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Every week, we include in this report a list of the highest quality and lowest quality stocks as defined by four key factors: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision Momentum; and 4) Fundamental Quality. At the end of each month, we take roughly 1/3 of the stocks on this list to construct our various long/short and long-only model portfolios based on real trade data. But as you can read below, there are several other ways to use this data.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).
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Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 1 [email protected]
Ascendere Associates LLC www.ascenderellc.com J. Stephen Castellano [email protected]
Ascendere Weekly Ranking Update: December 10, 2010 Every week, we include in this report a list of the highest quality and lowest quality stocks as defined by four key factors: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision Momentum; and 4) Fundamental Quality. At the end of each month, we take roughly 1/3 of the stocks on this list to construct our various long/short and long-only model portfolios based on real trade data. But as you can read below, there are several other ways to use this data. 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).
Three ways to use this newsletter: 1) Build your own hedge fund
Use data in this report at discretion or as an enhancement to our model portfolio strategy newsletter.
2) Anticipate sell side research ratings changes It is not uncommon to find these stocks presaging changes to sell side price targets, ratings or conviction lists. See our "Nostradamus" report.
3) Generate relevant long-term ideas for further study Buy and hold still does work. We do the heavy lifting and find you "high-quality" stocks; you provide the incremental research time and effort.
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. .
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 2 [email protected]
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.
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 3 [email protected]
"High-Quality" Stocks This week, 63 stocks make the "high-quality" list, in line with 63 names last week and with 8 additions and 8 deletions. The most promising "high-quality" name this week is Biogen Idec Inc. (BIIB). There is only one other attractive Healthcare stock on our list, which is the relatively higher ranked Hill-Rom Holdings, Inc. (HRC). In addition, there are some alternative ways to reviewing stocks as measured by our factors that anecdotally seem promising: 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. High Growth and Borderline Reasonable Value Stocks attaining high scores in every category are no necessarily the best performers from a stock perspective. We have noticed that a number of stocks that score 3 for Relative Value, 4 for Operating Momentum and 5 for Analyst Revisions tend to do extremely well. This may be because the market is anticipating outsized gains in improving fundamentals for the next 3-6 months. Stocks in this category include Fossil, Inc. (FOSL), Donaldson Company, Inc. (DCI), Parker Hannifin Corporation (PH), and Huntsman Corporation (HUN). 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).
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 4 [email protected]
Singularly Most Attractive Stock Idea this Week: Biogen Idec Inc. (BIIB) 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.
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 5 [email protected]
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 6 [email protected]
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 7 [email protected]
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 8 [email protected]
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 10 [email protected]
"High-Quality" Stocks (part 1 of 2)
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 11 [email protected]
"High-Quality" Stocks (part 2 of 2)
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 12 [email protected]
"Low-Quality" Stocks
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 13 [email protected]
New to the "High-Quality" List Relative to Last Week
Leaving the "High-Quality" List Relative to Last Week
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 14 [email protected]
New to the "Low-Quality" List Relative to Last Week
Moving Off the "Low-Quality" List Relative to Last Week
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 15 [email protected]
METHODOLOGY Ascendere Associates LLC quantitative research is based on several factors, including: 1) operating momentum 2) fundamental quality 3) analyst revision momentum; and 4) relative value. A number of these factors are overweighted on what we consider proxies for cash flow growth and return on invested capital. In our opinion these factors provide a good reflection of a company's value relative to other companies in its sector. Daily return data of our backtests are available to paying subscribers upon request. Ascendere currently sources raw financial data from Capital IQ. 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 Associates LLC December 10, 2010 J. Stephen Castellano Page 16 [email protected]
DISCLOSURES Ascendere is in the business of providing equity research and related consulting services to investors and their advisors. The equity research it provides includes basic quantitative model portfolios and more detailed fundamental research with respect to individual stocks. In addition, the firm manages stock portfolios for itself and clients. 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. 4) Ascendere has not received compensation from 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.
Ascendere Associates LLC December 10, 2010 J. Stephen Castellano Page 17 [email protected]
DISCLAIMERS This report is intended for informational purposes only and does not constitute a recommendation, or an offer, to buy or sell any securities or related financial instruments. The report is not intended to be in furtherance of the specific investment objectives, financial situation, or particular needs of any individual recipient. The information contained herein accurately reflects the opinion of Ascendere at the time the report was released. The opinions of Ascendere are subject to change at any time without notice and without obligation or notification. The officers, affiliates or family members of Ascendere Associates may hold positions in the securities of the Companies. No warranty is made as to the accuracy of the information contained herein. This information is intended for the sole use of clients of Ascendere. Any other use, distribution or reproduction is strictly prohibited. Investing in stocks includes a high degree of risk, including the risk of total loss.
