Two Window-Dressing Picks

 | Sep 25, 2012 | 1:30 PM EDT
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One of my favorite investment times of the year is approaching: quarter-end "window-dressing." This is when fund managers dump their losers for the quarter and add to their winning positions. They do this in a vain attempt to look good to their shareholders at quarter end, even if they underperformed their benchmarks.

This can lead to some predictable outcomes in the quarter's last week of trading. For example, there is a high probability that Apple (AAPL) and Google (GOOG) will be bought on any dip over the next week. These two stocks have contributed some 70% of the Nasdaq-100's performance for the quarter, and every money manager will want to show those positions in their quarter-end portfolio snapshots.

This action also provides opportunities for intrepid investors who are willing to buy some of the quarter's worst performers, knowing that the ones whose earnings stories are intact will likely outperform the market in the following quarter.

The energy sector, including the refiners, had some of the worst-performing stocks in the second quarter, but they turned out to some of the best performers of the third quarter. It is harder to find sectors that have had declining prices the third quarter, given stocks' strong performance.

One area that looks interesting here is auto-parts retailing, for myriad reasons:

  • The sector as a whole has vastly underperformed the market, turning in a negative performance, even as the S&P 500 has shot up more than 10% for the quarter.
  • The earnings story is intact, valuations are reasonable, and some firms have seen increases in consensus estimates even as their stock prices have declined.
  • The average age of an American car on the road is near 11 years old, near historical highs.
  • This retailing sector held up very well during the recession and should outperform the market if we hit harder economic times in 2013.

Here are two auto-parts retailers I like at current levels.

O'Reilly Automotive (ORLY) provides automotive aftermarket parts, tools, supplies, equipment and accessories in the U.S. It operates more than 3,800 stores in 39 states.

Here are four reasons why O'Reilly is a solid buy at just over $84 a share:

  1. This stock is a cash-flow machine. It has quadrupled operating cash flow over the past three years, and the stock currently sells for just 8x OCF.
  2. Despite dropping around 15% in the quarter, consensus earnings estimates for fiscal 2012 and fiscal 2013 have risen over the past two months.
  3. The company has grown earnings and revenue at a better than 20% annual clip over the past five years. Given this and its cash-flow growth, I believe that paying just 15x forward earnings is getting the stock at a discount.
  4. Store comps in July and August were marginally better than June's, and the company consistently beats quarterly earnings estimates.

AutoZone (AZO) is the largest auto retailing establishment in the U.S. It has more than 4,500 stores in U.S. and just under 300 stores in Mexico.

Here are four reasons why AutoZone is offering a good entry point at just under $370 a share:

  1. This is another stock whose price dropped in an overwhelming positive quarter. However, over the past three months, it has had a nice climb in consensus earnings estimates for fiscal 2012 and 2013.
  2. The company has steadily increasing operating cash flow and is on track to use that cash to repurchase almost 10% of its outstanding float in fiscal 2012.
  3. The stock is priced at a five-year projected price/earnings-to-growth ratio of under 1 (0.84). This is lower than all of its major competitors, including Advance Auto Parts (AAP), Pep Boys (PBY) and O'Reilly.
  4. Standard & Poor's recently raised its price target on AutoZone, the company is adding 4% to 5% to its store count annually, and it is the market leader in this space.

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