Why Apple is Under-Valued

Apple (NASDAQ: AAPL) is the second most highly valued company in the country -- behind ExxonMobil (NYSE: XOM). But it still has further to rise.

If Apple stock goes up another 12% and ExxonMobil's value remained unchanged, Apple could surpass the oil giant in market value.

What's great about Apple is what makes its stock scary for some -- Steve Jobs. After all, he is responsible for inventing the iPod, iTunes, iPhone, and iPad that have propelled Apple's phenomenal growth. But he is not in great physical shape and it's hard to imagine another human being who could replace him.

The question for investors is how long Apple could stay on an earnings roll if Jobs was no longer involved with Apple. Here are four reasons to consider the stock:

• Great earnings report. Apple  posted strong Q2 earnings driven by strong iPhone 4 and iPad 2 sales with revenue of $28.6 billion -- 13% above analysts' estimates -- and pro-forma EPS of $7.79 -- beating analysts' expectations by 36%. This was due to better than expected sales of iPhones (20.3 million units vs. Canaccord Genuity Technology's 16.8 million estimate) and iPads (9.3 million vs. 7.9 million estimate).
• Cheap stock. Apple's price to earnings to growth ratio of 0.89 (where a PEG of 1.0 is considered fairly priced) means its stock price is cheap. Apple has a P/E of 15.4 and is expected to grow 17.4% to $31.69 in 2012. And that growth forecast is much slower than 2011 forecast of 78% growth -- so odds are good that Apple stock is a bargain.Out-earned its capital cost. Apple is earning more than its cost of capital – and it’s improving at a phenomenally high rate. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half 2011, Apple’s EVA momentum was 17%, based on first nine months' 2010 annualized revenue of $59.8 billion, and EVA that improved from $7.3 billion annualizing the first nine months of 2010 to $17.4 billion annualizing the first nine months of 2011, using a 10% weighted average cost of capital.
• Rapid growth with pristine balance sheet. Apple has been growing fast with high profit margins. Its $65 billion in revenues have climbed at an average rate of 35.6% over the last five years and its net income of $14 billion has gone up at an even faster average rate of 62.7% over the period -- representing a 22% net margin. It has no debt and its cash grew at a 26% annual rate from $10.1 billion (2006) to $25.6 billion (2010).

This stock has further to rise -- but unless there is someone better than Steve Jobs out there to continue innovating Apple's way to success, the stock is going to top out. The problem is figuring out when that might happen and setting a stop loss so you can get out fast if you need to.

Should You Add Crocs To Your Portfolio?

Several years ago, Crocs (NASDAQ: CROX), a maker of aerated so-called Croslite, plastic, clogs, was all over the place -- getting stuck in mall escalators across the country and making investors rich. Then Crocs crashed -- a victim of market saturation and cheap knock-offs. But after a 15.6% spike in its stock price Thursday, is Crocs on another roll? And should you buy?

Crocs went public in February 2006 and enjoyed a tremendous upward run that lasted until the end of October 2007. During that time, Crocs stock was on a tear that took it from $13.28 to nearly $70 -- a compound annual growth rate of 179%.

Alas, that steep rise could not last. And from late October 2007 to late March 2009, the stock plunged to a low of $1.11 -- losing 98% of its value. One of the problems was that Crocs was so popular that it had attracted competitors who knocked them off and sold the ersatz Crox for $4 a pair. And that contributed to a disappointing earnings report that knocked 60% off of Crocs' market value.

Since then, Crocs stock has enjoyed an even more spectacular rise on a percentage basis. The reason is that in recent years, Crocs has expanded from just rubber clogs to selling all types of shoes from sandals to hiking boots. If you had bought it then and held until now, you would have enjoyed a 2,686% return on your investment -- up at a nice 300% compound annual rate.

Is it too late for you to get in on this rise? The short answer is yes -- it would be very unlikely for Crocs stock to continue going up 300% a year. But is a smaller return on investing in Crocs still possible?

