3 Stocks for You

We’re gonna talk about a couple stocks today.

Yeah, I know, with the stock market near all-time highs and the Fed looking for an opportunity to lay down a couple interest rate hikes, the general consensus is that you should not be buying stocks now. Buy low, sell high, and all that… 

I’m sure you know U.S. economic growth was pretty bad in the first quarter. In fact, there wasn’t any growth — GDP shrank by 0.07%. It sounds terrible, and it was. Do it again, and we’re officially in a recession!

But here’s the thing: That was last quarter. GDP is a trailing indicator. It tells you what has happened, not what’s going to happen. And stocks are never valued for what they have done, but rather what they could do in the future.

That’s why it’s always possible to find bargains, to identify stock prices that are mispriced — because people inevitably make mistakes. 

It might seem hard to believe that investors are still shell-shocked from the financial crisis. But think about it… Every time we see a big sell-off, doesn’t the fear of another giant stock market beat-down lurk in the back of your mind? I know that dark fear rises in my mind every time I see the Dow down 300+ points…

We can chalk some of the first-quarter weakness up to oil prices. Oil companies spent less and laid off workers, and that definitely had an impact on economic activity.

But don’t forget that with the exception of March, the U.S. economy continued a string of job gains unmatched since 1990. Manufacturing has picked up, so has the housing market, and even data from Europe has been beating expectations. 

However, the best indicator is probably earnings expectations. In the first quarter, earnings estimates were sharply lower — more than 10%. But as we get closer to second-quarter earnings, downward revisions are much lower. Analysts have lowered estimates by 2.1%.

The average downward revision over the last year has been 3.7%. Over the last 10 years, the average downward revision for S&P 500 earnings has been 3.4%. 

This is a sign that the economic weakness we’ve seen is priced in, and companies are more likely to surprise to the upside. 

Okay, sorry for the long-winded setup. I just can’t offer up stocks for your review without some qualification. The mainstream financial media always paints with broad strokes, and they will tell you the entire market is expensive. That’s just lazy. Do some digging, and you can find cheap stocks out there even now…

Cowen Group (NASDAQ: COWN)

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Cowen is a small investment bank and brokerage company. Trailing 12-month revenue was $376 million. And it’s expected to do ~$394 million for fiscal 2016.

For the last two quarters, it has trounced earnings expectations, reporting $0.16 and $0.20 a share against expectations of $0.11 and $0.14, respectively. Analysts have since pushed estimates higher, but the stock hasn’t really moved, as the overall market has been range-bound. 

The valuation looks good: trailing P/E is 5, forward P/E is 8.5, and it trades just below book value. Cowen has a net $500 million in cash, and the market cap is $1.3 billion. 

Cowen was a $20 stock back in 2007. It’s around $6 now, and it’s just breaking out to post-financial crisis highs. The stock has rallied ~25% since November 2014.

I wouldn’t be shocked to see Cowen shares pull back 10%, and I also wouldn’t be surprised to see it run another 60% to $10 over the next six months.

Alcoa (NYSE: AA)

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I’ve been scratching my head a bit on this one. It ran from $8 a share in 2013 to a 2014 high above $17. It has since pulled back to ~$12.50, a 52-week low.

But the thing is, the prospects look great for Alcoa. The company has been transitioning from a bulk aluminum producer to a value-added producer of finished products. A couple key acquisitions in the aerospace sector have made it a major supplier for Boeing. And Boeing is going great guns with its new line of planes. 

Alcoa is also a critical supplier for Ford’s new aluminum-bodied trucks. All indications are that this truck is being very well received. Other car companies will follow Ford’s success, as adding more aluminum lowers overall weight and improves performance and gas mileage. 

Alcoa has beaten earnings expectations in each of the last four quarters, yet analysts still will not raise forward estimates. With a forward P/E of 10 and a high probability that it will continue to beat earnings expectations, Alcoa should trade between $18 and $20 by the end of the year. 

Merrimack Pharmaceuticals (NASDAQ: MACK)

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Now, I am not a doctor — the science behind any biotech company is a bit of a mystery to me. And so I have to rely on the market’s acceptance of any biotech company for validation. For Merrimack, it looks pretty good. 

So far in 2015, the stock has moved from $9 in January to a recent high around $13.60. It has since pulled back to the ~$12 level. 

Merrimack is still in the development stage, so it is losing money on R&D. But next year’s loss has been cut significantly, which suggests that momentum is building.

Merrimack is valued at $1.3 billion, and it has $103 million in trailing revenues. In fiscal 2016, revenues are expected to jump to $189 million. But the thing is, Merrimack is already positive $20 million for levered cash flow, which accounts for administrative costs and debt payments. 

Merrimack is partnered with Baxter and receives milestone payments that are expected to cover operations through 2016, so funding shouldn’t be an issue. That’s always good for a development-stage company. For investors, the sole focus can be on efficacy of its two main drugs for pancreatic and breast cancer. 

Of course, there is always risk with any biotech stock. With Merrimack, the partnership with Baxter is a big plus. The fact that biotechs have been so strong is also a positive.

Big Pharma like Pfizer (NYSE: PFE) and Merck (NYSE: MRK) must make acquisitions to grow pipelines, and that’s been a big driver for biotechs. It’s not likely to end soon. 

Merrimack’s chart is a bit indecisive at $11.90 right now. The recent decline from $13 is the result of earnings, not negative results from its drugs. There’s support at $11, and that level would make a pretty good entry.  

Until next time,

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.