PFIZER

Informed opinion almost always advocates the popular course, so you must steel yourself to stand apart. To be a contrarian is to be an outsider – until you’re proven right.

David Dreman, Contrarian Investment Strategy, 1979

Pfizer (PFE) reached a high of $48 a share in June 2000, and now trades at about $20. Twenty-one analysts are following the stock, but only 6 are recommending purchase. The contrarian investor in me had to take a look.

First, I put Pfizer through the Fast Track screen. The stock passed my rule of failing no more than 3 categories, so I continued to do more research using the Company Stock Risk Profile research tool. While Pfizer came through with a Medium Risk rating, having failed 19 of the 50 categories, the stock missed being rated Low Risk by only 2 categories.

Pfizer’s Risk Profile highlighted these negatives:

1. Pfizer is not delivering any growth, as sales have been essentially flat since 2004. Reported earnings have been extremely erratic, impacted by ongoing “purchase accounting adjustments, acquisition related costs, discontinued operations and certain significant items.” Adjusted for these items, as management does, earnings are smoother, but still are not growing. First quarter 2008 sales declined 5.0%, and reported and adjusted earnings per share dropped 12.8% and 10.3%, respectively.
2. Pfizer is being hurt by multiple patent expirations on very successful pharmaceuticals – Zithromax (antibiotic) in November 2005, Zoloft (depression) in August 2006, and Norvasc (hypertension) in March 2007. Lipitor (cholesterol) produced sales of $12.7 billion in 2007, and its patent is up in March 2010. As an example of what could happen to Lipitor’s sales, Zoloft’s sales went from $3.3 billion in 2005 to $531 million last year. Generics, as well as branded competition, already are eating away at Lipitor’s U.S. sales, which fell 8% in 2007 and 18% in this year’s first quarter.

I’m not presenting anything new here, as these issues are well known and baked into the stock price. The following positive factors also are there for investors to see, but are being overlooked:

1. Pfizer has a fortress balance sheet. The company ended the first quarter with cash and cash equivalents and short-term investments of $28.6 billion, which is up from $25.5 billion at year-end 2007 and $22.5 billion a year earlier. Long-term debt as a percentage of total capital is at a low 10.8%. And if that is not enough, net current assets (current assets less current liabilities) are more than 3 times long-term debt.
2. Pfizer remains a strong cash flow generator. Cash flow from operations was $13.4 billion last year, and after capital expenditures, free cash flow was $11.5 billion. These same numbers in this year’s first quarter were $3.3 billion and $2.8 billion, respectively. 2007 free cash flow could drop 25% and still cover the dividend. Management is forecasting operating cash flow of $17 - $18 billion this year, and expects “to continue to generate strong operating cash flow beyond 2008.”
3. Pfizer has 102 medicines in its pipeline – 47 in phase 1, 37 in phase 2 and 16 in phase 3. Two drugs are in registration. Management’s goal is to have 15 – 20 submissions in 2010 – 2012. Whether any blockbuster drugs emerge is, of course, uncertain. But investors have no expectations anyway, leaving plenty of room for positive surprises.
4. Newer drugs already on board are doing well, and posted robust sales in this year’s first quarter: Lyrica (fibromyalgia) - $582 million, up 47%, Sutent (cancer) - $190 million, up 86%, Chantix (smoking cessation) - $277 million, up 71%.
5. Management is streamlining the company. Costs are targeted to drop by $1.5 - $2.0 billion by the end of 2008, as compared to 2006.
6. Pfizer is a cheap stock. The shares failed only 2 of the 12 Company Stock Risk Profile valuation measures. Pfizer offers a dividend with a juicy 6% yield, which I believe is safe based on the strength of the company’s balance sheet and cash generating capability.

Investors with the fortitude to take the road less traveled should consider Pfizer. Whether Pfizer delivers a positive surprise down the road is anyone’s guess. But if the company should, the stock would be a rewarding investment indeed. In the mean time, you’re getting paid a very attractive dividend and own a stock that I believe has minimal downside risk.

Fast Tracking for Ideas

The demand for oil continues to grow. New discoveries, such as Petrobras’ Tupi field, are offshore and in deep water. Spending by oil companies on exploration and production is increasing. I Fast Tracked several oil and gas drillers. Transocean (RIG) and Noble (NE) passed my screen.

Fast Track results: Transocean failed 3 categories, and Noble failed 2 categories.