Here are four reasons why it might be:

• Great second quarter earnings report. Crocs earned $55.5 million, 72% more than 2010's $32.3 million, or $0.37 a share. Crocs' EPS of $0.61 a share were 39% better than analysts expected. Crocs' revenue spiked 29.6% to $295.6 million -- 5% more than analysts' forecasts. Its fastest growth was in Europe  up 50% and Asia up 37.5% -- while U.S. sales grew 16%. And Crocs raised its third quarter EPS guidance to $0.40 -- 20% above analysts' expectations.
• Cheap stock. Crocs' price to earnings to growth (PEG) ratio of 0.80 makes it cheap (a PEG of 1.0 is considered fairly priced). Crocs' P/E is 26.2 and its earnings per share are expected to grow 32.6% to $1.48 in 2012.
• Growing with solid balance sheet. Crocs has been growing with decent profit margins. Its $790 million in revenues have climbed at an average rate of 22% over the last five years and its net income of $68 million has gone up just slightly -- representing a 9% net margin. It has no debt and its cash grew at a 22% annual rate from $65 million (2006) to $146 million (2010).
• Out-earned its capital cost. Crocs is earning more than its cost of capital – and it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half 2011, Crocs’ EVA momentum was 3%, based on first six months' 2010 annualized revenue of $790 million, and EVA that improved from $16 million annualizing the first six months of 2010 to $43 million annualizing the first six months of 2011, using a 12% weighted average cost of capital.

If you invest in this stock, you are not likely to earn 300% annual returns -- but with its expectations-beating earnings and revenue growth, Crocs stock has plenty of room to rise.

Is IAC/InterActiveCorp. A Match For Your Portfolio?

The owner of Ask.com, Match.com and more than 50 other web sites, IAC/InterActiveCorp., (NASDAQ: IACA), posted much better than expected growth in the second quarter and its stock popped 11%. Is it time to buy IAC?

Although it has one of the worst names for a business I can think of, IAC's numbers were surprisingly good. Its second quarter revenue jumped 23% to $485 million due to its Web-search products and growth in online dating subscribers. IAC's net income was up 212% to $42.4 million from $13.6 million in the same 2010 period. And its adjusted EPS of 62 cents a share were 63% more than 11 analysts' 38 cents average in a Bloomberg survey.

Besides this strong performance, are there any other reasons to own IAC? Other signals are confusing -- suggesting a turnaround may be underway after a period of weak performance:

• Under-earned its capital cost. IAC is earning less than its cost of capital – but it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half 2011, IAC’s EVA momentum was 9%, based on first six months' 2010 annualized revenue of $366 million, and EVA that improved from negative $244 million annualizing the first six months of 2010 to negative $1.5 billion annualizing the first six months of 2011, using a 12% weighted average cost of capital.
• Shrinking but cleaning up its balance sheet. IAC has been shrinking with thin profit margins. Its $1.7 billion in revenues have tumbled at an average rate of 20% over the last five years and its net income of $30 million represented a thin 2% net margin. Its debt has declined faster than its cash. Its debt fell at 42% annual rate from $856 million (2009) to $96 million (2010) while its cash slumped at a 13% annual rate from $2.3 billion to $1.3 billion.
• Expensive stock -- depending on which growth rate you use. IAC's price to earnings to growth (PEG) ratio of 2.64 makes it expensive (a PEG of 1.0 is considered fairly priced). IAC's P/E is 60 and its earnings per share are expected to grow 22.7% to $1.44 in 2012. But if you look at its expected 2011 earnings growth of 805%, the stock looks cheap. And if you apply its Q2 profit growth rate of 212% its PEG is a cheap 0.28.

IAC stock is up 77% in the last year so the best argument for investing in IAC is that it might continue to provide investors with upside surprises. I might take a look at this stock again if it gets taken down in the wave of selling that seems poised to continue thanks to Washington turbulence.

Should Dow Be In Your Portfolio?

Economic statistics say that inflation is low, but a look at Dow Chemical (NYSE: DOW) reveals a 19% price increase in 2011. And after reporting a huge profit rise Wednesday, Dow stock could keep rising. Should you invest?

