Stuart Shaw, CFA

Target is on the cover of the current issue of Fortune. I like shopping at Target, and the stock is down 30% from its 52-week high.

Fast Track results: Target failed 5 categories, so I would not go further with this idea.

Key points:

1. Target has a lot of financial leverage with long-term debt as a percentage of total capital of 49.7%.
2. Free cash flow has been declining since fiscal 2005, and came in at a negative $244 million last year.
3. Consensus earnings estimates have been trending lower.
4. The stock passed two valuation measures, and more than half the analysts covering the stock are not recommending purchase are positive factors.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

In June 2005, I concluded that, “Starbucks is a great company, but the shares are expensive. Moreover, their valuation reflects investors’ expectations that management will deliver on their forecast. I do not want to take on the valuation risk at the current price that they may not.” The stock has fallen 33% from that time and 57% from its high in May 2006.

Fast Track results: Starbucks failed 3 categories, and is an idea that is worthwhile taking a closer look.

Key points:

1. Starbucks has new operating management as founder and Chairman, Howard Schultz, took over as CEO in 2007. His plan is to renew the company’s focus on coffee, improve profitability, and emphasize growth in overseas markets. Investors’ expectations about management delivering on these plans are much lower today.
2. The power of the Starbucks brand name has not changed.
3. The balance sheet is solid with long-term debt as a percentage of total capital at a low 19.6%.
4. Free cash flow has been growing: $360.4 million in 2006, $559.1 million in 2007, and $695.2 million in the latest 12-months.
5. The stock passed Fast Track’s two valuation measures.
6. Nine of the 18 analysts covering Starbucks rate the stock hold leaving plenty of room for ratings upgrades.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

The ideal stock probably does not exist. But if it did, I believe it would look like this: great fundamentals and outstanding value, which have gone undiscovered by investors. In my ongoing search for stock ideas, I try to come as close to my view of the ideal stock as possible. Here’s what I look for.

The company produces products and services that people need and use every day giving it staying power through economic cycles. Individuals and businesses forego what they do not need when economic times are tough.

An established leader, the company dominates its markets with strong brand names. It has the critical mass to be a low cost producer and a very effective competitor, with the marketing muscle to successfully capitalize on powerful brand identification.

Cash from operations and after capital expenditures (free cash flow) is strong and growing. Also, cash from operations is consistently higher than net income indicating quality earnings. A company reporting positive net income, but ongoing negative cash from operations will eventually crash and burn. Real cash is a company’s lifeblood. I want to invest in companies that generate cash to grow their businesses, pay me dividends and buy back stock.

The company has a fortress balance sheet, with lots of cash that is growing and little or no debt. Cash from operations is the principle source of growing cash on the balance sheet, suggesting a profitable and well-managed company.

Management has a large stake in the ownership of the company, and they are buying stock for themselves. Real owners are apt to make better decisions than managers who do not have their personal fortunes at stake.

Managements whose interests are aligned with shareholders run businesses for cash, build strong balance sheets, and have large personal stakes in the outcome.

Earnings have been beating Street estimates for the last several quarters. Underestimating the company’s operating performance, Street analysts are raising their earnings estimates as they try to catch up to what is really happening. Rising earnings estimates indicate positive change, a key element supporting a rising stock price.

The company has a demonstrated record of high profitability. Profitability measures how well management utilizes the company’s resources to produce value for shareholders. Profitability (net profit margin and return on equity and their components) is rising and outperforming the company’s industry as well as the average company as represented by the S&P 500. The quality of profitability is high. Return on equity is rising because of higher pretax margins and asset utilization as opposed to a lower tax rate and higher leverage or debt.

I want stocks that pay dividends. Real cash in my pocket, dividends are a clear reflection of management’s confidence in the future of their business. As one CEO so aptly stated: “Paying a reliable and attractive dividend from the cash we generate each year is one of the most direct and transparent means we have of delivering shareholder value.”

