Page 286 - How to Make Money in Stocks Trilogy

164 A WINNING SYSTEM

Cyclical stocks in basic industries such as steel, chemicals, paper, rubber,
autos, and machinery usually lag in the new bull market’s early phase.
Young growth stocks will typically dominate for at least two bull market
cycles. Then the emphasis may change to cyclicals, turnarounds, or other
newly improved sectors for a short period.
While three out of four big market winners in the past were growth
stocks, one in four was a cyclical or turnaround situation. In 1982, Chrysler
and Ford were two such spirited turnaround plays. Cyclical and turnaround
opportunities led in the market waves of 1953–1955, 1963–1965, and
1974–1975. Cyclicals including paper, aluminum, autos, chemicals, and
plastics returned to the fore in 1987, and home-building stocks, which are
also cyclical, have led in other periods. Examples of turnaround situations
include IBM in 1994 and Apple in 2003.
Yet even when cyclical stocks are in favor, some pretty dramatic young
growth issues are also available. Cyclical stocks in the United States are often
those in older, less-efficient industries. Some of these companies weren’t
competitive until the demand for steel, copper, chemicals, and oil surged as
a result of the rapid buildup of basic industries in China. That’s why cyclicals
were resurrected aggressively after the 2000 bear market ended in 2003.
They are still cyclical stocks, however, and they may not represent Amer-
ica’s true future. In addition, large, old-line companies in America fre-
quently have the added disadvantage of size: they are simply too large to be
able to innovate and continually renew themselves so that they can compete
with nimble foreign rivals and with America’s young new entrepreneurs.
Rallies in cyclical stocks may tend to be more short-lived and prone to falter
at the first hint of a recession or an earnings slowdown. Should you decide to
buy a turnaround stock, look for annual earnings growth of at least 5% to 10%
and two straight quarters of sharp earnings recovery that lift results for the lat-
est 12 months into or very near new high ground. Check the 12-month earnings
line on a stock chart; the sharper the angle of the earnings upswing, the better.
If the profit upswing is so dramatic that it reaches a new high, one quar-
ter of earnings turnaround will sometimes suffice. Cleveland Cliffs, a sup-
plier of iron ore pellets to the steel industry (and now known as Cliffs
Natural Resources), came from a deficit position to dramatically accelerate
quarterly earnings in 2004 by 64% and then by 241%. With that impetus,
the stock rapidly advanced 170% in the next eight months.

How to Weed Out the Losers in a Group
Insisting on three years of earnings growth will help you quickly weed out
80% of the stocks in any industry group. Growth rates for most stocks in
most groups are lackluster or nonexistent—unlike, for example,