Stocks that do well in a downturn are always worth a second look.
Over the past two months, the broader market has fallen more than 5% on concerns about higher interest rates, an uncertain geopolitical landscape and soaring oil prices. But some stocks have held up surprisingly well and are sitting at or near their 52-week highs.
Old Dominion Freight Line
Smart & Final
are up 21%, 12% and 5%, respectively, since the
peaked in early March.
While there's no guarantee these stocks will continue to rally, their strong performance in a weak market is a bullish sign.
"I think relative strength is pretty important," said Jordan Kahn, portfolio manager at Berger & Associates and contributor to
. "The theory is that those stocks that held up well during a market downturn should outperform when the market turns back up."
Relative strength compares a stock's price change over a period of time with that of a market index such as the S&P 500. A relative strength of 70 suggests the stock has performed better than 70% of stocks in the market over a given time frame.
Over the past three months, SCP Pool has outperformed 95% of stocks in the market, while Old Dominion and Smart & Final have performed better than 91% and 90% of stocks, respectively. Numbers for the last 12 months are also impressive.
"Relative strength isn't the only thing investors should look at, but given two companies with the same earnings power and valuation, I would prefer the one with higher relative strength," Kahn said.
Although some analysts believe that relative strength is a contrarian indicator that flashes a sell signal, there are reasons to believe the three stocks mentioned above will continue to attract investor interest.
SCP Pool, the world's largest provider of swimming pool supplies, equipment and related products, said earnings almost tripled to $4.1 million, or 11 cents a share, in the second quarter. Although the company's fortunes are tied to the weather, which is obviously unpredictable, the company has produced steady sales and earnings growth for the past decade.
This consistent performance and projections for 15% annual earnings growth over the next few years make the stock appealing. SCP, which recently declared its first dividend and now yields just over 1%, trades at 1.2 times sales.
"We continue to believe that POOL is very well positioned for above-average growth over the long term," said Douglas Lane, an analyst at Avondale Partners.
The firm has no national competition, a solid balance sheet, strong free cash flow and expanding operating margins, he added.
Freight carrier Old Dominion also looks attractive from a fundamental perspective. While the name doesn't inspire much excitement, the returns might. The company reported a big leap in earnings in the most recent quarter and raised its forecast for 2004.
Robert Dunn, an analyst at Sidoti & Co., said the firm has been expanding rapidly, helping to boost market share and drive profits higher. Analysts expect a 27% increase in earnings per share this year.
"It's trading around the industry average but should be trading at a premium," said Dunn. Old Dominion has a price-to-sales ratio of 0.84.
J.P. Morgan analyst Gregory Burns agrees that the stock is undervalued, noting that the firm should continue to outgrow its competitors and generate higher returns going forward.
"We expect Old Dominion Freight Lines to continue to leverage its low-cost market position to generate double-digit growth at the expense of its unionized competitors," he said.
Like Old Dominion, Smart & Final is expected to perform well this year. The firm, which sells food, food-service products and culinary equipment through warehouse and wholesale stores, is probably an unfamiliar name to many on Wall Street because it's been largely overlooked by the major brokers. Yet it recently reported a 7.2% jump in first-quarter same-store sales, excluding the impact of a grocery strike in Southern California. Meanwhile, earnings jumped 141%.
Although the company has made some missteps over the past couple of years -- its entrance into the Florida market was considered a "disaster" -- Smart & Final's fundamentals are improving.
"They're delivering on their numbers ... the latest quarter was very sound," said Doug Christopher, an analyst at Crowell, Weedon & Co. "There's a lot of earnings leverage and we expect them to continue to do well and grow."
Christopher said the long-term earnings and sales growth for Smart & Final is around 10% and 8%, respectively. The stock trades at just 0.2 times sales. "Is this a stock that's poised to do well? Well, we think so."
Smart & Final last traded at $14.05, less than 2% away from its 52-week high. Old Dominion and SCP Pool are also close to their 52-week highs at $37.65 and $39.58, respectively. When fundamentally sound companies gain this kind of investor support in a difficult market, it's probably time to take notice.
(Crowell, Weedon, Avondale and Sidoti have no banking relationships with the firms mentioned. J.P. Morgan makes a market in shares of Old Dominion and has had a banking relationship with the firm in the last 12 months.)