More Safe-Haven Ideas

 | Oct 05, 2011 | 11:00 AM EDT  | Comments
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In Monday's column, I looked for "safe haven" stocks on the long side -- companies that have a good chance to report solid earnings, and perhaps even an earnings surprise. Names that saw earnings-per-share estimates rise in the third quarter feel like safer bets, since rising estimates in the face of poor economic news indicate business is probably holding up. (There is still risk, though, because even with good earnings, a company can still have a poor outlook, so we must look deeper than numbers alone.)

But looking at the third-quarter EPS estimate from point to point ignores that the estimate may have risen early in the quarter and could be falling now. As a refinement, I look at the more recent revision trend from week to week, and I look at both the quarterly estimate and the full year 2011 and 2012. By looking at the annual estimate, you can detect where the near-term earnings are holding up and see where analysts detect long-term weakness that could signal a guidance reduction. How you weight each of these estimate trends is up to you; I have my own way, but the weights are somewhat arbitrary. The key is to weight near-term trends more heavily, as they are more certain than 2012 estimates.

Another refinement is to avoid looking at the absolute estimate trend but compare the universe of stocks and pick the strongest. This is important because the stock market is nothing but a comparison machine, and an absolute trend could be great or terrible compared to how other names are performing. I sort all the names and then decile rank them (into ten groups with the top 10% ranked first, and so on.)

Below is a table I created with the best trends in earnings estimates -- a blend of near-term and annual estimates -- sorted to the top 20%, as shown by the ranking of one or two. (As of Monday, I used only stocks with market caps greater than $5 billion, to shrink it to a manageable number.)

There were a lot of twos in my first sort, so I went one step further and only used names with a single digit price-to-earnings ratio. This final sort is important too, because the low PE gives you a further margin of safety. Low PE indicates low expectations, so if we are wrong and the company reports poor earnings, the damage to the stock is likely to be contained.

Source: FactSet and FirstCall Estimates

Several names stand out. Priceline (PCLN) might be risky as travel might decline in a weak economy, but travelers gravitate to value, which drives this business. Wynn Resort's (WYNN) exposure to Las Vegas is at risk, but business in the Chinese gambling enclave of Macau is booming and driving results. Conversely, both software maker Red Hat (RHT) and Alexion Pharmaceuticals (ALXN) are too expensive for my taste --- there's no margin of safety if they blow up. By industry group, you'll notice many oil service names on the list thanks to the boom in shale gas that's driving a pocket of strong business in a weakening economy.

With so much uncertainty in the markets and the economy right now, consider a strategy along these lines to help protect your portfolio as we move into what could be a very treacherous earnings season.

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