Surprise Party
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Not necessarily. On Wall Street, the term surprise usually refers to the difference between analysts’ consensus earnings expectations and the actual results. And positive surprises — that is, when earnings beat expectations — are more common than you might think, even these days. According to Thomson Financial/First Call, 277 of the companies in the Standard & Poor’s 500 (56%) have reported fourth-quarter 2001 earnings that were above analysts’ expectations. Positive earnings surprises tend to be good for stocks. According to Merrill Lynch’s periodic survey of professional stock pickers, “[Positive] EPS surprise has been the most consistently popular factor, on average, throughout the history of our [11-year-old] survey.” So we went searching for stocks that might just pull off the unexpected. As you might guess, chief executives love to report better-than-expected results in good times and bad. As a result, official corporate earnings guidance tends to err on the conservative side. But analysts are free to take or leave official guidance numbers as they see fit. You’ll note in our earnings-surprise screen recipe (see sidebar) that we demanded a four-quarter history of positive surprises, to eliminate the Johnny-come-latelies. In addition, we shunned companies with recent downward earnings revisions. Using our stock screening tool, that helped trim our list of 1,948 upside surprisers to a more manageable number of companies that really seem to be a roll. The goal was to find companies that not only have delighted investors in the past, but are also likely to do so in the future. To that end, we also demanded a low standard deviation of estimates. The standard deviation expresses how much each individual figure differs from the consensus estimate. When those estimates are tightly clustered in a narrow band, the chances are greater that a company’s results will fall outside that band. If they fall above it, that’s a big stock booster. But this cuts both ways: A company that delivers surprisingly poor results when there’s a low standard deviation of estimates is more likely to see its stock taken to the woodshed. The rest of our recipe is straightforward. We didn’t want unprofitable companies, or those whose earnings are expected to decline in the year ahead. In addition to earnings stability, we also looked for some share-price stability. Since upside surprises should be uplifting over time, we wanted to see shares trading within 25% of their 52-week highs. But since valuation also matters, we looked at the price-to-earnings-growth, or PEG, ratio as well. This measures a stock’s price relative to its long-term growth expectations. We demanded that PEGs be below one, the rule of thumb for inexpensive stocks. Typically, our recipe would stop here. But we found that the same recipe that brought us 47 companies back in November yielded 85 companies in March. So we added some more hoops for our survivors to jump through. We chucked companies with lots of debt, and those whose stock has recently been downgraded by analysts. That yielded 23 survivors, falling into three main categories: health care (AdvancePCS (ADVP), AmerisourceBergen (ABC), Caremark Rx (CMX), D&K Healthcare Resources (DKWD), Mylan Laboratories (MYL), TriZetto Group (TZIX) and Zoll Medical (ZOLL)); retail (Chico’s FAS (CHS), Christopher & Banks (CHBS), Hibbett Sporting Goods (HIBB), Quiksilver (ZQK) and Too Inc. (TOO)); and technology (Cadence Design Systems (CDN), Compuware (CPWR), Storage Technology (STK), Synopsys (SNPS) and Versity (VRST)). With retail companies still reporting their January results and technology companies just starting to warn about projected shortfalls for their March quarters, we decided to check up on the health-care sector this week. Two survivors — AmerisourceBergen and D&K Healthcare Resources — are in the drug-distribution business. Throw in the few publicly traded competitors (most notably, Cardinal Health (CAH) and McKesson (MCK) which didn’t survive our rigorous requirements), and you account for 96% of the entire drug-distribution market, notes Prudential Securities analyst Eric Coldwell. And according to Prudential estimates, the drug-distribution industry as a whole is expected to grow 17% this year. (Prudential doesn’t do investment banking for any the firms mentioned, and analyst Coldwell doesn’t hold shares of Amerisource or D&K.) But a quick StockCompare will show you how different Amerisource Bergen and D&K really are. As the industry’s biggest player, Amerisource reaped almost 12 times as much in revenue last year as D&K did. In addition, Amerisource’s market cap is more than 17 times D&K’s. As the industry’s distant number four (based on revenue, market cap and market share), D&K looks downright dinky in comparison. Yet in terms of earnings surprises, smaller can be better. “If D&K moves from a 2% market share to a 3% market share, that’s a huge move,” notes Coldwell. And to gain market share, the company can acquire smaller, privately held competitors. Thanks to its tremendous earnings growth last year, D&K shares soared nearly 321%. (The company calls itself an overnight success, 14 years in the making.) Now, D&K might have enough purchasing power to fuel robust growth. Indeed, management expects 40% sales growth and 31% earnings growth this fiscal year — which are among the highest growth expectations in the industry. Meanwhile, Amerisource has already played the consolidation game. The company was borne of the megamerger between AmeriSource Health (based in Pennsylvania) and Bergen Brunswig (based in California), completed less than seven months ago. The combination gave the new entity full national reach and better pricing power. Yet Amerisource’s regional origins remain apparent, with 30% of its current distribution revenues coming from small, independent pharmacies. By contrast, competitors Cardinal and McKesson are all about serving the national chains, which is how they used to dominate the industry. Now Amerisource can compete for its rivals’ best business. So far, Amerisource is surprising Wall Street with a remarkably smooth merger transition and heady growth in its mail-order drug business (including a 30% plus surge in sales last quarter). In the future, Prudential’s Coldwell thinks the company can keep outperforming the industry as a whole, thanks to its newfound leverage with clients and other profit-boosting efficiencies. To keep on surprising Wall Street, the distribution giant (Amerisource) and upstart (D&K) have very different tasks ahead of them. Some analysts argue that there’s room for both to succeed. More : smartmoney.com |