Stuart Shaw, CFA

“We’re off to a good start in what we expect to be another strong year of financial performance for Boeing,” said Chairman and Chief Executive Jim McNerney. The company delivered first quarter earnings that handily beat the Street’s consensus estimate.

Fast Track results: Boeing failed 3 categories. The stock is a potential idea that is worthwhile thoroughly researching.

Key points:

1. Cash and equivalents ended the first quarter at $9.6 billion, up from $7.0 billion last year and $3.2 billion in 2004.
2. Free cash flow came in at $1.5 billion in the first quarter, as compared with $277 million a year earlier.
3. Boeing’s earnings have beat Street estimates for the last 4 quarters. The Street has been lowering estimates, and that trend could change.
4. Boeing’s stock passed Fast Track’s 2 valuation measures.
5. Eleven analysts rate the stock hold and 3 underperform/sell out of a total of 22 analysts, leaving 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.

Unlike oil, gold, and other such commodities, water is the one commodity we must have to live. And I don’t even think about it. I don’t have to. Clean water is delivered to my home and where I work. It’s always available, and it’s cheap. Will it always be this easy?

Living in Arizona, one of the fastest growing and driest states, I thought back to a discussion I heard on NPR about population migration. I remembered this startling prediction: the Southwest will be riddled with ghost towns when water runs out, and those looking back 50 years from now will be mystified as to why people ever wanted to live there. Last year 26% of the Southeast was covered by an “exceptional” drought – the National Weather Service’s worst drought category.

Consider these worldwide facts from the United Nations’ Human Development Report 2006:

1. Less than 1% of the world’s freshwater is easily accessible.
2. 1.2 billion people lack access to freshwater, and 2.6 billion are without adequate sanitation.

More people with higher living standards, pollution, and climate change may be pointing to water shortages down the road. A key example, China has 20% of the world’s population but only 7% of the water. Will China have enough water to support its rapidly growing urban population?

The water industry should be ripe with investment opportunities. I put together a group of 18 stocks, certainly not all-inclusive of ways to participate in the industry, to begin to find out:

York (YORW), Pennichuck (PNNW), Middlesex (MSEX), Connecticut (CTWS), Southwest (SWWC), Artesian (ARTNA), SJW (SJW), American States (AWR), Aqua America (WTR), and California (CWT) are all domestic water utilities.

Mueller Industries (MLI) - tubes and fittings used in water distribution systems.

Watts Water Technologies (WTS) – water safety and flow control products.

Nalco (NLC) - water treatment chemicals and services.

Flowserve (FLS) – flow control equipment.

Gorman-Rupp (GRC) – pumps and fluid control equipment.

Calgon Carbon (CCC) – products to purify water and air.

Veolia Environment (VE) – water treatment services based in France.

Consolidated Water (CWCO) – desalination plants and water distribution systems in the Caribbean.

I used Fast Track to get a quick study on the group and find potential buy ideas:

1. These are mostly small cap stocks, and they are not widely followed on the Street. Thirteen stocks have market capitalizations under $ 1 billion. Thirteen stocks are covered by 5 analysts or less, and 9 stocks by 3 analysts or less.
2. Financial leverage is high, with long-term debt to total capital averaging 40.9%, ranging from 0% for Gorman-Rupp to 74.1% for Nalco.
3. Free cash flow was negative at 10 companies in 2007, and 7 companies posted negative free cash flow in each of the last 5 years. These are all utilities.
4. Thirteen stocks had P/E’s below their high / low 5-year average. Only two stocks, Mueller and Watts, also had PEG ratios that were below both their industry and the S&P 500.
5. California Water was the only company where management was a net buyer of stock.
6. The Street is not particularly enamored with this group of stocks. There are 40 purchase recommendations out of a total of 86 ratings, so there’s room for ratings upgrades. Aqua America seems to be the darling of the group with 10 analysts following the stock and 9 recommending purchase.

