Markets & Finance

Stocks: Five by Five by Five


Stocks on this week's list get the top ranking in S&P's STARS and Fair Value systems, and have shown profit growth in each of the past five years

From Standard & Poor's Equity ResearchFrom Standard & Poor's weekly investing newsletter, The Outlook.

This screen goes straight to the top of two of S&P's key investment metrics. First, S&P looked for stocks ranked 5 STARS (strong buy), meaning S&P analysts expect them to outperform the S&P 500-stock index by a wide margin over the coming 12 months on a total return basis, with the shares rising in price on an absolute basis.

The next filter used S&P's proprietary Fair Value model, a quantitative stock ranking system. This model calculates a stock's weekly Fair Value—the price at which it should trade at current market levels—based on fundamental data such as corporate earnings and growth potential, return on equity, current yield relative to the S&P 500, and price-to-book value. Stocks are ranked from 5, indicating significant undervaluation compared to the Fair Value universe, to 1, indicating significant overvaluation. This screen looked for those issues ranked 5.

Finally, each of the companies on the list had to have shown profit growth in each of the past five years.

When the screen was finished, six names emerged (listed below). Two of the companies on the list are spotlighted here.

Coach

The leading U.S. designer and marketer of high-quality handbags and accessories has reinvigorated and revitalized the Coach brand over the past decade, building on its popular core categories by introducing new products in a broader array of materials and styles, as well as by adding new categories, the latest of which includes fashion jewelry and fragrance.

By implementing a flexible sourcing and manufacturing model, Coach is able to bring a broader range of products to market more rapidly and efficiently. We estimate per-share earnings of $2.10 in fiscal 2008 (ending June) and $2.50 in fiscal 2009, vs. the $1.69 reported for fiscal 2007.

The shares trade at about 14 times our fiscal 2009 estimate—more than a 5% discount to specialty apparel retail peers. Our 12-month target price of $53 is 25 times our fiscal 2008 estimate, a modest discount to the shares' historical five-year average price-earnings ratio of 28.

Risks to our recommendation and target price include changes in consumer spending patterns, and risks associated with sourcing, fashion, and inventory.

Starbucks

Through its more than 15,000 retail outlets, Starbucks has made its name synonymous with specialty coffee. The company also has a significant business in selling coffee to food-service operators. Additionally, it has a consumer products group to sell coffee mugs, coffee makers, and similar products through its chain of stores.

The company continues on a rapid growth trajectory, with plans for adding about 2,500 retail locations a year for the foreseeable future. Much of this growth is in international markets, which are largely underpenetrated relative to the U.S. A second growth initiative is the rollout of food and pastry items into the stores.

Our per-share profit estimate for fiscal 2008 (ending September) is $1.02 a share compared with the 87¢ earned in fiscal 2007. We expect growth will continue in fiscal 2009, with estimated per-share profits of $1.25.

Risks to our recommendation and target price include the potentially negative impact of a recent price increase on customer traffic, lack of customer acceptance of the company's food initiatives, and the possibility that aggressive expansion in the U.S. will result in cannibalization of existing cafés.

Our 12-month target price of $34 implies a p-e of 32 times our calendar 2008 earnings estimate of $1.05.

Recommended Stocks

Company (ticker)

Price (12/20/07)

Best Buy (BBY)

$51.67

Coach (COH)

$31.59

CVS Caremark (CVS)

$38.84

Danaher (DHR)

$86.66

Oracle (ORCL)

$22.10

Starbucks (SBUX)

$20.53


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