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Top Ten Trader
Discover the Market’s Strongest Stocks

September 10, 2012

The market lifted to new highs on big volume late last week and many leaders went along for the ride. It’s not going to be a straight-shot higher, but it’s clear the buyers remain in control. Thus, while you should keep your feet on the ground, you should remain optimistic the higher prices are coming.This week’s Cabot Top Ten Trader has plenty of attractive names. Our favorite of the weeks is one of many strong retail stocks that is heading higher after a powerful earnings gap a couple of weeks ago.

Just What You Want to See

The market and many leaders bolted ahead last week, which is just what we wanted to see as the big investors came back from the beach; it’s clear the buyers are in control. That said, despite some heady gains, we wouldn’t call this a runaway bull market—we’re seeing some under-the-surface rotation every few days, with money cycling out of some stocks and sectors and into others. That is totally orderly and, over time, healthy, but it does mean you get some periodic weakness in favored names. Thus, keep your feet on the ground, and look to use pullbacks as buying opportunities in the best stocks. As for winners, you should generally hold on to your best performers, though taking partial profits here and there (hopefully on the way up) is a good idea.

This week’s list is another potpourri of stocks and sectors, most of which have unique catalysts for higher prices. Our favorite of the group is Urban Outfitters (URBN), part of the very strong retail group. The stock is following through beautifully from a huge earnings gap a couple of weeks ago. Try to buy on weakness.

Stock NamePriceBuy RangeLoss Limit
Affiliated Managers Group, Inc. (AMG) 0.00118-122-
eBay Inc. (EBAY) 0.0047-48.5-
Fortune Brands Home & Security (FBHS) 81.0225.5-26.5-
GHL (GHL) 0.0046-48-
IPG Photonics (IPGP) 0.0059-62-
Men’s Wearhouse (MW) 0.0036-37-
ServiceNow (NOW) 341.8633-35-
Tesoro (TSO) 0.0038-41-
Urban Outfitters (URBN) 0.0037-38.5-
Valero Energy (VLO) 97.4030-31.5-

Affiliated Managers Group, Inc. (AMG)

amg.com

Why the Strength

Affiliated Managers Group is what we call a Bull Market stock—a company (usually in the money-management business) that sees its bottom line spike as the market revs up. However, what’s really interesting about Affiliated is that it’s an investment firm that buys other investment firms! Started in the mid-1990s by a Goldman Sachs employee, the company buys stakes in asset management firms (the vast majority of which focus on equities), usually from managers who began their own businesses years ago and are looking to partially cash out. (Because many asset managers got their start during the bull market of the 1980s and 1990s, many are in fact looking toward their golden years now.) Affiliated Managers offers some marketing and other advice, and it requires that the top money managers sign 10-year contracts (to make sure they don’t up and leave), but other than that, the company leaves these money managers to their own devices. Affiliated now has a claim to $385 billion of assets, and its collection of 28 firms have shown a net asset inflow during the past eight quarters, which is unusually good given the outflows from equity funds in the industry. The numbers in the table below aren’t inspiring, but that’s the past—with the market acting better, analysts see earnings up 22% this year and another 20% next year, both of which could prove conservative if this bull move continues. All in all, we think it’s a good way to play the bull trend.

Technical Analysis

AMG generally moves up and down with the market, so it’s not surprising to see the stock fall hard last summer and fall, rally early this year, correct into June and, now, spike to new highs. The stock is sure to bounce around, partly because it trades an average of just 400,000 shares per day, but we like the solid-volume advance last week and a lack of any distribution during the past three months. You could buy a little here or, ideally, on a little weakness, with a stop around 112.

AMG Weekly Chart

AMG Daily Chart

eBay Inc. (EBAY)

www.ebay.com

Why the Strength

We view eBay as a big-cap, steady growth stock of this bull move—it’s unlikely to wow you with any strength, but we feel it’s likely to make good progress over time. As for why the stock is strong, there are a few ancillary reasons, such as decent growth among its core Marketplace business and a reasonable valuation (22 times earnings), but the ruling reason to own eBay is its PayPal business, which remains the dominant form of online payment, and is quickly making inroads into the offline world, too. The latest deal to expand PayPal’s reach came a few weeks ago, when eBay inked a deal with Discover, allowing shoppers to pay with PayPal at more than seven million merchants that are part of the Discover Network. Of course, to this point, earnings growth hasn’t picked up in a meaningful way (see table below), and analysts see the bottom line growing 15% this year and next. But we feel some acceleration could be on the horizon, mainly because PayPal is becoming a larger piece of eBay’s pie (40% of revenues in the second quarter) and is growing much faster than the core Marketplace segment (26% vs. just 9% in the last quarter). It’s not going to make you rich, but eBay can be a great compliment to your portfolio, especially if you already own a few fastballs.

