Price Momentum Plus Value Equals Tempting Stocks: John Dorfman

Feb. 22 (Bloomberg) - When I choose stocks, I put very little weight on relative strength. Yet I know many investors swear by it.

The metric shows price momentum over a specific time span. To calculate it, take a large group of stocks and rank them by price appreciation. Then slice the results into 100 percentiles and presto -- you have a relative strength rating.

Many people won’t buy a stock unless it has been outperforming its peers. That’s why once or twice a year I like to write about stocks that combine value and price momentum.

This time, I started with a universe of 1,695 U.S. stocks with a market value of $1 billion or more. I then looked for a share price gain of 20 percent or more in the 60 trading days through Feb. 15, cutting the field to 487.

Next, I applied my two most basic value-investing criteria: a share price no more than 15 times the company’s earnings for the past four quarters, and debt less than stockholders’ equity. Those two filters narrowed the group to 57. I would like to recommend four of them. MetLife Inc. is recovering from woes it suffered during the financial crisis. Like other big insurance companies, MetLife holds a large number of stocks and bonds. These securities wilted during the panic. In 2009 the company lost $2.89 a share.

The insurer climbed back to post earnings of $3 a share in 2010. This year, analysts expect profits to increase more than 50 percent, to about $4.70. They think MetLife can tack on about another dollar in earnings in 2012.

Insurers May Rebound

During recessions people tend to skimp on insurance because their budgets are too tight. And they often increase their coverage as the economy recovers. This dynamic could help MetLife this year and next.

One of the cheapest stocks on this list is PolyOne Corp., a plastics manufacturer located in Avon Lake, Ohio. Its shares trade at about eight times earnings.

Responding to the downturn, the company cut jobs and reduced production. After a loss in 2008, PolyOne made a profit in 2009 and increased its gain in 2010. Analysts expect earnings to fall this year, to about $1.02 a share from $1.69 in 2010.

In the past, PolyOne has beaten analysts’ estimates. I think it might do that again this year. Seven of the eight analysts who cover the company rate it a “buy.” Normally I prefer to go against the crowd, but in this case I agree with the majority.

Hot Stocks

The two hottest stocks in the group during the period were Micron Technology Inc. and GT Solar International Inc. They were up 57 percent and 55 percent, respectively. I have discussed both in previous columns, so won’t comment here. However, I still like them at today’s prices.

Houston-based W&T Offshore Inc. has also been a big gainer, up 48 percent in the 60-trading-day period. The company owns more than 70 oil and gas wells, primarily in the Gulf of Mexico. In November it announced plans to purchase Royal Dutch Shell Plc’s holdings in six wells for $450 million.

Tracy W. Krohn, the founder and chief executive of W&T, personally owns more than 52 percent of the stock. That means he has a freer hand than most chief executives, and little incentive to smooth out quarterly earnings, as some do.

The stock is unpopular. Ten of 13 analysts who cover it say “hold” and three say “sell.” In this case, I am back in my usual role as a contrarian. I think production in the Gulf of Mexico may resume a normal pace more quickly than people expect.

Debt Free

W&T has more debt than I would prefer. By contrast, one of the strongest balance sheets in this group belongs to TriQuint Semiconductor Inc. of Hillsboro, Oregon. It is debt free.

TriQuint develops semiconductor technologies and materials used in military and civilian equipment, especially wireless applications. That seems to me to be an area likely to continue expanding for the next few years.

The company lost money in four straight years starting in 2001. It has posted a profit every year since except in 2008.

This month TriQuint announced that its first quarter earnings will be less than analysts estimated. Some analysts said a problem in production capacity was the main culprit. That’s the kind of real but temporary bad news on which I often like to invest. The stock sells for 12 times earnings.

Critics of relative strength often say that using it tends to pull investors into more frequent trading, which pushes up commissions and taxes. I think there is some truth to the criticism, though I’m neutral on the larger question of whether investors should favor stocks that are rising. I neither endorse nor disqualify a stock because it has risen, or because it has fallen.

Disclosure note: Personally and for clients, I own shares of GT Solar. I have no long or short positions in the other stocks mentioned in this column.

John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)

To contact the writer of this column: John Dorfman at jdorfman@thunderstormcapital.com.

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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