Key points:

1. Transocean is the world’s largest offshore drilling contractor with 138 rigs, as well as being the leader in deep water drilling. Noble has 62 mobile offshore drilling units.
2. Transocean and Noble are benefitting from strong backlogs, high rig utilization rates, and high day rates.
3. Both companies are generating a lot of cash. Noble recently declared a special dividend of $0.75 a share.
4. Transocean is highly leveraged with long-term debt as a percentage of total capital of 46.9%. I prefer Noble’s 13.1%.
5. Earnings at both companies have equaled or beat Street consensus estimates in each of the last 4 quarters.
6. Both stocks passed Fast Track’s valuation measures.

Transocean and Noble are potential buy ideas worthwhile thoroughly researching.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

Fast Tracking for Ideas

“We’re off to a good start in what we expect to be another strong year of financial performance for Boeing,” said Chairman and Chief Executive Jim McNerney. The company delivered first quarter earnings that handily beat the Street’s consensus estimate.

Fast Track results: Boeing failed 3 categories. The stock is a potential idea that is worthwhile thoroughly researching.

Key points:

1. Cash and equivalents ended the first quarter at $9.6 billion, up from $7.0 billion last year and $3.2 billion in 2004.
2. Free cash flow came in at $1.5 billion in the first quarter, as compared with $277 million a year earlier.
3. Boeing’s earnings have beat Street estimates for the last 4 quarters. The Street has been lowering estimates, and that trend could change.
4. Boeing’s stock passed Fast Track’s 2 valuation measures.
5. Eleven analysts rate the stock hold and 3 underperform/sell out of a total of 22 analysts, leaving room for ratings upgrades.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

Water: Staying on the Sidelines for Now

Unlike oil, gold, and other such commodities, water is the one commodity we must have to live. And I don’t even think about it. I don’t have to. Clean water is delivered to my home and where I work. It’s always available, and it’s cheap. Will it always be this easy?

Living in Arizona, one of the fastest growing and driest states, I thought back to a discussion I heard on NPR about population migration. I remembered this startling prediction: the Southwest will be riddled with ghost towns when water runs out, and those looking back 50 years from now will be mystified as to why people ever wanted to live there. Last year 26% of the Southeast was covered by an “exceptional” drought – the National Weather Service’s worst drought category.

Consider these worldwide facts from the United Nations’ Human Development Report 2006:

1. Less than 1% of the world’s freshwater is easily accessible.
2. 1.2 billion people lack access to freshwater, and 2.6 billion are without adequate sanitation.

More people with higher living standards, pollution, and climate change may be pointing to water shortages down the road. A key example, China has 20% of the world’s population but only 7% of the water. Will China have enough water to support its rapidly growing urban population?

The water industry should be ripe with investment opportunities. I put together a group of 18 stocks, certainly not all-inclusive of ways to participate in the industry, to begin to find out:

York (YORW), Pennichuck (PNNW), Middlesex (MSEX), Connecticut (CTWS), Southwest (SWWC), Artesian (ARTNA), SJW (SJW), American States (AWR), Aqua America (WTR), and California (CWT) are all domestic water utilities.

Mueller Industries (MLI) - tubes and fittings used in water distribution systems.

Watts Water Technologies (WTS) – water safety and flow control products.

Nalco (NLC) - water treatment chemicals and services.

Flowserve (FLS) – flow control equipment.

Gorman-Rupp (GRC) – pumps and fluid control equipment.

Calgon Carbon (CCC) – products to purify water and air.

Veolia Environment (VE) – water treatment services based in France.

Consolidated Water (CWCO) – desalination plants and water distribution systems in the Caribbean.

I used Fast Track to get a quick study on the group and find potential buy ideas:

1. These are mostly small cap stocks, and they are not widely followed on the Street. Thirteen stocks have market capitalizations under $ 1 billion. Thirteen stocks are covered by 5 analysts or less, and 9 stocks by 3 analysts or less.
2. Financial leverage is high, with long-term debt to total capital averaging 40.9%, ranging from 0% for Gorman-Rupp to 74.1% for Nalco.
3. Free cash flow was negative at 10 companies in 2007, and 7 companies posted negative free cash flow in each of the last 5 years. These are all utilities.
4. Thirteen stocks had P/E’s below their high / low 5-year average. Only two stocks, Mueller and Watts, also had PEG ratios that were below both their industry and the S&P 500.
5. California Water was the only company where management was a net buyer of stock.
6. The Street is not particularly enamored with this group of stocks. There are 40 purchase recommendations out of a total of 86 ratings, so there’s room for ratings upgrades. Aqua America seems to be the darling of the group with 10 analysts following the stock and 9 recommending purchase.