Technical Analysis

EBAY gapped up on earnings in mid-July and hasn’t come close to closing below its 25-day moving average (now at 46.5) since. Interestingly, after a report surfaced that the firm’s Marketplace business might have slowed during August, shares dipped temporarily but found support north of 46, and then bolted ahead on Thursday along with the entire market. EBAY isn’t likely to run away on the upside, so if you want in, target a pullback of a point or so, with a stop around 45.

EBAY Weekly Chart

EBAY Daily Chart

Fortune Brands Home & Security (FBHS)

fbhs.com

Why the Strength

Fortune Home & Security is a young company with a lineup of old, respected brands. The company was spun off from Fortune Brands (Beam Whiskey) in 2011, taking with it product lines like Moen plumbing fixtures, ThermaTru doors, Master Lock and Masterbrand Cabinets and a host of other brands marketing window, doors, hardware and other fixtures. Fortune also took with it a network of dealers and wholesalers whose footprint is virtually the entire world. The company has been getting support from the improving fundamentals in the homebuilding and remodeling industry. Investors appreciate the company’s solidity; it has the capacity to grow quickly if housing takes off, but management has kept staffing lean just in case things cool off. There is also a large amount of cash on hand, and management has authorized a $150 million stock buyback program and rumors are buzzing that a dividend may by under consideration. It’s a rare company that’s this young (at least on paper) and so mature at the same time.

Technical Analysis

FBHS came public at 12 in October 2011 and the stock made substantial progress right away. The only correction in the stock’s entire history has been a dip from 24 last April to 19 in late June while the stock rebased for three months. A new, orderly rally began in August and the stock pushed out to new all-time highs last week. Since hitting 27 last Friday, FBHS has dropped back by a half a point, offering a reasonable entry point. A retreat to 25.5 is possible, but not something you should count on. You can put in a stop at 24.

FBHS Weekly Chart

FBHS Daily Chart

(GHL)

Why the Strength

Greenhill & Co. was established in 1996 by Robert Greenhill, a former president of Morgan Stanley and former Chair and CEO of Smith Barney. For 13 years, the company functioned as a merchant bank, managing funds, but since late 2009 it focused solely on the financial advisory business, giving advice on mergers, acquisitions, restructurings, financings and capital raising via its offices in New York, London, Frankfurt, Stockholm, Sydney, Tokyo, Toronto, Chicago, Dallas, Houston, Los Angeles, Melbourne and San Francisco. The company’s complete lack of research, trading, lending and other activities makes it a completely conflict-free advisor, and its roster of managing directors is a powerhouse of expertise and experience. The big buzz about Greenhill in recent months is due to CEO Scott Bok’s statement that full-year 2012 revenue would match that of 2011. Since Q2 revenue was down 48% from 2011 levels, this led to some skepticism; short interest reached 13 days to cover. At the same time, buyers have been getting their bets down, knowing that good news in Q3 could spark a short-covering rally. Beyond that side-bet issue, Greenhill looks like a solid bet on the wave of increased M&A activity that would accompany an economic recovery. And its generous dividend (3.7% forward annual yield) ia a bonus.

Technical Analysis

GHL plunged during the first nine months of 2011, falling from 85 to 26, and volatility since then has been significant. The relevant movement has been the accelerating rally that began in June and skyrocketed during the first few days of September. Given the high short interest, this is a high-risk play, and you should take that into account. But the big dividend is an argument all on its own, and makes GHL look more attractive than most thinly traded (averaging 316,000 shares traded a day) financial stocks. A pullback of a point would present an improved risk profile.

GHL Weekly Chart

GHL Daily Chart

IPG Photonics (IPGP)

www.ipgphotonics.com

Why the Strength

IPG Photonics makes fiber lasers and fiber amplifiers that are rapidly displacing traditional lasers because of their superior performance and lower cost. The company’s lasers range from tiny output (1 to 99 watts) devices used in medicine to monsters that are used to cut pipes and steel plates. IPG is a vertically integrated manufacturer, based in Oxford, Massachusetts, but with manufacturing facilities in Germany, Italy and Russia and regional sales offices in Detroit, Silicon Valley, China, France, India, Japan, Korea, Singapore and the U.K. IPG Photonics has a huge technological lead over its competitors in the fiber laser business. Fiber lasers owned just 15.5% of the $3.8 billion laser business in 2011, but projections are that by 2015, the laser market will be worth $4.8 billion and fiber lasers will have a nearly 29% share. IPG Photonic’s lasers have materials process, telecom, medical and measurement uses and the 59% revenue growth in 2010 and 60% in 2011 attest to the attractiveness of this product to customers. The company is also expanding via acquisition, buying J.P. Sercel Associates, a leading supplier of laser micromachining systems. The deal is expected to add to earnings by 2013. IPG Photonics is cutting a swaththrough the laser industry.

