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2006 Extravaganza of Predictions – A Two-Month Update

(Guest Commentary - March 2, 2006)

Dear Subscribers and Readers,

For those who had wanted to learn more about picking stocks and evaluating companies, it is that time of the month again the time when we bring in our regular guest commentator Mr. Bill Rempel for a quick discussion of his methods and thought processes.  In this commentary, Bill is going to provide us an update on his 2006 predictions as first discussed in his December 29, 2005 guest commentary (A 2006 "Extravaganza" of Predictions).  This includes an update on his 2006 predictions for the S&P 500, as well as for certain stocks that he believes will outperform or underperform the broad market.  Without further ado, following is biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see What I Like About Liz for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) in back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

The updates here are from the close of December 30, 2005 through the Friday, February 24, 2006 close.  For purpose of comparison, an investment in SPY (S&P 500 tracking ETF) would have returned 3.9% in appreciation, with no dividend being paid.  An investment in DIA (Dow Industrial tracking ETF) would have returned 3.6% in appreciation, or 3.9% including dividends.

Predictions for 2006 Predictive Modeling

The 52-week model for the S&P 500 was reading in the 6th decile. The 6th decile is neutral in the sense that it suggests an average 52-week return. Median and average returns for this reading are 13.4% and 11.7% vs. standard median and average returns of 12.4% and 11.8%.  The 6th decile implies a 79% chance of gains, with about a 52% chance of above-average gains, and a still-hefty 13% chance of ending the year down more than 10% from where we are today.  Overall, the model output suggested a U.S. stock market year that is somewhat typical and not anything to be especially excited about or afraid of.

How does it look so far?  4% in two months ... but still too early to call.

Predictions for 2006 Large Caps Picked to Outperform

In the large cap (over $5 billion) universe, I did find several that were appealing.  These are, for the most part, profitable companies with high returns on assets, trading at attractive multiples from earnings, book value, and PEG, and pretty much contrarian picks in that they have not shown great returns over the last year and are currently underappreciated in the market.  In alphabetical order, they are:

1. Dow Chemical (DOW)

2. Gannett Co. Inc* (GCI)

3. Gap Inc (GPS)

4. Magna International** (MGA)

5. P.P.G. Industries (PPG)

6. V.F. Corporation (VFC)

I also came across somewhat less appealing large caps, listed separately because of various departures from the above profile, i.e., either they've already had a decent run-up, or they're PEG is high for my tastes, etc.  I still believe that they have a significant chance to outperform the indices by the end of 2006, however.

7. Chevron* (CVX)

8. Coca Cola Enterprises (CCE, not KO)

9. Con-Agra Food Inc. (CAG)

10. Huaneng Power Int. (HNP)

11. Paccar Inc. (PCAR)

12. Verizon Communications (VZ)

So there we have it, 12 large caps that I believe will outperform the broader market over the next year.

How have they done so far?  Note, PCAR not only had a dividend, but also had a $2 per share disbursement.  The ex-date on the disbursement was before I listed PCAR as a pick, so I excluded it from the table.  It would have moved the gain for this set of picks up approximately 0.2% had it been included.

Symbol Mkt Cap 12/30/2005 2/24/2006 Gain Beat Idx
DOW 42.292B 43.82 43.43 -0.9% No
GCI 14.530B 60.57 62.71 3.5% No
GPS 15.340B 17.64 18.43 4.5% Yes
MGA 7.865B 71.98 73.6 2.3% No
PPG* 9.671B 57.9 59.9 3.5% No
VFC 6.152B 55.34 56.23 1.6% No
CVX* 127.4B 56.77 58.1 2.3% No
CCE* 9.077B 19.17 19.85 3.6% No
CAG 10.524B 20.28 20.95 3.3% No
HNP 7.899B 26.21 27.51 5.0% Yes
PCAR* 11.720B 69.23 69.7 0.7% No
VZ* 83.281B 30.12 34.22 13.6% Yes
AVERAGE     3.6% No

SPY vs. DIA vs. LCOP

Predictions for 2006 Small Caps Picked to Outperform

Typically, however, I prefer small caps to large caps.  Not only is there more potential upside, the lack of analyst coverage and popular interest increases the odds of finding significantly mispriced securities.  Note that I don't screen based on market capitalization, but when looking for financially strong, profitable companies whose stocks are trading at a significant discount, you don't find too many large caps that fit the bill.

1. Dorel Industries* (DIIB)

2. Golden Telecom* (GLDN)

3. Kindred Healthcare* (KND)

4. Sanderson Farms* (SAFM)

I found several that were also appealing to me, but seemed a bit more risky in my eyes for various reasons.  However, I still think the following small caps have great potential to outperform the indices in 2006. Yes, I'm aware that LIZ is a mid-cap, but cut me some slack, here!

5. Affirmative Insurance (AFFM)

6. America's Car-Mart (CRMT)

7. Direct General (DRCT)

8. Helen of Troy (HELE)

9. Lacrosse Footwear (BOOT)

10. Liz Claiborne (LIZ)

11. Nash Finch Co. (NAFC)

12. Rocky Shoes and Boots (RCKY)

And there we go, 11 small caps and 1 mid cap that I believe will, as a portfolio, outperform the broader market by the end of 2006.

How have they done so far?

