Markets & Finance

Stocks with Strong Upside Potential


If major indexes are getting back on their feet, which names could post the biggest gains? S&P has a number of candidates

From Standard & Poor's Equity ResearchAfter three weeks of red arrows, when the Standard & Poor's 500-stock index fell 6.4% and the S&P SmallCap 600 declined 7.8% (and 128 of the 137 subindustries in the S&P Composite 1500 index were in the red), Mark Arbeter, S&P's chief technical strategist, believes that based on the favorable end-of-day close, on Friday, Aug. 10, we may have successfully retested the 1430 level on the S&P 500.

In Arbeter's opinion, if the 1430 area holds, as he expects, then "we would likely see a strong rally develop and take out the recent closing high up at 1497…this would complete a very compact double bottom reversal formation and would suggest that the worst is over."

Should Arbeter be correct that this market is ready to move higher, what could trigger this relief rally, in our opinion, is a continuation of favorable earnings reports from the June-quarter reporting season and favorable outcomes for the economic reports in the week ahead.

Beating Estimates

Take a look at the accompanying table. So far, combining actual results with the remaining estimates for companies in the S&P 500, it appears as if the year-over-year increase in operating EPS will reach 11.0%, eclipsing our June 29 estimate by more than 100%, and our Dec. 29, 2006 projection of 8.5% by nearly 30%.

Additionally encouraging is that seven of the 10 sectors in the "500" will likely see better results than earlier anticipated, implying the buoyancy did not come from a minority of groups. Specifically, Financials, Health Care, and Telecom Services should see double-digit increases this quarter. Only Consumer Discretionary will likely post a decline.

This week there will be more than 10 economic releases. In particular, we think investors will pay close attention to the retail sales, PPI, CPI, industrial production, housing starts, and University of Michigan consumer sentiment reports. Should the consumer and industrial surveys come in weaker than anticipated, while inflation remains benign or even moderates, we believe investors will feel heartened that the Fed soon will start lowering short-term interest rates. Indeed, Fed funds futures indicate increased expectations for a Fed rate cut by the September FOMC meeting.

What's more, S&P economist Beth Ann Bovino wrote on Aug. 10, "After the [Aug. 7] FOMC statement, we expected that the Fed would remain on hold through year-end, with policy easing likely in January, 2008. But the Fed's actions indicate to us that they are aware of the liquidity constraints in the market and they are willing to do whatever it takes to keep markets functioning fairly effectively. The Fed's market action makes it more likely that it will cut rates earlier, possibly at September's FOMC meeting."

Setting the Screen

Should this near-term rally materialize, what do S&P equity analysts think are the best opportunities? S&P's 65 U.S. equity analysts cover nearly 1,600 stocks, for which they issue buy, hold and sell rankings, as well as projected 12-month target prices. Screening for 5-STARS (strong buy) stocks with the highest differences between recent and target prices (using www.advisorinsight.com), I show up to three representatives for each sector, with Trump Entertainment (TRMP), Six Flags (SIX), Assured Guaranty (AGO), Maidenform Brands (MFB), and Medicis Pharmaceutical (MRX) offering the greatest upside potential.

5-STARS Stocks with Highest 12-Month Price Appreciation Potential

S&P Sector

Company

Ticker

Curr. Price

Tgt. Price

% Chg.

Consumer Discretionary

Trump Entertainment

TRMP

7

14

106

Six Flags

SIX

4

8

104

MaidenForm Brands

MFB

16

27

67

Consumer Staples

Altria Group

MO

67

85

26

CVS Caremark

CVS

38

46

21

Walgreen Co.

WAG

46

56

21

Energy

Statoil ASA ADS

STO

28

40

45

Mariner Energy

ME

21

29

39

Swift Energy

SFY

38

52

36

Financials

Assured Guaranty

AGO

24

42

75

Allstate

ALL

52

75

44

Wachovia

WB

47

67

41

Health Care

Medicis Pharmaceutical

MRX

27

42

55

ICON Plc ADS

ICLR

44

64

45

Thermo Fisher Scientific

TMO

53

74

39

Industrials

Trinity Industries

TRN

37

55

49

Landstar System

LSTR

44

61

38

Pike Electric

PEC

20

27

38

Information Technology

Corning

GLW

23

33

41

Citrix Systems

CTXS

34

46

36

EMC Corp.

EMC

18

24

35

Materials

Glatfelter

GLT

14

18

28

FMC Corp.

FMC

85

105

24

Airgas

ARG

46

56

23

Telecom. Svcs.

Citizens Communications

CZN

14

17

26

Utilities

NICOR

GAS

41

53

28

Entergy

ETR

98

119

21

Source: Standard & Poor's Equity Research; Data as of 8/10/07

Should we get the relief rally we expect, don't get too complacent and put everything on autopilot. Arbeter cautions that even if the S&P 500 does hold around 1430 and subsequently rallies, he still expects more testing sometime later in August or September. So remember to check back frequently.


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