Technical Analysis

IPGP has been volatile since it finished a multi-year rally at 79 in June 2011. After several ups and down, the stock put in a nice bottom from mid-May to mid-July centering on 44. A strong rally that began in July got a burst of energy from a strong earnings report and that cleared out the old overhead. IPGP has been trading very tightly sideways between 60 and 63, forming a beautiful base. The 25-day moving average has just caught up with the price and the stock has shown some response, pushing near 64. With this constructive five-week base to work with, we think you can buy a little on any weakness, then add to the position on any breakout. A stop at 56 makes sense.

IPGP Weekly Chart

IPGP Daily Chart

Men’s Wearhouse (MW)

www.menswearhouse.com

Why the Strength

Men’s Wearhouse, one of the largest specialty retailers in the U.S., has had a rough time during this period of economic uncertainty, but the company appears to have turned a corner. Last week, the company posted solid second-quarter earnings figures, easily surpassing Wall Street’s expectations. While the results received a minor boost from a lower-than-expected tax rate, a broad improvement in sales combined with stronger margins were the main fundamental drivers. During an investor conference call, CEO Douglas Ewert said that sales trends were better than expected, with customers buying product at full price. Additionally, tuxedo rental revenue improved on higher prices, helping to lift same-store revenue by 4.4%. With these strong sales trends expected to continue, according to company guidance, it may be time for investors to once again suit up for Men’s Wearhouse.

Technical Analysis

Like many stocks, MW shares looked strong in the first half of 2012. But the stock hit a rough patch in the middle of the year, which was complicated by a negative investor reaction to quarterly guidance in early June. But MW refused to enter an extended decline, instead consolidating into support throughout June and July. This period of consolidation was ultimately resolved in a bullish cup formation, with MW vaulting higher in the wake of its second-quarter earnings report. The stock is now trading back above long-term support near 35. The post-earnings surge has left MW a bit overextended, and so we recommend buying on weakness. A stop-loss below 34 is also recommended.

MW Weekly Chart

MW Daily Chart

ServiceNow (NOW)

www.servicenow.com

Why the Strength

ServiceNow has two major factors going for it: the cloud is the hottest trend in the technology sector, and the aging technology services sector is ripe for the picking. The company specializes in cloud-based services designed to automate enterprise IT operations. While many firms would find it daunting to compete with the likes of IBM, Hewlett-Packard and BMC Software, ServiceNow has made a business of picking apart the legacy software offerings of these larger competitors. Taking cues from other successful cloud services, ServiceNow’s offering is sold on a subscription basis. Additionally, ServiceNow’s platform automates many routine tasks; for example, the recent addition of end-to-end VMware Lifecycle automation for virtual machines will help prevent inefficient and wasteful use of IT resources and data sprawl. The company’s disruptive business model is paying off, with ServiceNow landing more than 1,200 enterprise customers – 127 of which were added in the last quarter alone. What’s more, ServiceNow has posted double-digit revenue growth for the past four quarters, averaging year-over-year growth of 93% during this period. Given the company’s blistering rate of growth, and the rapid adoption of cloud-based IT services, ServiceNow should definitely be on your radar.

Technical Analysis

Being the first Internet-technology company to proceed with an initial public offering (IPO) in the wake of the Facebook debacle hasn’t hurt NOW shares at all. In fact, the stock’s durability in the face of skepticism is impressive. Since its IPO, NOW has rallied more than 47%, with shares establishing key support at its 10-day and 25-day trendlines. The shares have recently broken out above potential resistance at the 35 level, hinting that there may be buying support in the region. You can take bites here, but pullbacks could offer the best entry points. Also, consider placing a stop-loss near 30.

NOW Weekly Chart

NOW Daily Chart

Tesoro (TSO)

www.tsocorp.com

Why the Strength

While refining stocks are far more cyclical than growth oriented, Tesoro has been one of Top Ten’s all-time favorite stocks (it’s making its 20th appearance since 2003!). The reason, of course, is that the industry has had many upturns during the past decade, and Tesoro’s top management has taken advantage of them. Today, the stock is super strong for two main reasons, the first of which was the firm’s blowout earnings report in early August—the numbers absolutely crushed expectations as prices for Tesoro’s products (like gasoline) rose, while prices for its inputs (crude oil) fell. (Analysts have hiked their earnings estimates for this year from $4.16 per share to $5.85 per share in the past three months!) The second reason for the stock’s strength might be even more important—Tesoro is making a bold move to acquire a refinery from BP that has 266 million barrels per day of capacity, as well as 800 dealer operated retail stations. Management said the new refinery should boost its bottom line by more than 20% in the first two years alone! The combination of bullish industry fundamentals (which are helping many in the group) and this acquisition should keep big investors interested in the weeks to come.