The company has no controversial issues surrounding it, which potentially can crush a stock. These may be issues of questionable accounting and management practices, antitrust matters, new competition, and litigation, to name a few.

The stock is off the beaten track, with no analyst coverage and little institutional ownership. Investors have yet to discover the idea, leaving plenty of room for positive change in perception, expectations and stock price.

The company is poised to show substantial positive change that is going unrecognized by investors. No one is watching, but a catalyst is going to jolt the Street with a positive surprise and change investor perception. Catalysts could be a new product, new management, the sale of underperforming businesses, a strengthening balance sheet, a major cost cutting initiative. Substantial positive change also could emanate from expected negative events that do not happen, e.g. Altria in 2000 at $20 discounting a potential bankruptcy due to litigation.

The stock is undervalued. I use the Company Stock Risk Profile™ valuation measures. Multifaceted in its approach, the Company Stock Risk Profile uses six valuation methods comprised of twelve measures to value stocks yielding a comprehensive result. The ideal stock would be undervalued on all twelve measures.

Recession or not, we all need to eat. The food industry should be one place I would expect to find solid balance sheets and consistent operating performance in an uncertain economic environment.

I screened 14 food, beverage and confectionary stocks using the Company Stock Risk Profile Fast Track. Here’s what I found.

The industry has a lot of financial leverage. Long-term debt as a percentage of total capital averaged 38.2% for all 14 companies. Only three companies were below 20%, which is the Company Stock Risk Profile’s definition of low long-term debt – Coca-Cola (KO), Pepsico (PEP) and Diamond Foods (DMND). Heinz (HNZ) and Hershey (HSY) were at the high end with 70.4% and 68.3%, respectively.

This is not a consistently cash rich industry. Free cash flow at as many as six companies was not stable and declining.

Eight companies reported disappointing earnings as compared with Street expectations in at least one quarter in the latest four quarters. Street analysts have lowered earnings estimates at only two companies. Are these analysts too optimistic?

Valuation is a mixed picture. Eleven stocks had P/E’s (using trailing 12-month earnings) below the average of the high and low P/E’s for the last five years. But based on the PEG ratio (forward P/E / Projected Earnings Growth Rate), 12 stocks were overvalued relative to the industry and/or the S&P 500.

Managements have not demonstrated enthusiasm for their stocks. Kraft was the only company where management had purchased their company’s stock.

The Street on balance likes this group. There were eight stocks where more than half the analysts following them were recommending buy. The Company Stock Risk Profile and Fast Track favor stocks where less than half the analysts are recommending purchase, leaving plenty of room for ratings upgrades.

There were only two stocks that had both low long-term debt and stable or growing free cash flow. They were Coca-Cola and Pepsico. And Coca-Cola was the only stock that failed only 3 of the 10 Fast Track categories, leading me to take a closer look.

Coca-Cola’s Company Stock Risk Profile rating turned out to be Medium Risk. While the company’s fundamentals are solid, two variables raised the stock’s Risk Profile. Failing 8 of 12 valuation measures, the stock is far from cheap. And the Street is extremely bullish with 14 of the 16 analysts following the stock recommending purchase. Admittedly, I passed on Coca-Cola in March 2005 when the stock was $43 based on valuation.

The stock I find most intriguing is Kraft (KFT). Although the stock failed 4 of the 10 Fast Track categories, I broke my 3-category rule and put the stock through the complete Company Stock Risk Profile research process. Kraft is a turnaround story, so I wasn’t surprised that the Risk Profile rating was Medium. Here’s what caught my interest:

1. Kraft is one of the world’s leading food and beverage companies with such well-known and established brands as Philadelphia cream cheese, Oscar Mayer, Post cereals, Nabisco, and Kraft.
2. Kraft has new management at the top. Irene Rosenfeld was appointed Chief Executive Officer in June 2006, and also became Chairman in March 2007 following Altria’s spin-off of Kraft. Rosenfeld is a 25 year industry veteran, and came back to Kraft from Pepsico’s Frito-Lay where she was Chairman and CEO since 2004.
3. The company generated cash flow from operations of $3.6 billion last year and, after capital expenditures, free cash flow of $2.3 billion.
4. Insiders purchased stock this past February.
5. Kraft has yet to gain support on the Street. Only 4 of the 18 analysts following the stock are recommending buy.
6. Warren Buffett’s Berkshire Hathaway owns 132.4 million shares or 8.6% of the outstanding shares.

