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Top Ten Trader
Discover the Market’s Strongest Stocks

March 31, 2008

The market is attempting to build a bottom, but individual stocks remain very tricky. Thus, buying right and keeping your purchases small should be a top priority; when a new bull market arrives, there will be plenty of opportunities, so there’s no need to force things. This week’s Top Ten Report contains another interesting batch of commodity stocks (oil and steel), along with a few growth stocks. We believe the upcoming earnings season should give us a clearer view of what’s in store for the market and its leading stocks.

Lots Of Crosscurrents

Overall, we continue to see many signs that the market is transitioning from a bear phase to a bullish phase—sentiment is horrid, stocks have refused to break down on the worst of news (i.e., Bear Stearns) and the indexes have held above support for many weeks. However, when it comes to buying individual stocks, there are few options—steel and some oil stocks remain in favor, but for every stock that pops its head up, there seems to be another that gets slapped down. Bottom line, it’s still not a time for aggressive buying, but picking up a few shares of potential leaders during pullbacks can still work out. Just don’t go overboard! This week’s Top Ten is commodity-heavy, with a few growth-oriented names sprinkled in. Our favorite of the week is Comstock Resources (CRK), which staged a good-looking breakout last week. We think you can pick up a few shares on weakness.

Stock NamePriceBuy RangeLoss Limit
CLF (CLF) 0.00110-125-
CLR (CLR) 0.0029-33-
CRK (CRK) 0.0035-39-
ILMN (ILMN) 0.0068-74-
MT (MT) 0.0079-83-
OI (OI) 0.0053-56-
PQ (PQ) 0.0015-17-
RIMM (RIMM) 0.00130-140-
STLD (STLD) 0.0031 1/2 - 34 1/2-
TNE (TNE) 0.0021-25-

(CLF)

Why the Strength

Cleveland-Cliffs is the largest producer of iron ore pellets in North America, with a market share of more than 28%. Iron ore, of course is the principal ingredient of steel, and the steel business is booming because of all the building taking place in China, India, Dubai and elsewhere. But the story is even better than that; just last year Cleveland-Cliffs diversified into the metallurgical coal business, buying PinnOak Resources, a company previously owned by U.S. Steel. And that’s proven a great strategic move, because metallurgical coal is the #1 fuel used in steel-making furnaces. The company also has bought a coal operation in Australia, a location better suited to serving the booming Asian market. Like most natural resource stocks, CLF looks like a bargain on a price/earnings basis, but that reflects, in part, the fact that part of the company’s destiny is out of its control. As long as steel prices keep climbing, however, shareholders should do very well. The stock will split 2-for-1 on May 1.

Technical Analysis

This marks CLF’s fourth appearance in Cabot Top Ten Report since February; generally, repeat appearances are a plus. The stock has been strong since early 2003, with one big pullback in 2006. More recently, we’ve seen a four-month period (October into February) where the stock worked to break out above 105, and then a big volume run up to 120. The consolidation at 120 continues today, and there are no obvious selling pressures, so it’s likely the uptrend will continue. We recommend buying soon … as always, the lower the better.

CLF Weekly Chart

CLF Daily Chart

(CLR)

Why the Strength

Continental is a basic oil and gas explorer and producer, with properties in Oklahoma, Illinois, Texas, Louisiana, Montana, North Dakota, South Dakota and Wyoming. Like every company in the industry, it has benefited tremendously from higher prices. But shareholders in Continental have more reasons to celebrate. One, the company seems to have underestimated its reserves; recent drilling activity has revealed far more capacity than previously estimated. Two, earnings growth is now accelerating in a big way. Three, after-tax profit margins in the fourth quarter reached an extremely profitable 46.4%. And four, the stock is young, which means it’s still being discovered and there are minimal selling pressures. Admittedly, a plunge in oil and gas prices could upset the whole apple cart, but the same is true for every company in the industry.

Technical Analysis

CLR came public at 15 in May 2007, built a base at that level for 16 weeks, and then embarked on the uptrend that continues to this day. At the end of October, the stock hit 25, a level that served as resistance for a while. And just two weeks ago, the stock corrected from 29 back to 25, thus establishing that level as support. In the process, it fell below its 50-day moving average, washing out the weakest shareholders, and then, boom, off to the races again. We think you can buy on this breakout.

CLR Weekly Chart

CLR Daily Chart

(CRK)

Why the Strength

Making its first-ever Top Ten appearance, Comstock Resources, based in Frisco, Texas, is an independent oil and natural gas company with operations in Texas, Louisiana and the Gulf of Mexico. There’s nothing revolutionary going on here, just a successful energy company with a long history (founded in 1919) that’s growing both through drilling activity (180 wells drilled in 2007, with 165 successes) and through enhancement of production from existing wells. Q4 offshore production increased 20% over 2006 while onshore production increased 32%. With Q4 earnings up 153% over 2006 and revenues up 54%, Comstock is riding the wave of higher energy prices and projects 51% earnings growth for 2008. The company’s reserves are composed of 77% natural gas and 23% crude oil, which will allow for production increases for many years. For 2008, management expects 15%-20% growth in output.

