RealMoney Silver - A Stock That Glitters in the Scrapyard

A Stock That Glitters in the Scrapyard
By John Reese
RealMoney.com Contributor
5/8/2008 4:01 PM EDT

I pick stocks to recommend by looking at what my guru strategies like at any given time. These are computerized strategies I created through careful readings of how several of Wall Street's greatest investors ply their trade, and then automating my results. When one strategy really likes a stock, that stock is worth considering. When two like a stock, well, it is impressive. And when three like a stock, which is rare, it is cause for celebration.

Let us celebrate New Jersey-based Metalico (MEA) , which practices a form of alchemy by turning scrap metal into gold, or at least into high-profit, high-growth sales. Three of my guru strategies -- those based on the writings of William O'Neil, James P. O'Shaughnessy and Peter Lynch -- indicate there is something almost magical about Metalico.

The company is in two businesses, both metal related. It operates recycling facilities for both ferrous (containing iron) and non-ferrous scrap metal. It buys metal from manufacturers, contractors, demolition contractors and others, recycles it, and produces steel, iron and aluminum which it then sells to mills, furnaces and foundries. This is a highly cyclical and volatile market. The company's second business is lead fabrication. Metalico says it is the largest such fabricator in the country.

One way the company grows is through acquisitions. It made several last year and has already announced three this year, including one made public on April 24. The company also grows through internal growth and through increases in the prices it receives.

One aspect that the O'Neil strategy highlights about Metalico is how fast annual earnings growth has been over the past five years. The strategy requires this to be above 18%, but prefers it to be north of 25%. Metalico just gets above this upper threshold with a five-year growth rate of 25.53%. Not only has growth been rapid, but is has been consistent. During the five-year period when EPS growth was so healthy, earnings per share also increased each year.

Unlike other investment strategies, the O'Neil strategy looks for stocks that are high-priced (on the basis of their 52-week trading range) and that seem poised to break out into new territory. The thinking here is that if you want quality, you have to pay for it. Do not look for bargains if you want to own a quality stock. According to the O'Neil strategy, the stock's price should be within 15% of its 52-week high. Metalico's stock currently trades within about 6% of its 52-week high.

Relative strength is how well a stock performed relative to the overall market in the past year. A relative strength of, say, 80, means the stock outperformed 80% of the market's stocks. A relative strength of 80 is required by the strategy, though it really likes to see this number at 90 or more. Metalico performs outstandingly with regard to this variable, with a relative strength of 96.

To make sure a company's industry is attractive, the strategy requires that at least one other company in subject firm's industry has a relative strength at or above 80. Metalico's industry, iron and steel, has 14 such companies.

The strategy also looks at a couple of classic financial benchmarks. One is the debt-to-equity ratio, which should be 2 or less. Metalico's is 0.66. The other is return on equity, which has a minimum of 17%. Metalico's ROE is 18.5%.

Corraboration

I mentioned that my strategy based on James P. O'Shaughnessy's investment approach also likes Metalico. The company's market cap of $476 million is in its favor, as this strategy requires a market cap of at least $150 million. And, like the O'Neil strategy, it wants EPS to increase in each of the past five years.

An additional variable is the price-to-sales ratio, which is a measure of how much you are paying for sales. This should not be above 1.5:1, and Metalico's P/S ratio is 1.05:1. Finally, the stock's strong relative strength, along with the other criteria we just discussed, places it among the market's most desirable stocks, according to the O'Shaughnessy strategy.

Metalico is a favorite of my Peter Lynch strategy, as well. Considered a "fast grower" by the strategy because its growth rate of 25.5% exceeds 20%, this strategy is a particular fan of the P/E/G ratio. This is a measure of the P/E relative to growth, and it needs to be below 1.0 to be acceptable. On the basis of Metalico's three-, four- and five-year EPS growth rates, the company's P/E/G is a perfectly acceptable 0.86.

Three strategies have Metalico in their sights. They like its financial performance, its earnings consistency and its stock price. Metalico deals a lot with scrap, but it knows how to turn such material into profitable, high-growth products.

A note to readers: I'll be a featured speaker at the Las Vegas Money Show on May 13 and 14, talking about how to profit from guru analysis. I would be happy to meet any of my readers there.