What's behind Dow's great performance? Dow is expanding in Saudi Arabia and on the U.S. Gulf Coast to turn low-cost natural gas into chemicals used in food packaging and auto parts. And Dow's profit in the basic plastics and chemicals units rose, contrary to expectations of those betting on weaker Chinese demand, according to Bloomberg.

Here are three reasons to consider an investment in Dow:

• Great second quarter earnings report. Dow's second quarter net income was $1.07 billion, or 84 cents a share, 64% more than its 2010 Q2 earnings of $651 million, or 50 cents. Its adjusted EPS of 85 cents a share were 8% above the 79-cent average estimate of 12 analysts in a Bloomberg survey. Dow's revenue rose 18% to $16 billion from $13.6 billion.
• Cheap stock. Dow's price to earnings to growth (PEG) ratio of 0.88 makes it inexpensive (a PEG of 1.0 is considered fairly priced). Dow's P/E is 19.4 and its earnings per share are expected to grow 22.1% to $3.58 in 2012.
• Decent dividend. Dow pays a 2.79% dividend yield and it's been raising that dividend at a 3.9% annual rate over the last five years.

Here are two negatives for the stock:

• Under-earned its capital cost. Dow is earning less than its cost of capital – but it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half 2011, Dow’s EVA momentum was 3%, based on first six months' 2010 annualized revenue of $54.1 billion, and EVA that improved from negative $3.1 billion annualizing the first six months of 2010 to negative $1.3 billion annualizing the first six months of 2011, using an 11% weighted average cost of capital.
• Solid growth but declining profits and more debt-laden balance sheet. Dow has grown solidly. Its $55 billion in revenues have increased at an average rate of 3% over the last five years and its net income of $2.1 billion has declined at a 15% annual rate over that period. Its debt has grown faster than its cash. Its debt climbed at 26.7% annual rate from $8 billion (2009) to $20.6 billion (2010) while its cash rose at a 24.7% annual rate from $2.9 billion to $7 billion. The good news in 2011 is that Dow is trying to pay down that debt.

Dow is in a boom and bust industry. And its last five years were the bust part. If its second quarter report is any indication, the boom could be just beginning. This suggests that Dow's current bargain price will not last long.

Should You Invest in 3M?

3M (NYSE: MMM) reports second quarter earnings Tuesday and they're expected to be up. Should you buy its shares?

3M -- famous for Post-It Notes and letting their employees spending 20% of their time on self-directed projects -- is expected to report $1.59 a share -- five cents more than it did in 2010. And if 3M does meet or exceed expectations it will be the latest in a strong of strong reports.

3M has been using acquisitions to spur its growth. For example, in 2010 it made $1.8 billion worth of deals and most recently announced that it would acquire French home improvement company, GPI Group. And to its credit, 3M is "very well placed in emerging markets, such as Asia and Latin America," according to Morningstar.

Is all the good news on 3M already reflected in its stock price or does it have further to rise?

Here are three reasons to consider investing:

• Out-earned its capital cost. 3M is earning more than its cost of capital – and it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2010, 3M’s EVA momentum was 3%, based on 2010 revenue of $23.1 billion, and EVA that improved from $2.2 billion in 2009 to $2.9 billion in 2010, using a 9% weighted average cost of capital.
• Strong first quarter earnings. In April, 3M reported a 16% rise in earnings which beat analysts' estimates. 3M also raised its estimate for 2011 earnings 2% from between $5.95 and $6.20 to a range from $6.05 to $6.25 a share.3M enjoyed a big jump in sales in China and India that is expected to continue to contribute to its growth.
• Decent dividend. 3M pays a 2.3% dividend yield and it's been raising that dividend at a 2.5% annual rate over the last five years.