Here’s my take:

1. I was disappointed to find that Flowserve was the only stock that passed my Fast Track screen, having failed no more than 3 categories. But Flowserve is really a play on oil and gas, which accounts for 41% of their business, as opposed to 6% for water.
2. Only 3 companies, Veolia, Flowserve and Calgon, did not report disappointing earnings in any of the last 4 quarters. But Street analysts have held their earnings estimates steady at 12 companies. Watts pre-announced an earnings disappointment for their March quarter, citing weak construction here, slowing economic activity in Europe, and even problems in China. While this could be unique to Watts, is it a harbinger of more disappointments at other companies?
3. No company in the group delivered consistent earnings growth in the last 5 years. This, and that Watts is a pure play on water makes me question whether the water industry’s growth story has really kicked in yet.

I’ve decided to stay on the sidelines for now.

Use the parameters listed below to quickly screen for potential stock ideas. You can usually find the information at these websites:

Company website
http://finance.yahoo.com
http://online.wsj.com (fee)
www.reuters.com
www.morningstar.com

Just fill in the answers with an X under yes or no on this easy to use worksheet. I like to see a stock fail no more than 3 categories before going further with more extensive research. Whether you choose to use Fast Track or any other screening tool, always thoroughly research the stocks that pass your screen before buying.

Company Stock Risk Profile Fast Track™

Company Name ———— Stock Symbol—————- Date

Yes —No

Cash and cash equivalents
and short-term investments
are stable or growing.

Low or no long term debt.

Cash generated from
operations is close to or
higher than net income.

Free cash flow has been
stable or growing.

Reported earnings have
equaled or exceeded analysts’
consensus earnings estimates
for the last four quarters.

Analysts’ consensus earnings
estimates have been stable
or rising.

P/E is less than 100% of the
average of the high and low
P/E’s of the last five years.

PEG is below the Industry’s
and S&P’s 500’s.

Management has been buying
stock.

Of the analysts following the
stock, no more than half are
recommending purchase.

Definitions:

Low long-term debt = long-term debt as a percentage of total capital of no more than 20%.

Free cash flow = cash from operations less capital expenditures.

PEG = price / forward earnings divided by forecasted earnings growth, usually the Street consensus for the next 5 years. Read the rest of this entry »

Initial claims for unemployment benefits rose to a seasonally adjusted 407,000 for the week ended March 29. Claims over 400,000 are usually considered recession territory. The Labor Department just reported that nonfarm payrolls fell 80,000 in March bringing the unemployment rate to 5.1%. But the unemployment rate is a lagging economic indicator.

What may the market be telling us about the economy? I looked at the year-to-date performance of the Dow Jones Industries Indexes, and I found this:

Delivery Services + 6.70%
Railroads +13.16%
Transportation Services +25.07%
Trucking +14.95%
Home Construction +24.28%
Home Improvement Retailers +8.56%
Hotels +5.07%

The stock market is a discounting mechanism, and the strong performance of these economically sensitive industries may be telling us that a pickup in economic activity is up ahead.

I also thought that it may be informative to look at passenger traffic at McCarran International Airport in Las Vegas. Passenger traffic as compared to a year ago was up 3.4% in February and 0.2% year-to-date.

This also caught my attention. Research in Motion added 2.2 million subscribers and shipped 4.4 million smart phones in the quarter ended March 1.

So, more people are going to Las Vegas to vacation and gamble, and they are buying a lot of BlackBerrys. Is the economy really as bad as the headlines make it seem?

Study: Wall Street Analysts Still Exuberant in Their Earnings Projections
Researchers find that upward bias persists even after 2003 Global Analyst Research Settlement

“Previous studies suggest their stock recommendations do not perform well, and now we show that their long-term earnings per share growth rate forecasts are excessive and upwardly biased.” – from the study by J. Randall Woolridge and Patrick Cusatis, Penn State Smeal College of Business.

My observations:

First, let’s do our own research rather than depend on others to do it for us. We do not have to pay high fees to someone else to manage our money, particularly to brokers peddling flawed Street research.

Maybe we should get out of the forecasting business. Here’s what I would suggest.

1. Use trailing 12-months earnings per share from continuing operations and before extraordinary items in the denominator of the price/earnings ratio. If you feel you have to use an earnings estimate, use the lowest estimate among the analysts offering forecasts for a margin of safety.
2. Instead of using the Street’s consensus 5-year earnings forecast in the denominator of the PEG ratio (price/earnings divided by earnings growth rate), use a company’s internal or sustainable earnings growth rate calculated as follows: earnings retention ratio ((net income – dividends) / net income)) X return on equity.