Here’s my take:

1. I was disappointed to find that Flowserve was the only stock that passed my Fast Track screen, having failed no more than 3 categories. But Flowserve is really a play on oil and gas, which accounts for 41% of their business, as opposed to 6% for water.
2. Only 3 companies, Veolia, Flowserve and Calgon, did not report disappointing earnings in any of the last 4 quarters. But Street analysts have held their earnings estimates steady at 12 companies. Watts pre-announced an earnings disappointment for their March quarter, citing weak construction here, slowing economic activity in Europe, and even problems in China. While this could be unique to Watts, is it a harbinger of more disappointments at other companies?
3. No company in the group delivered consistent earnings growth in the last 5 years. This, and that Watts is a pure play on water makes me question whether the water industry’s growth story has really kicked in yet.

I’ve decided to stay on the sidelines for now.

Here’s How to Fast Track for Ideas

Use the parameters listed below to quickly screen for potential stock ideas. You can usually find the information at these websites:

Company website
http://finance.yahoo.com
http://online.wsj.com (fee)
www.reuters.com
www.morningstar.com

Just fill in the answers with an X under yes or no on this easy to use worksheet. I like to see a stock fail no more than 3 categories before going further with more extensive research. Whether you choose to use Fast Track or any other screening tool, always thoroughly research the stocks that pass your screen before buying.

Company Stock Risk Profile Fast Track™

Company Name ———— Stock Symbol—————- Date

Yes —No

Cash and cash equivalents
and short-term investments
are stable or growing.

Low or no long term debt.

Cash generated from
operations is close to or
higher than net income.

Free cash flow has been
stable or growing.

Reported earnings have
equaled or exceeded analysts’
consensus earnings estimates
for the last four quarters.

Analysts’ consensus earnings
estimates have been stable
or rising.

P/E is less than 100% of the
average of the high and low
P/E’s of the last five years.

PEG is below the Industry’s
and S&P’s 500’s.

Management has been buying
stock.

Of the analysts following the
stock, no more than half are
recommending purchase.

Definitions:

Low long-term debt = long-term debt as a percentage of total capital of no more than 20%.

Free cash flow = cash from operations less capital expenditures.

PEG = price / forward earnings divided by forecasted earnings growth, usually the Street consensus for the next 5 years.

Is the Recession Here Yet?

Initial claims for unemployment benefits rose to a seasonally adjusted 407,000 for the week ended March 29. Claims over 400,000 are usually considered recession territory. The Labor Department just reported that nonfarm payrolls fell 80,000 in March bringing the unemployment rate to 5.1%. But the unemployment rate is a lagging economic indicator.

What may the market be telling us about the economy? I looked at the year-to-date performance of the Dow Jones Industries Indexes, and I found this:

Delivery Services + 6.70%
Railroads +13.16%
Transportation Services +25.07%
Trucking +14.95%
Home Construction +24.28%
Home Improvement Retailers +8.56%
Hotels +5.07%

The stock market is a discounting mechanism, and the strong performance of these economically sensitive industries may be telling us that a pickup in economic activity is up ahead.

I also thought that it may be informative to look at passenger traffic at McCarran International Airport in Las Vegas. Passenger traffic as compared to a year ago was up 3.4% in February and 0.2% year-to-date.

This also caught my attention. Research in Motion added 2.2 million subscribers and shipped 4.4 million smart phones in the quarter ended March 1.

So, more people are going to Las Vegas to vacation and gamble, and they are buying a lot of BlackBerrys. Is the economy really as bad as the headlines make it seem?

Analysts’ Earnings Estimates

Study: Wall Street Analysts Still Exuberant in Their Earnings Projections
Researchers find that upward bias persists even after 2003 Global Analyst Research Settlement

“Previous studies suggest their stock recommendations do not perform well, and now we show that their long-term earnings per share growth rate forecasts are excessive and upwardly biased.” – from the study by J. Randall Woolridge and Patrick Cusatis, Penn State Smeal College of Business.

My observations:

First, let’s do our own research rather than depend on others to do it for us. We do not have to pay high fees to someone else to manage our money, particularly to brokers peddling flawed Street research.

Maybe we should get out of the forecasting business. Here’s what I would suggest.

1. Use trailing 12-months earnings per share from continuing operations and before extraordinary items in the denominator of the price/earnings ratio. If you feel you have to use an earnings estimate, use the lowest estimate among the analysts offering forecasts for a margin of safety.
2. Instead of using the Street’s consensus 5-year earnings forecast in the denominator of the PEG ratio (price/earnings divided by earnings growth rate), use a company’s internal or sustainable earnings growth rate calculated as follows: earnings retention ratio (net income – dividends) X return on equity.

Fast Tracking for Ideas

Target is on the cover of the current issue of Fortune. I like shopping at Target, and the stock is down 30% from its 52-week high.

Fast Track results: Target failed 5 categories, so I would not go further with this idea.