There also are negative factors to consider: (1) Management’s strategy to accelerate growth and cut costs has yet to prove successful, although top line growth is beginning to pick up; and, (2) The shares are not a bargain, having failed 7 of 12 valuation measures.

Because most Street analysts probably have low expectations, Kraft is positioned to surprise on the upside if the implementation of management’s strategy continues to move in the right direction. But the stock doesn’t yet offer the value I require to be appropriately compensated for the risk inherent in a turnaround. Nevertheless, I believe Kraft has the potential to be an attractive buy idea, and I’m going to follow the stock closely.

Pfizer (PFE) is the world’s largest pharmaceutical company with such well-known products as Lipitor, Celebrex and Aricept. The stock has fallen into the rubble pile as the price dropped precipitously from $39 in February 2004 to $21 currently, reflecting patent expirations, including Lipitor’s in 2010, and flat sales last year.

Fast Track results: The stock failed 3 categories. Pfizer is a classic contrarian idea, and is worth a closer look.

Key Points:

1. Pfizer has a fortress balance sheet. The company is cash rich with $25.5 billion of cash and short-term investments on the balance sheet at year-end 2007. Long-term debt as a percentage of total capital is a low 10.1%.
2. Pfizer generated operating cash flow of $13.4 billion in 2007 and, after capital expenditures, free cash flow of $11.5 billion. Management is forecasting operating cash flow to rise to $17-$18 billion this year.
3. The Street on balance is not interested in the stock, with 13 hold and 2 underperform ratings out of a total of 23 analysts.
4. The stock offers a hefty 6% yield. As an expression of confidence in the future of the business, management raised the dividend 10% in this year’s first quarter.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

Pension Plans Take Chance on Mortgages
By Jim Davenport, Associated Press Writer

Maybe this is an early sign that the mortgage market is beginning to stabilize. This also is an excellent example of contrarian thinking and investing.

See my post Move Out Ahead of the Crowd, October 1, 2006.

I like to go where the cash is. So, I Fast Tracked Google (GOOG), Apple (AAPL) and Microsoft (MSFT).

Fast Track results: Each stock failed four categories. Staying with the discipline of my three-category rule, I’m not going further with these ideas.

Key Points:

1. These companies are cash machines, with strong and growing free cash flow, lots of cash on their balance sheets, and no long-term debt. While substantial, cash balances at Microsoft have been declining.
2. Google reported earnings that were slightly below Street estimates in two of the last four quarters. Street estimates have been trending lower at Google and Apple. Microsoft’s earnings have not disappointed and estimates have been stable.
3. Valuation is a mixed picture at Apple and Microsoft. Google’s stock passed Fast Track’s two valuation measures.
4. Managements at all three companies have been selling stock at the same time that the Street loves these stocks. I want to see just the opposite. There are a total of 97 ratings on all three stocks, of which 81% are buy recommendations – not much room for any disappointment.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than three categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

Johnson & Johnson’s (JNJ) products are part of our daily living. Tylenol, Aveeno, Band-Aid and, of course, Johnson’s Baby Powder are well known brands. But did you know that Johnson & Johnson is the leading company in the medical devices industry and the 5th largest pharmaceutical company?

Fast Track results: Johnson & Johnson’s stock failed 3 categories, and is an idea worthwhile thoroughly researching.

Key Points:

Generated $12.3 billion of free cash flow last year.