Here are two negatives for the stock:

• Solid growth but more debt-laden balance sheet. 3M has grown solidly. Its $27.6 billion in revenues have increased at an average rate of 4.7% over the last five years and its net income of $4.2 billion has risen at a 5.4% annual rate over that period. To finance acquisitions, its debt has grown nearly twice as fast as its cash. Its debt climbed at 44% annual rate from $1 billion (2009) to $4.3 billion (2010) while its cash rose at a 24% annual rate from $1.9 billion to $4.5 billion.
• Slightly over-priced stock. 3M's price to earnings to growth (PEG) ratio of 1.29 makes it somewhat expensive (a PEG of 1.0 is considered fairly priced). 3M's P/E is 16.3 and its earnings are expected to grow 12.6% to $7.11 in 2012.

After a 10% rise in the last year, 3M stock is hardly cheap. But if investors are going to profit from investing in 3M, the key will be for management to earn a greater proportion of its revenues from faster growing emerging markets.

I consider 3M to be a solid company and a stable stock. Just don't expect enormous capital appreciation if you buy its shares.

Should You Add Whole Foods to Your Basket of Securities?

Whole Foods Markets (NASDAQ: WFM) is poised to report second quarter 2011 earnings Wednesday and it's in the news Monday for a resignation letter from an employee who casts aspersions on what he sees as the gap between its values and its practices. Should that stop you from investing in Whole Foods shares?

On July 27, Whole Foods is expected to report EPS of $0.47 per share on revenues of $2.42 billion. Last year, Whole Foods reported EPS of $0.38 on revenues of $2.16 billion in its second quarter. And over the previous four quarters, Whole Foods has beaten analysts' estimates.

Meanwhile, a resignation letter from a Toronto Whole Foods employee casts doubt on the company's sincerity when it comes to acting on its values of caring about the community, the environment, and its team member happiness and excellence, according to Gawker. The letter alleges that Whole Foods treats its people poorly, underpays them, and wastes energy and other environmental resources.

As I wrote in my book, Value Leadership (Wiley, 2003), if there is a gap between a company’s values and its actions, investors should be wary. And this letter raises questions about whether such a gap might exist.
This is hardly the first time Whole Foods has encountered controversy. As I wrote in 2009, Whole Foods' CEO, John Mackey, got into some hot water for writing an op-ed entitled "The Whole Foods Alternative to ObamaCare" which called for health-care savings accounts and declared that health care is not an intrinsic right. The problem was that many of his customers responded by calling for a boycott against Whole Foods.

Despite its controversies, Whole Foods stock has been on a tear. After a 77% rise in the last 12 months, does Whole Foods stock have further to run? Here are two reasons to consider it:

• Out-earned its capital cost. Whole Foods is earning more than its cost of capital – and it’s improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, Whole Foods ’s EVA momentum was 1%, based on 2010 revenue of $9 billion, and EVA that improved from negative $49 million in 2009 to $36 million in 2010, using a 7% weighted average cost of capital.
• Strong second quarter earnings. Whole Foods reported EPS of $0.51 for the quarter ending March 30, 2011 -- 11% ahead of the consensus estimate. Revenues for the quarter were up 11.6% to $2.35 billion -- slightly below the $2.37 billion consensus estimate. Mackey announced in May that Whole Foods expected 2011 earnings to be $0.10 higher and that its sales for the year would be up between 11.7% and 12.6%.

Here are two negatives for the stock:

• Rapid growth but deteriorating balance sheet. Whole Foods has grown solidly. Its $9.6 billion in revenues have increased at an average rate of 13.9% over the last five years and its net income of $302 million has risen at a 12% annual rate over that period. To finance acquisitions -- such as its 2007 deal for Wild Oats, its debt has skyrocketed while its cash has grown more slowly. Its debt skyrocketed at 174% annual rate from $9 million (2009) to $508 million (2010) while its cash while its cash rose at a 23.9% annual rate from $196 million to $462 million.
• Expensive stock. Whole Foods price to earnings to growth (PEG) ratio of 2.77 makes it very expensive (a PEG of 1.0 is considered fairly priced). Whole Foods' P/E is 38.2 and its earnings are expected to grow 13.8% to $2.16 in 2012

At its current high price, Whole Foods looks like it is poised to plunge unless it beats expectations again. But despite its public gaffes, it's a solid performer. I'd consider buying it after a market break. And as Washington stumbles on debt-ceiling negotiations, such a break could be at our doorstep.

