizona.
Why ASYS is an Earnings Buster: Amtech’s 2011 earnings are expected to increase
+111.5% from its 2010 earnings and are expected to grow +35% per year over the next five years.
The current P/E is 14.7, but the forward P/E is 8.8, which is very good considering the projected
earnings. ASYS has an outstanding CGR of 3.89, and its accounting practices are considered
conservative. Sabrient rates ASYS a Buy.
7. Delphi Financial Group, Inc. (DFG) ($30.71)
Delphi Financial Group, Inc. is a holding company whose subsidiaries—Reliance Standard Life
Insurance Company, Safety National, and Matrix Absence Management, Inc.—offer integrated
employee benefit services. Services include group insurance coverage for long-term and short-term
disability, life, excess workers’ compensation for self-insured employers, large casualty programs
including large deductible workers’ compensation, travel accident, dental, and limited benefit health
insurance.
Why DFG is an Earnings Buster: DFG has modest earnings growth expectations for 2011
(+6%), but it is expected to grow at +10.3% per year for the next five years. Moreover, the company
had positive earnings surprises in every quarter of 2010, beating the 4th quarter estimates by 11.6%.
The current P.E is 9.7, but the forward P/E drops to 7.6. The company has a respectable CGR of
1.36 and is rated as conservative for its accounting and governance practices. Sabrient rates DFG
rated a Strong Buy.
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10 Earnings-Busting Stocks To Trade Now
8. Brigham Exploration Co. (BEXP) ($34.46)
Brigham Exploration Company is an independent exploration, development, and production company
located in Austin, Texas. Its current focus is on the oil shale fields in North Dakota, primarily the
Williston Basin’s Bakken formation. Brigham uses horizontal drilling and the latest rock-smashing
technologies to recover oil trapped in the shale. According to one writer, oil is “everywhere” in the
Bakken formation, and Brigham owns more than 368,000 net acres of it. Oil shale reserves in the U.S.
total about 1.5 trillion barrels of oil, the development of which could dramatically decrease our
dependence on foreign oil.
Why BEXP is an Earnings Buster: For starters, Brigham is in the Energy Sector which has
been one of the top-performing sectors in the past weeks because of the ongoing crises in the Middle
East. That aside, its estimated earnings growth rate for 2011 is 115.0% with an expected growth rate of
40.8% per year over the next five years. While the current P/E is 87.5, the forward P/E ratio is just 14.8.
Considering the earnings growth rates, it earns an excellent CGR of 2.76. All this overcomes its slightly
aggressive rating for accounting and governance practices. Sabrient rates BEXP a Strong Buy.
9. International Coal Group, Inc. (ICO) ($10.68)
Australia is responsible for some 66% of the world's metallurgical coal, but the devastating floods in the
first quarter of this year have severely hampered mining operations. As a result, inventories have
tightened and prices have shot up. This is bad for Australian-based coal companies, but good for the
bottom line of companies like International Coal Group.
ICO is a leading producer of coal in Northern and Central Appalachia, with mining complexes in
West Virginia, Kentucky, Virginia, and Maryland, and one mining complex in the Illinois Basin. Its
operations consist of both surface and underground mines. The company controls one billion tons of coal
reserves that are primarily high-BTU, low-sulfur steam, and metallurgical quality coal.
Why ICO is an Earnings Buster: Coal is a major source of fuel for power generation and steel
production, and demand for coal is accelerating with the growth of emerging nations like China and
India. The coal industry is further boosted by the nuclear meltdown threats in Japan, which has severely
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10 Earnings-Busting Stocks To Trade Now
tainted the nuclear energy outlook. Coal companies are the fortunate recipients of Japan’s unfortunate
disaster. ICO is one of the smaller players in the industry, but its earnings outlook is exceptional. The
company’s earnings are expected to grow 137% in 2011 and 77% per year for the next five years.
Although the current P/E is 70.1, the high earnings growth rates drop the forward P/E all the way to
9.1—and give the company a phenomenal CGR of 8.46. ICO’s accounting and governance practices are
rated very conservative. The stock is rated a Buy by Sabrient.
10. Baidu, Inc. (BIDU) ($149.31)
According to one of the founders, Robin Li, the name ‘Baidu’ was inspired by a poem written more
than 800 years ago during the Song Dynasty. The literal meaning of the word is “hundreds of
times,” which Li says represents a persistent search for the ideal. An appropriate name for a search
engine, don’t you think?
Baidu is a Chinese search engine that also offers an online collaboratively-built encyclopedia
and a searchable keyword-based discussion forum. It’s rather like a Chinese combination of Google
and Wikipedia, except that it censors its content as required by the Chinese government. The real
Wikipedia states that Baidu has a market share of 56.6% of the 4.02 billion search queries in China
in the fourth quarter of 2010. Baidu is included in the NASDAQ-100 index
Why ICO is an Earnings Buster: Baidu’s earnings are expected to grow at 66% in 2011.
The current P/E is high at 99.7, but the forward P/E is 37. That may still seem high, but considering
the projected 58% earnings growth rate per year over the next 5 years, it is more than acceptable.
The company has a CGR of 1.58, and its accounting and governance practices are conservative.
Sabrient rates BIDU rated as a Strong Buy.
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10 Earnings-Busting Stocks To Trade Now
Recap of Quantifiable Data
In a future post on this blog, I will show you how to quantify the data and rank the stocks based on
how well they meet the criteria for earnings-busting stocks. Although all 10 stocks qualify as earnings
busters, keep in mind that some of the overall scores are better than others. It is helpful to learn how
to rank the stocks so that you can buy the ones at the very top of the list.
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10 Earnings-Busting Stocks To Trade Now
David Brown
Chief Market Strategist
Sabrient Systems, LLC
David Brown is Chief Market Strategist for Sabrient Investors (H)Edge and a former NASA
scientist, businessman, and a lifelong investor. As former CEO of Telescan Inc., a public
company, he designed and developed the critically acclaimed stock search program, ProSearch,
and the market timing indicator, the Brown Breakout Ratio (BBR).
David was named Stock Traders Almanac's Man of the Year in 1988 for "[showing] the average
investor how to spot the stocks that the hottest money managers are buying." He currently
writes the weekly Sabrient Investor’s (H)Edge Portfolio, which has shown a 36% gain since
inception on Jan 30, 2009, as well as the weekly market letters, Trader’s Talk and What the
Market Wants.
He has documented his investing expertise in four books on investing, including All about
Stock Market Strategies (McGraw-Hill, June 2002) and Cyber-Investing: Cracking Wall Street
with your Personal Computer (John Wiley & Sons, 1994, 1997). The latter was named Book of
the Year in 1997 by PBS's Inside Money. He has taught finance and security analysis courses at
the University of Houston.
He holds an M.B.A. in Finance from the University of Houston and a B.S. in Engineering from
the University of Pittsburgh. He is a member of the Author's Guild.
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10 Earnings-Busting Stocks To Trade Now
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10 Earnings-Busting Stocks To Trade Now