1. Generated $12.3 billion of free cash flow last year.
2. Ended 2007 with $9.3 billion of cash and marketable securities on the balance sheet.
3. Long-term debt as a percentage of total capital is a low 14%.
4. Warren Buffett’s Berkshire Hathaway is a major shareholder with 61.8 million shares.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

General Electric (GE) is a broad based industrial company spanning infrastructure, healthcare and consumer products, in addition to media and financial services.

Fast Track results: GE’s stock failed 3 categories, and is worthwhile thoroughly researching.

Key points:

1. Strong free cash flow.
2. Earnings have not disappointed, and analysts’ estimates have been stable.
3. Management has been buying stock.
4. Attractive 3.6% yield.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

World economic collapse is imminent. 1929 is just around the corner. My stocks will never stop going down. I can’t take this anymore, and I’m getting out now. This is a new age for the economy and the stock market, and there’s no way stocks are going down. Everyone else has been making a lot of money in the stock market, and I’m not going to be left out. Feel familiar? These are examples of strong emotions that can push you into making bad investment decisions. However, these same emotions can be your allies, and a resource that you can use to take advantage of investment opportunities.

There are many angry investors who were caught up in the dot.com, telecommunications, and technology bubble and subsequent collapse, Enron included. Some people lost their life savings. This does not have to happen to you.

The stock market is like riding a wave up and down. Sometimes the wave can be dramatic and last a long time before it crashes or takes you up. While the market seems to extend itself, that is go beyond what seems reasonable, on the upside and downside, it always changes direction. While this may seem obvious, it takes a lot of emotional strength to fully embrace this fact when you’re feeling great and complacent when the market is soaring, and it seems that it will never end, or when you’re feeling fear and panic when the market is dropping rapidly, and it seems it will never stop falling.

Are you on the verge of selling all of your stocks because you cannot take the falling prices anymore causing you to panic? Or, are you about to buy stocks, possibly stocks with a high degree of risk, because you feel that all’s well with the stock market, and there’s no way anything can go wrong? Are these the extreme emotions that are really behind the investment decisions you are about to make? Are you about to sell at the bottom of the market or buy at the top because you are caught up in your emotions?

Get a pencil and paper and draw an elongated S shaped curve. Write Exuberance at the top and Fear and Panic at the bottom. These extreme emotions represent market tops and bottoms. To the right of this graph draw a vertical line and label it Risk. Write the word Highest at the top of the line and the word Lowest at the bottom. I call this the Exuberance / Fear and Panic Graphic.

You must understand risk within the context of your emotions. You are putting your money at the highest risk of losing it when you are the most comfortable and complacent about your holdings, when you are exuberant. Risk is at its lowest level just at the time when you are the most negative about the market’s outlook, when you are feeling fear and panic. Objectively recognizing your emotions, you can then turn your emotions and the graph upside down with Exuberance at the bottom and Fear and Panic at the top. Seeing risk with new clarity, you are able to make better investment decisions to protect your capital and take advantage of opportunity.

What action should you take when you are able to gather the emotional strength to turn the graph upside down? Be afraid of the market at the top of the graph. Turning exuberance into fear, sell your stocks and be entirely in cash. If you find yourself at the bottom of the graph, transform your fears into excitement about finding stocks to buy. Put cash to work towards being fully invested in stocks.

There are various methods of valuing markets, among them price / earnings ratios, dividend yields, earnings yields, sentiment indicators, and technical analysis or charting. These methods look outward. I’m proposing that you also should look inward at yourself with the aid of the Exuberance / Fear and Panic Graphic as another, albeit unconventional, approach.

A successful investor is objective, disciplined, and has a clear understanding of risk. The Exuberance / Fear and Panic Graphic helps you to objectively examine your emotions, attain the discipline not to get caught up in the wrong emotions at the wrong time, and to recognize the real risk inherent in your investment decisions.