Key points:

1. Target has a lot of financial leverage with long-term debt as a percentage of total capital of 49.7%.
2. Free cash flow has been declining since fiscal 2005, and came in at a negative $244 million last year.
3. Consensus earnings estimates have been trending lower.
4. The stock passed two valuation measures, and more than half the analysts covering the stock are not recommending purchase are positive factors.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

Fast Tracking for Ideas

In June 2005, I concluded that, “Starbucks is a great company, but the shares are expensive. Moreover, their valuation reflects investors’ expectations that management will deliver on their forecast. I do not want to take on the valuation risk at the current price that they may not.” The stock has fallen 33% from that time and 57% from its high in May 2006.

Fast Track results: Starbucks failed 3 categories, and is an idea that is worthwhile taking a closer look.

Key points:

1. Starbucks has new operating management as founder and Chairman, Howard Schultz, took over as CEO in 2007. His plan is to renew the company’s focus on coffee, improve profitability, and emphasize growth in overseas markets. Investors’ expectations about management delivering on these plans are much lower today.
2. The power of the Starbucks brand name has not changed.
3. The balance sheet is solid with long-term debt as a percentage of total capital at a low 19.6%.
4. Free cash flow has been growing: $360.4 million in 2006, $559.1 million in 2007, and $695.2 million in the latest 12-months.
5. The stock passed Fast Track’s two valuation measures.
6. Nine of the 18 analysts covering Starbucks rate the stock hold leaving plenty of room for ratings upgrades.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

The Ideal Stock

The ideal stock probably does not exist. But if it did, I believe it would look like this: great fundamentals and outstanding value, which have gone undiscovered by investors. In my ongoing search for stock ideas, I try to come as close to my view of the ideal stock as possible. Here’s what I look for.

The company produces products and services that people need and use every day giving it staying power through economic cycles. Individuals and businesses forego what they do not need when economic times are tough.

An established leader, the company dominates its markets with strong brand names. It has the critical mass to be a low cost producer and a very effective competitor, with the marketing muscle to successfully capitalize on powerful brand identification.

Cash from operations and after capital expenditures (free cash flow) is strong and growing. Also, cash from operations is consistently higher than net income indicating quality earnings. A company reporting positive net income, but ongoing negative cash from operations will eventually crash and burn. Real cash is a company’s lifeblood. I want to invest in companies that generate cash to grow their businesses, pay me dividends and buy back stock.

The company has a fortress balance sheet, with lots of cash that is growing and little or no debt. Cash from operations is the principle source of growing cash on the balance sheet, suggesting a profitable and well-managed company.

Management has a large stake in the ownership of the company, and they are buying stock for themselves. Real owners are apt to make better decisions than managers who do not have their personal fortunes at stake.

Managements whose interests are aligned with shareholders run businesses for cash, build strong balance sheets, and have large personal stakes in the outcome.

Earnings have been beating Street estimates for the last several quarters. Underestimating the company’s operating performance, Street analysts are raising their earnings estimates as they try to catch up to what is really happening. Rising earnings estimates indicate positive change, a key element supporting a rising stock price.

The company has a demonstrated record of high profitability. Profitability measures how well management utilizes the company’s resources to produce value for shareholders. Profitability (net profit margin and return on equity and their components) is rising and outperforming the company’s industry as well as the average company as represented by the S&P 500. The quality of profitability is high. Return on equity is rising because of higher pretax margins and asset utilization as opposed to a lower tax rate and higher leverage or debt.

I want stocks that pay dividends. Real cash in my pocket, dividends are a clear reflection of management’s confidence in the future of their business. As one CEO so aptly stated: “Paying a reliable and attractive dividend from the cash we generate each year is one of the most direct and transparent means we have of delivering shareholder value.”

The company has no controversial issues surrounding it, which potentially can crush a stock. These may be issues of questionable accounting and management practices, antitrust matters, new competition, and litigation, to name a few.

The stock is off the beaten track, with no analyst coverage and little institutional ownership. Investors have yet to discover the idea, leaving plenty of room for positive change in perception, expectations and stock price.

The company is poised to show substantial positive change that is going unrecognized by investors. No one is watching, but a catalyst is going to jolt the Street with a positive surprise and change investor perception. Catalysts could be a new product, new management, the sale of underperforming businesses, a strengthening balance sheet, a major cost cutting initiative. Substantial positive change also could emanate from expected negative events that do not happen, e.g. Altria in 2000 at $20 discounting a potential bankruptcy due to litigation.

The stock is undervalued. I use the Company Stock Risk Profile™ valuation measures. Multifaceted in its approach, the Company Stock Risk Profile uses six valuation methods comprised of twelve measures to value stocks yielding a comprehensive result. The ideal stock would be undervalued on all twelve measures.