Technical Analysis

CRK hasn’t been a ball of fire, spending all of 2005 and 2006 and most of 2007 under resistance at 34. But the stock popped up to 39 in October 2007 and has just broken out above 40 on good volume. With that new price peak and a new RP peak under its belt, the stock is waiting for the next catalyst for appreciation; higher oil and gas prices are the likeliest candidate for that honor. A temporary slip back toward the 25-day moving average at 36 would provide a prudent buying opportunity.

CRK Weekly Chart

CRK Daily Chart

(ILMN)

Why the Strength

With 10 previous Top Ten appearances, Illumina is an honored veteran among growth stocks. The company is a leader in the business of large-scale analysis of genetic samples, both for variation and function. Illumina’s Bead series—BeadLabs, BeadStations and BeadArray Readers—are favorites among pharmaceutical firms, biotechs, agri-biz and medical enterprises as well as academic and private research centers. Despite a couple of quarters of moderating earnings because of one-time stock compensation expenses, the company continues to find favor with institutional investors and has raised earnings estimates for the next couple of years. We like the fact that the stock has appeared in Top Ten every year since its first appearance in February 2005.

Technical Analysis

ILMN gapped up to 75 in early January, then corrected to as low as 62 later in the month. Another run at 75 in February eked out a new high, but gave way to another slide back to the low 60s. The most-recent run at 75, however, led to five days of very tight action and today’s attempted breakout. Use any dip toward the 50-day moving average, just under 70, as an opportunity to build a position.

ILMN Weekly Chart

ILMN Daily Chart

(MT)

Why the Strength

Recent issues of Cabot Top Ten Report have featured steelmakers Nucor (NUE) and Steel Dynamics (STLD), and those stocks still look great. Now here’s ArcelorMittal, the biggest steel company in the world. At the helm of the company is Lakshmi Mittal, born to a father who had already made a fortune in steel. Raised in India and now living in London, Lakshmi (the fifth-richest man in the world) merged his Ispat International and LNM Holdings in 2004 and then merged with International Steel (the remnants of Bethlehem Steel, Republic Steel and LTV Steel) to create Mittal Steel. Then in 2006 he merged with Arcelor to create ArcelorMittal. All told, the company now accounts for about 10% of the steel made in the world. Nominally headquartered in Luxembourg, the company has an industrial presence in 27 countries, with 64 steel-making facilities. The main reason for the stock’s strength, of course, is that demand for steel continues to exceed supply, so prices of steel have risen. With a price/earnings ratio of just 10, we think ArcelorMittal can climb a lot higher … and of course it can grow further by merger!

Technical Analysis

MT has been trending strongly upwards since the start of 2003, its ascent interrupted only by a 50% downdraft in 2006 when the Arcelor Mittal merger was on shaky ground. Today, we’re looking at a six-month basing formation, followed by a breakout today on average volume. It’s not an ideal setup, but it may work nonetheless.

MT Weekly Chart

MT Daily Chart

(OI)

Why the Strength

Owens-Illinois is a turnaround story, pure and simple. There’s nothing revolutionary here, as the company is a major player in the worldwide glass container industry—just about the least exciting sector you could imagine. Yet after years battling asbestos liabilities and seeing earnings bob and weave, management has taken bold steps to significantly boost the bottom line. The company has cut costs across the board, and more important, has made a decision to emphasize pricing over volumes. Output in the fourth quarter, for instance, slipped 1%, but higher prices and a weak U.S. dollar helped sales jump 15%. That caused earnings to explode, more than doubling estimates. Looking ahead, rapidly rising prices for raw materials are an issue, but management expects its myriad contract negotiations to result in much higher selling prices. Earnings are forecast to reach $4.11 per share this year, but that estimate was just $3 one quarter ago. Translation: Most investors are underestimating this turnaround story, which could have a few more quarters to go.

Technical Analysis

OI is certainly not early in its advance—the stock has risen from an oversold low of 13 in August 2006 to as high as 59 in recent weeks. It looked like the run was over earlier this year, as the stock slid to 39 as the market collapsed. But a terrific quarterly report pushed OI to new peaks, and impressively, it’s traded in a relatively tight range since, despite all the ups and downs of the market. It’s tempting to advise jumping on board should the stock break out to new peaks, but we think a better strategy in this environment is to buy just a little on a pullback into the mid 50s. Just note that any decisive break of 51 is a sign to get out.

