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TRW, Mentor and Darling show value and momentum

John Dorfman
| Tuesday, Aug. 28, 2012, 12:01 a.m.

Suppose you are choosing between two stocks, National Widget and Amalgamated Widget. The two companies look like twins when it comes to their balance sheets and profitability. Both have able leaders with good business plans. And both stocks sell for $15 a share. But one stock has descended from $20, while the other has risen from $10. Which would you choose?

The answer says a lot about your instincts as an investor. Many serious students of the stock market — William O'Neill, Ned Davis, Martin Zweig and Josef Lakonishok, to name a few — believe that positive momentum is a good thing for a stock to have.

My own view is that the two stocks are equally attractive. After all, the stock doesn't know where it has been. To be sure, there are studies showing that momentum tends to continue for a while. But I doubt the effect is strong enough to overcome the extra trading costs and taxes that often come with a momentum approach.

I'm aware that many investors prefer stocks that are on the rise. So about twice a year I write about stocks that I think have both value and momentum.

This is my 21st column on “Value Plus Momentum” stocks. Twelve-month results can be calculated for 19 of the previous columns (published in February 2000 through February 2011). The average one-year return has been 19.5 percent, compared with 5.2 percent for the Standard & Poor's 500 Index. Sixteen of the 19 lists were profitable and 13 beat the index.

My latest list, published in February 2012, is performing badly, but still has six months to redeem itself.

Now it's time for some new selections. Here are four stocks that I believe offer good value and have risen at least 20 percent year-to-date through Aug. 24, exceeding the S&P 500's 12 percent gain.

First, I recommend TRW Automotive Holdings Corp. (TRW), which makes car chassis, air bags and other auto parts. The car business is notoriously cyclical, but I believe we are in the early stages of a new up cycle.

Analysts expect TRW to notch about $5.87 a share in earnings this year, and the stock sells for just seven times that figure. Earnings are likely to rise in 2013, according to the analysts, and to rise further in 2014. So, even though TRW shares are up 28 percent this year, I think they can run a lot more.

Next, I plump for Mentor Graphics, a computer-aided-design (CAD) company based in Wilsonville, Ore. Financier Carl Icahn has made a $1.8 billion bid for the company. The stock, up 20 percent this year, sells for about $16.35 a share, giving it a market value right near Icahn's bid.

Mentor Graphics isn't merely a takeover play. After losing money in fiscal 2009 and 2010, it earned a profit of 26 cents a share in fiscal 2011 and improved to 74 cents in the latest fiscal year (which ended in January). For the year in progress, analysts expect $1.17, and for fiscal 2014 they predict $1.37.

Third, I like Darling International Inc. of Irving, Texas. The company collects used cooking oil, fat and inedible waste products from restaurants and food processors, then recycles it into other products. Long term, I think it benefits from the trend for people to eat more and more meals away from home.

Short term, the company just had its best year ever, earning $1.47 a share in 2011. Analysts don't expect earnings the next two years to match last year's figure. Nevertheless, seven of the nine analysts who follow Darling recommend it. I don't usually like to stand with the majority but in this case, I do.

Fourth, I offer a spectacular example of how rapidly investors' views of a stock can change. The example is Western Digital Corp. (WDC), which I own for clients and which is up 41 percent this year. Based in Irvine, Calif., the company is the world's second-largest manufacturer of computer disk drives.

Western Digital rose 33 percent in the first quarter, only to fall 26 percent in the second. It jumped 30 percent in July and rose 9.7 percent in the first 24 days of August. What investors treated as trash in the second quarter was gold in the first and third quarter.

The company is part of an oligopoly of only four significant disk-drive makers worldwide. It enjoys good profit margins, and makes a commodity that I believe will still be needed for years. At five times earnings, I believe it is a distinct value.

John Dorfman is chairman of Thunderstorm Capital LLC in Boston.

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