How to Take a Stock's 'Temperature'

Financial media tend to recommend good news stocks. It's rare to see articles touting beaten-down shares, with dreadful recent charts, as bargains getting ready to turn around. How can you know if a currently favored name can continue to shine vs. being too expensive to buy? The best way to differentiate is to take the temperature of the stock in question to determine if it is feverish and ready to cool off, or hypothermic and destined to heat up again. Gauging human health is easy -- 98.6 degrees is considered normal. We easily compare our current thermometer reading to that benchmark to find out how we're faring. Individual stocks don't have a common normal, though. It takes some work to determine the valuation level that should be used to evaluate a stock's health. Medical/dental supply company Henry Schein suffered a big hit early this week. Was that plunge a signal to get out, or a great chance to buy in cheaply? Establishing normal for HSIC required going to its history to see where it typically traded. Note that the data that follow reflect pricing before a recent 2-for-1 split. The $140.08 share price from Tuesday was really $70.04 post-split. From 2010 through 2016, HSIC carried an average P/E of 20.6x. Traders' best entry points (green-starred) came when the shares sold for well below that normal level. Schein's two most obvious should have sold moments (red-starred) both reflected historically high valuation multiples. Momentum chasers who waded in at those peaks are clearly underwater today. Investors who purchased at 2016's low point (equivalent to $71.30 post-split) did not lock in bargain pricing, at about 23x forward estimates. Unsurprisingly, they are now still slightly below break-even, more than 20 months later, though sales and EPS have improved. Knowing normal gives you the power to resist bad advice when journalists recommend overpriced, but upwardly trending, stocks. Barron's ran a glowing story about HSIC on June 18, 2016, pitching the shares right after a major run-up. HSIC was then selling at 26.3x that year's projected earnings. Following Barron's on that suggestion wasn't a good idea. Within months, HSIC had fallen substantially. Most research firms employ quantitative analysis in setting fair values for stocks they cover. Morningstar's opinions are almost totally based on that objective mathematical concept. Other houses, like Standard & Poor's, generate analyst recommendations and buy/sell/hold advice from people, who are much more subjective. S&P then adds a computer-generated fair value to the mix in a later section of their reports. Here were the two June 2016 reports on Henry Schein that were in effect when the Barron's article was published. Morningstar correctly called HSIC as overpriced, giving it a one-star (out of five) Sell rating. Its price to fair value ratio showed Schein had not been as expensively valued in years. S&P's research on HSIC was incomprehensible. Analyst K. Snyder assigned HSIC a four-star Buy rating with the stock at $178.35. That seemed pretty crazy when his 12-month target price weighed in at just $173. S&P's computer, devoid of emotion, did a better job than their analyst. It called the shares somewhat overpriced. Fair value was listed as $154.80 ($77.40 post-2-for-1 split). No wonder normal investors are so confused by Wall Street research. Barron's and S&P's person loved HSIC. Morningstar and S&P's computer hated the stock, all at the same time and price. That is why knowing the share's true value is so important for decision making. Applying Schein's typical 20.6 P/E to its newly tweaked 2018 estimate of $3.80 (on post-split shares) supports an end-of-2018 target price of about $80. As of early afternoon on Wednesday, HSIC was trading for $68.65. That implies about 16.5% upside potential over the coming 12 to 15 months if fair value can be achieved. Schein thus appears somewhat underpriced for those with reasonable time horizons. Creating a well-thought-out goal gives you something to hang your hat on. It allows you to dismiss media hype that doesn't really stand up to logical scrutiny. There is a lot of bad information and plenty of ridiculous trading ideas out there. Work the historical numbers on any stock you're thinking about and you can come up with a fact-based estimate of where your choice should be trading. Knowledge is power.

How to Take a Stock's 'Temperature'

Is it running hot and ready to cool off, or heating up after a chilly spell?

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