Looking for Losers


By Sam Stovall In last week's column, I set out to find the industry groups with the highest scores in two key categories: S&P STARS and Relative-Strength Rankings (see BW Online, 12/7/05, "The STARS Align for Oil Drillers"). This week, I'm heading for the not-so-sunny side of the street, by identifying the groups with the lowest marks in those two categories.

As a reminder, S&P's Stock Appreciation Ranking System, or STARS, encompasses S&P's 66 U.S. equity-research analysts, who establish buy, hold, and sell recommendations on more than 1,500 stocks for the coming 12 months. A stock with 5 STARS is ranked strong buy, while 3 STARS means hold, and 1 STARS indicates strong sell. (See the glossary and disclosure statement at the end of this report for a more complete description.)

THE TIRED 10. As with the last time around, I've combined industries' market-cap weighted average STARS ranking along with our 12-month

Relative-Strength Ranking (RSR) metric. But this time, we're looking for the underachievers.

The list below shows the bottom 10 industries, based on two criteria: (1) the lowest 12-month RSR, as indicated by an RSR score of 2 or 1, and (2) an industry's market-cap weighted average STARS below the average of 3.7 for all stocks in the S&P 1500.

S&P 1500 Subindustry

STARS

RSR

Auto Parts & Equipment

2.8

1

Automobile Manufacturers

2.6

1

Brewers

3.0

1

Commodity Chemicals

3.0

1

Internet Retail

3.0

1

Leisure Products

2.9

2

Motorcycle Manufacturers

3.0

1

Office Electronics

3.0

1

Paper Products

2.5

2

Photographic Products

2.0

1

One of the categories on the list that should come as no surprise to investors: auto makers. Frequently, investors have asked me if it is time to buy back into the automobile-related stocks. To find out if these issues represent bargains, I checked with Efraim Levy, CFA, S&P's Auto and Auto Parts analyst.

Levy says S&P's fundamental outlook for the automobile manufacturers subindustry is negative. S&P expects that 2005 U.S. light-vehicle sales volume will total about 17 million, up from the 16.9 million sold in 2004. Levy sees a drop to 16.7 million in 2006.

BIG-THREE BLUES. Competition should remain intense, in S&P's view, in part because of new-product introductions and incentives. Gasoline prices, which recently topped $3 per gallon before pulling back, appear to be hurting demand for fuel-inefficient -- but profitable -- light trucks. Aging vehicle models and increased competition are also pressuring sales, in Levy's view. Lower production and/or increased incentives, in turn, could reduce income in 2005 and 2006.

S&P expects the Big Three U.S. auto makers -- General Motors (GM), Ford (F), and the Chrysler unit of DaimlerChrysler (DCX) -- collectively to lose market share to foreign carmakers in 2005 and 2006.

Of special concern to Levy is the highly profitable light truck, minivan, and sport utility segment, which he thinks faces increasing pricing pressure now that the Big Three's dominance is waning, gasoline prices are rising sharply, and a shift in market share to less-profitable Crossover Utility Vehicles (CUVs) is occurring. S&P projects that margins will come down in this segment.

DEMAND UP, MARGINS DOWN Increased sales of luxury import models are also hurting domestic manufacturers' margins in the luxury-vehicle category, in S&P's view. Levy thinks restructuring and other cost-reduction efforts should offset some of the margin pressure in 2006. However, he expects higher raw-material and retiree and health-care costs to squeeze margins.

S&P believes the favorable backdrop of relatively high employment, combined with aggressive vehicle incentives in the form of discounted prices and financing rates, should bode well for a continuation of relatively high demand for motor vehicles. However, rising competition will likely make profits harder to come by. With a combination of cost reductions and a move to more-profitable non-car vehicle sales, auto makers' profits have been strong during this up cycle.

While a new higher-sales plateau in North America may be sustainable, Levy has concerns about intensifying competition and acceleration of already-heavy incentive activity.

WHO'S STRONG? So there you have it. In S&P's view, the subindustry's price momentum still looks unhealthy, while the 12-month fundamental outlook also appears unappealing.

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative-Strength Rankings of "5" (price performances in the past 12 months that placed among the top 10% of the industries in the S&P 1500) as of Dec. 9, 2005.

Subindustry

Construction & Engineering

Diversified Metals & Mining

Fertilizers & Agricultural Chemicals

Health Care Services

Managed Health Care

Oil & Gas Drilling

Oil & Gas Equipment & Services

Oil & Gas Exploration & Production

Oil & Gas Refining & Marketing

Specialized Finance

Steel

Water Utilities

Glossary

S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:

A+

Highest

B

Lower

A

High

C

Lowest

A-

Above Average

D

In Reorganization

B+

Average

NR

Not Ranked

B-

Below Average

S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.

S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.

Required Disclosures

In the U.S.

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.

In Europe

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations and 20.4% with sell recommendations.

In Asia

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 28.1% of issuers with buy recommendations, 51.1% with hold recommendations and 20.8% with sell recommendations.

Globally

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 29.3% of issuers with buy recommendations, 57.7% with hold recommendations and 13.0% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.

For All Regions:

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, NY, NY.

Other Disclosures

This report has been prepared and issued by Standard & Poor's and/or one of its affiliates. In the United States, research reports are prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). In the United States, research reports are issued by Standard & Poor's ("S&P"), in the United Kingdom by Standard & Poor's LLC ("S&P LLC"), which is authorized and regulated by the Financial Services Authority; in Hong Kong by Standard & Poor's LLC which is regulated by the Hong Kong Securities Futures Commission, in Singapore by Standard & Poor's LLC, which is regulated by the Monetary Authority of Singapore; in Japan by Standard & Poor's LLC, which is regulated by the Kanto Financial Bureau; and in Sweden by Standard & Poor's AB ("S&P AB").

The research and analytical services performed by SPIAS, S&P LLC and S&P AB are each conducted separately from any other analytical activity of Standard & Poor's.

Disclaimers

This material is based upon information that Standard & Poor's considers to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions and estimates constitute Standard & Poor's judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

For residents of the U.K.: This report is only directed at and should only be relied on by persons outside of the United Kingdom or persons who are inside the United Kingdom and who have professional experience in matters relating to investments or who are high net worth persons, as defined in Article 19(5) or Article 49(2) (a) to (d) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001, respectively.

Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations.

Stovall is chief investment strategist for Standard & Poor's


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