Streetwise for Sunday April 27, 2008

Streetwise for Sunday April 27, 2008

 

 

Streetwise

 

Lauren Rudd

 

Sunday, April 27, 2008

 

Right Dance Partners Means Stocks Playing Your Song

 

 

Whether you are a regular on the Wall Street dance card or are just sitting on the sidelines trying to make up your mind if your are going to ask a company to be your partner, you are undoubtedly aware that the party on the Street has been anything but pleasant lately. Unfortunately, we probably have yet to see the light at the end of the tunnel. If you do see a light it is most likely the freight train of inflation bearing down on you. So what should you do?

 

You could buy into that hot tip you learned about from Uncle Harry, or watch as some stockbroker continually “rebalances” your portfolio. Unfortunately, the enjoyment derived from those dance tunes, and the accompanying price tag, means that you will probably be leaving the party early with a lighter wallet.

 

So how do you protect yourself from the seemingly endless vagaries of Wall Street, while still trying to achieve above average returns from your portfolio? The answer is simple. You create a list of companies you trust and whose products you understand, all the while maintaining an investment horizon measured in years.

 

From then on the rest is easy. You simply decide how many companies you want to ask to dance and select your partners. Just remember, it’s a long dance so you want to pick carefully. How many companies should you pick? If you can conjure up a modicum of uncanny luck, in conjunction with some supernatural analytics, then investing in just one stock should reserve your seat in Valhalla.

 

However, as Clint Eastwood was so fond of saying in his Dirty Harry movies, “A man has got to know his limitations.” Therefore, most of us are going to need to invest in a number of companies if we are going to achieve our hoped for returns. Therefore, your goal should be to invest in a minimum of 12 companies and a maximum of about 30. The upper limit is driven by time and resource requirements.

 

So where do you start? One possibility is Raytheon, a company never discussed here before. When Raytheon reported its 2007 results, its guidance for 2008 earnings from continuing operations was $3.65 to $3.80 per share on sales of $22.4 billion to $22.9 billion. However, look for the Raytheon to raise its 2008 outlook, in part due to a pickup in international orders. The company has a large opportunity pipeline abroad, including Patriot sales to Kuwait, South Korea and Taiwan and border security work in Saudi Arabia, Kuwait and Iraq.

 

Furthermore, Raytheon has a track record of receiving add-ons to current work. For example, during the first quarter, Raytheon won a follow-on contract worth roughly $179 million from the British government to continue work on a computerized system that will track arriving and departing travelers and match their names against watch lists. Raytheon's shares rose 6.4 percent in the first quarter to end the period at $64.61.

 

Calculating the intrinsic value of the shares using a discounted earnings approach, with a discount rate of 11 percent, yields a value per share of $103. A free cash flow to the firm approach results in a per share value of $109. Both numbers are well in excess of the current $66 share price. My 2008 earnings estimate for Raytheon is $3.92 and $4.45 for 2009, with a 12 month target price on the stock of $75, for a potential gain of 13.6 percent. In addition there is a 1.7 percent dividend yield.

 

However, one of the difficulties in analyzing Raytheon is that the beta of the stock varied between 0.25 and 0.99, depending on the research site. For the purposes of the free cash flow model, I used 0.99 since it resulted in the most conservative answer.

 

A note to my readers: The web site, www.RuddReport.com, has been down for almost two weeks due to difficulties at the hosting company. I am pleased to report that the software has been reprogrammed and all is well. Recent columns and commentary are available now and everything else should be available within a week. Enjoy.