OI Weekly Chart

OI Daily Chart

(PQ)

Why the Strength

Petroquest Energy, like Comstock, is an independent oil and gas explorer/developer/acquirer/producer operating in Texas, Louisiana and the Gulf of Mexico. The company was founded in 1985 and had reserves totaling 2.73 million barrels of crude and 118 billion cubic feet of natural gas at the end of 2006. The company experienced record production, revenues, earnings and cash flows in 2007, and expects to grow its reserves by more than 30% in 2008 through its drilling activity alone. Wells in the Woodford Shale formation in Oklahoma have begun to produce, marking an increase in onshore activity. Petroquest is another small, agile energy company that’s ramping up production and looking for both drill-bit expansion and acquisition opportunities. It should continue to benefit from the record high energy prices that keyed a 2,100% increase in Q4 earnings and will continue to attract institutional investors.

Technical Analysis

PQ rose strongly in 2004–05, then slowed somewhat in 2006–07. But it lost its upward momentum only briefly in 2007 before surging crude prices got it moving again. With a 60% gain over the past 10 weeks, the stock is extended here. The sensible strategy is to wait for a correction to the 25-day moving average (now at 16) and start a small position there, adding to it as the stock makes progress.

PQ Weekly Chart

PQ Daily Chart

(RIMM)

Why the Strength

Research in Motion is one of the only big technology leaders of last year that’s still hanging in there after five months of bear market action. You probably know the ruling reason for the firm’s success by now: Its BlackBerry franchise of PDAs for professionals and, more recently, for consumers, continue to sell like hotcakes, despite the popularity of Apple’s iPhone. (On the flip side, Motorola’s troubles are likely helping RIMM.) Looking at the numbers in the table below, there’s certainly nothing to be desired—earnings growth is still accelerating, while revenue growth has been holding at triple-digit levels. But the intermediate-term outlook is going to come down to the firm’s earnings report, due out this Wednesday (April 2) after the market’s close. We know business is good, the question is, is it good enough to impress institutional investors? The potential for the stock to return to leadership status is there, so keep a close eye on it.

Technical Analysis

RIMM is in a sloppy base-building pattern. The stock fell 41% from high to low, which is more than the typical winner corrects, though it’s been creeping higher since bottoming in January, a good sign. In fact, the stock’s relative performance (RP) line is already reaching new peaks, displaying the stock’s resilience. So, how should you handle RIMM? Our advice is to wait for the earnings report, and if you see a big gap up—hopefully above 135—buy a little. Such earnings gaps tend to lead to strength in the intermediate-term, so buying on a huge upmove could work well. But if RIMM gaps down, just cross it off your watch list.

RIMM Weekly Chart

RIMM Daily Chart

(STLD)

Why the Strength

Steel stocks are largely unfazed by the volatility in commodity stocks, and Steel Dynamics remains one of the leaders. The company has always been a relatively efficient producer, but the big story here is the recent price hikes; usually, when steel firms start to successfully raise prices, there are more to come, as demand trends for steel tend to be long-lasting and somewhat “sticky.” It doesn’t hurt that other steel firms also are starting to hike prices. That’s causing investors to look ahead and think that even the current bullish earnings forecast for 2008 ($5.76 per share, which would be up 41% from 2007) could be conservative. Obviously, this story doesn’t have anything new going for it, but the wind is at the industry’s back right now, and Steel Dynamics is helping to lead the way.

Technical Analysis

STLD decisively broke out to new peaks three weeks ago, when news of higher steel prices and a higher first-quarter earnings outlook (it hiked views to $1.25 or more, versus $1.15 before) caused a rush of buying. And we like the action since that time; it’s suffered a few scary down days, but downside volume has been light, while relatively strong buying volume tells us big investors remain interested. The stock just split 2-for-1 this morning, its second 2-for-1 split in 16 months, which is a red flag. (Stocks often top after a couple of splits.) But considering the tight action, we think you can buy a little in this area.

STLD Weekly Chart

STLD Daily Chart

(TNE)

Why the Strength

Tele Norte Leste is a rapidly growing telecom giant in a rapidly growing country, Brazil. The company came into being in 1998 with the privatization of the Brazilian national phone company, and grew organically with a mix of wireline, long distance and data services. In 2001, all 16 regional operating subsidiaries were united into one company and in 2002 the company began offering mobile services. Now operating under the brand name Oi, Tele Norte Leste is rapidly becoming a totally integrated fixed, mobile, broadband and internet company. The news that has been tantalizing investors is the ongoing negotiation process that will allow Oi to take over Brasil Telecom. The deal would give Oi about 70% of Brazil’s fixed-line market, immediately enlarging its target for integrated voice and data services, as well. Brazil’s growth is supporting Oi, and Oi’s growth is pushing cutting edge communications services into Brazil. It looks like a mutually beneficial arrangement.

Technical Analysis

TNE, which had been in the long-term doldrums, got moving in mid-2007. But it took the prospect of the Brasil Telecom takeover to really kick the stock into high gear. After a January leap to new price and RP peaks (which occasioned the stock’s first Top Ten appearance), TNE banged around for a couple of months in a tightening pattern. A dip toward 24 would make for a satisfactory buying opportunity, although any move below 22 would be bearish.

TNE Weekly Chart

TNE Daily Chart