Technical Analysis

TSO’s weekly chart is a thing of awe—the stock topped out in April 2011 and formed a series of wide-and-loose bases before finally coming under control during the past few months. Shares began marching higher in June, and then broke out after the company’s earnings report in early August. And then the roof blew clean off after news of the refinery acquisition! Since that buyout announcement a month ago, TSO has traded very tightly, refusing to give up any ground as investors pick up shares on any weakness. Yes, it’s extended, but we think you can buy a little around here or on any weakness, with a loose stop around 35.

TSO Weekly Chart

TSO Daily Chart

Urban Outfitters (URBN)

urbn.com

Why the Strength

Philadelphia-based Urban Outfitters is riding the wave of resurgence in retail, making its first appearance in Cabot Top Ten Trader since it showed up five times in 2008. The company sells clothing, accessories and gear with a young, irreverent vibe that’s usually pigeon-holed as “hipster retailer.” The company’s various outlets include Urban Outfitters (130 stores in the U.S., Canada and Europe), aimed at 18- to 30-year-old urbanites; Anthropologie (135 stores worldwide), designed to appeal to women from 28 to 45; Free People (over 30 stores in the U.S. and three wholesale showrooms), selling through catalogs, websites and specialty boutiques to women from 25 to 30; BHLDN (first store opened fall 2011), a high-end wedding gown/party boutique; and Terrain (one location in Glen Mills, Pennsylvania), which hosts events and workshops. Urban Outfitters is hot right now because of a strong earnings report on August 20 that showed a 20% jump in earnings and caused a flurry of upgrades and increased price targets from analysts. Running a retail empire that relies on being able to anticipate, identify and shape what young people think of as hip goods is a tricky business, but Urban Outfitters looks to be at the top of its game with its target audiences.

Technical Analysis

URBN spent much of 2010 and 2011 meandering downward, falling from 41 in April 2010 to 21 last year at this time. But after 11 months of trading sideways in a tightening band, the stock was well set up for its August 20 blastoff from 31 to 37. After that gap up, the stock traded in a microscopic range for six days before lifting off again in the last few days of August. URBN climbed as high as 39 last week, and will likely need a little time to allow its 25-day moving average (now at 34) to catch up. If the stock were to pull back by a full point, that would mark a good entry point. Otherwise, you should either make a small buy here or wait for the stock to trade sideways for a while. A stop below 36 makes sense.

URBN Weekly Chart

URBN Daily Chart

Valero Energy (VLO)

www.valero.com

Why the Strength

Valero Energy is the world’s largest independent petroleum refiner and marketer, with refineries and ethanol plants stretching from the U.S. West and Gulf coasts to Canada, the U.K. and the Caribbean. The company has benefited greatly from the boom in domestic oil production, with U.S. oil output surging to its highest level in 13 years in July due to unconventional oil and gas extraction methods, such as hydraulic fracking. As a result, Valero is not only buying less imported oil, it is also paying considerably less for domestic oil, greatly improving operating margins. Currently, Valero sports a market cap approaching $18 billion, and offers an attractive dividend of 70 cents per share, making it a solid portfolio addition in terms of growth. However, a recent development could make Valero juicy enough for even speculative investors. While many investors and analysts recognize Valero’s value as a refiner, many have overlooked the value of the company’s retail segment. Valero is looking to change that perception, announcing that it is pursuing a separation of its retail business—one that could include a tax efficient distribution to shareholders.Valero’s refining business appears to be hitting on all cylinders, and spinning off its retail business to focus on its core refining operations can only provide additional benefits for investors.

Technical Analysis

Given the company’s strong prospects, it should not be surprising to see VLO shares breaking out to fresh multi-year highs. Since tagging a mid-year low near 20, the stock has been on a tear, rallying steadily along support at its 10-day and 25-day moving averages. In fact, VLO has not closed a session below its 10-day trendline since July 11! Recent news regarding the company’s retail businesses has provided an additional catalyst for VLO, pushing shares past former long-term resistance near 30. Investors should note that VLO has been trading in overbought territory since nearly the beginning of August, meaning that buying on pullbacks should be the order of the day. A stop loss near 28.5 may also be prudent.

VLO Weekly Chart

VLO Daily Chart