Symbol Mkt Cap 12/30/2005 2/24/2006 Gain Beat Idx
DIIB 782.0M 23.8 29.04 22.0% Yes
GLDN 948.9M 26.05 29.96 15.0% Yes
KND 1.004B 25.76 21.83 -15.3% No
SAFM* 622.6M 30.53 24.97 -18.2% No
AFFM 217.4M 14.59 14.05 -3.7% No
CRMT 195.9M 16.52 18.6 12.6% Yes
DRCT 343.7M 16.9 15.86 -6.2% No
HELE 482.2M 16.11 19.65 22.0% Yes
BOOT 64.8M 10.83 11.79 8.9% Yes
LIZ* 3.820B 35.82 36.4 1.6% No
NAFC 337.0M 25.48 31.01 21.7% Yes
RCKY 129.6M 24.36 23 -5.6% No
AVERAGE     4.6% Yes

SPY vs. DIA vs. SCOP

Predictions for 2006 Large Caps Picked to Underperform

Based on the same type of modeling that I have been using in my own investing, I have assembled a list of one dozen large cap stocks that I think are poised to underperform the broader market by the end of 2006.  In a similar format, I'll list alphabetically the ones I have the least confidence in first, then alphabetically the remainder of the dozen.

1. Schering Plough (SGP)

2. Serono SA ADS (SRA)

3. Shire Plc ADS (SHPGY)

IMO the first three might actually make good shorts over the long term, although they may be crowded I haven't checked their short ratios.

4. Alcon Inc (ACL)

5. Chicago Merc. Exc. A (CME)

6. Cognizant Tech (CTSH)

7. Genentech Inc. (DNA)

8. Google (GOOG)

9. Infosys Techn ADS (INFY)

10. Paychex Inc. (PAYX)

11. Starbucks (SBUX)

12. Wipro Ltd. (WIT)

While I don't have confidence these will make good long-term shorts, they might be worth shorting on and off, since IMO they will either be range-bound or declining over the course of the year.

How have they done so far?

Symbol Mkt Cap 12/30/2005 2/24/2006 Gain Beat Idx
SGP* 30.814B 20.85 18.86 -9.6% No
SRA 21.033B 19.86 18.15 -8.6% No
SHPGY 6.398B 38.79 47.25 21.8% Yes
ACL 39.727B 129.6 112.9 -12.9% No
CME 12.670B 367.49 422.65 15.0% Yes
CTSH 6.948B 50.27 57.42 14.2% Yes
DNA 97.542B 92.5 84.95 -8.2% No
GOOG 122.6B 414.86 377.4 -9.0% No
INFY 44.094B 80.86 70.16 -13.2% No
PAYX* 14.470B 38.12 37.84 -0.7% No
SBUX 22.931B 30.01 35.92 19.7% Yes
WIT 16.909B 11.95 13.83 15.7% Yes
AVERAGE     2.0% No

Wow.  Actually several of these presented good short opportunities earlier than I expected, and I actually took advantage of one or two.

SPY vs. DIA vs. LCUP

Predictions for 2006 Very Confident They'll Underperform

Using the same historical database I mined to devise my investing style, I have been looking for indicators of dramatic underperformance.  The following are a dozen stocks that I anticipate will not only underperform the indices by the end of 2006, but will actually decline and additionally, these all have very small short ratios as of the most recent data, making them potentially attractive shorts.  These are listed in descending order of market cap.

1. Sunpower Corp (SPWR)

2. (BIDU)

3. Theravance (THRX)

4. China Medical Tech (CMED)

5. Silver Wheaton Co. (SLW)

6. Birch Mountain Res. Ltd. (BMD)

7. Threshold Pharm (THLD)

8. Rackable Systems (RACK) - Oddly enough, Cramer just mentioned this as a bull!

9. Biocryst Pharm (BCRX)

10. Tan Range Exploration (TRE)

11. SIFY Limited ADR (SIFY)

12. Dexcom (DXCM)

How have they done?  In this case, embarrassingly well.  This is a lesson that I'm learning in momentum ... the best and most obviously overvalued short plays are often really good long momentum plays for quite a while

I still have a lot of confidence these picks will both underperform over the course of 2006, and present really good short opportunities for the brave, but so far this section of my picks has been the most frustrating. {Editor's Note: I definitely agree with Bill on this.  As our 2006 mid-cycle slowdown scenario emerges out of the woodwork, I believe the small and the most speculative stocks will significantly underperform with most of the underperformance coming in the latter parts of this year}.

Symbol Mkt Cap 12/30/2005 2/24/2006 Gain Beat Idx
SPWR 2.033B 33.99 39.67 16.7% Yes
BIDU 1.511B 62.92 52.86 -16.0% No
THRX 1.423B 22.52 28.27 25.5% Yes
CMED 869.5M 31.78 33.01 3.9% No
SLW 970.1M 5.8 8.25 42.2% Yes
BMD 571.1M 7.17 6.65 -7.3% No
THLD 538.1M 14.45 14.75 2.1% No
RACK 570.6M 28.48 37.99 33.4% Yes
BCRX 443.0M 16.75 19.74 17.9% Yes
TRE 514.6M 6.07 6.59 8.6% Yes
SIFY 380.8M 10.76 12.82 19.1% Yes
DXCM 378.6M 14.92 17 13.9% Yes
AVERAGE     13.3% Yes

SPY vs. DIA vs. SHRT

Update on LIZ

Just a reminder, LIZ reports earnings this week. [Editor's Note: Liz Claiborne actually reported earnings on Wednesday morning with the stock rising over 3% immediately after the earnings report in Wednesday's trading session.  For the Motley Fool's take on the latest earnings report, please click here.]

Liz Claiborne

Until next time, happy and profitable investing!

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