Will GE bring good things to your portfolio?

General Electric (NYSE: GE) stock has fallen 40% in the near-decade since Jack Welch handed off the CEO slot to Jeff Immelt. Friday, GE reported earnings that beat expectations. Does this make GE a buy?

Jeff Immelt has been bad for GE shareholders -- especially when compared to Welch. As I wrote in 2006, Immelt earned a gentleman's C for his performance as CEO. That's because GE's stock was down 14% since Immelt took over during which time the S&P 500 rose 25%. And, as I noted then, Immelt's excuse was that Wall Street had the "blue chip blues."

This was a lame excuse -- since the stock of 3M Company (NYSE: MMM), another blue chip run by Immelt's GE-CEO-race-rival, Jim McNerney -- the subject of my book, You Can't Order Change, was up 45% under his tenure.

Meanwhile his predecessor oversaw nearly two decades of double-digit quarterly earnings growth and a massive boost in shareholder value. Under Welch, GE's market value increased 5,096%, inclusive of dividends, during Welch's 20 year tenure as CEO which began in 1981. This represents an average annual increase in GE's shareholder value of 21.3% a year. The S&P 500 increased 1,433% over the same period, or about 14.3% a year, also inclusive of dividends.

Is Immelt's leadership going to pay off for shareholders? Based on GE's second quarter earnings results, it looks like there is a bit of reason for optimism. Its profit was $3.69 billion -- up 22% from the year before, or 35 cents per share. On an adjusted basis, GE's second quarter EPS of 34 cents a share beat analysts' estimates by 6%. And GE's $35.63 billion in second quarter revenues were 2.7% higher than analysts expected.

GE is the largest conglomerate out there -- meaning it owns a grab-bag of businesses with fairly limited activity sharing among them. Back in July 2007, I met with GE's CFO and he asked me what GE could do to boost its shareholder value. My response was to sell everything except the infrastructure businesses -- like aircraft engines, energy, and locomotives -- where GE is selling to rapidly growing emerging markets and has a competitive advantage.

Such a move would entail dumping its other units -- including appliances, NBC, and financial services. To his credit, Immelt has partially sold NBC but has not been able to find a buyer for GE's appliances business. The part of GE that makes mortgages and issues credit cards is still sucking up too much capital.

Those infrastructure businesses performed well in the second quarter. For example, GE's strongest growth came its railroad locomotive unit, which posted a 74% rise in revenue following a long period of slow growth. Equipment orders climbed 33% as GE introduced more efficient wind and gas turbines, service orders rose 16% percent; and Infrastructure orders increased 24%.

In the last year, GE stock is up 26% compared to 23% for the Dow. Should you go along for the ride?

Here are two reasons to buy the stock:

• Low price. GE's price to earnings to growth ratio of 0.68 (where a PEG of 1.0 is considered fairly priced) means its stock is very expensive. GE's P/E is 15 and its earnings are expected to grow 22% to $1.67 in 2012.
• Dividend. GE's dividend yield of 3.13% is attractive and it's been growing at an average annual rate of 3.6% over the last year.

One reason to pause is a mixed longer-term financial track record. GE has suffered from slow growth and declining profits. GE has grown slowly with profits declining. Its $152 billion in revenues have inched up at an average rate of 1.9% over the last five years and its net income of $13.4 billion has fallen at a 6.6% annual rate over that period.

The good news is that its balance sheet has been improving. Its cash has risen faster than its debt. Specifically, GE's cash has risen at a 54% annual rate from $14 billion (2009) to $79 billion (2010) while its debt was up at an 8.4% annual rate from $261 billion (2009) to $361 billion (2010).

With its low stock valuation and high dividend, it may be worth considering that after a decade, Jeff Immelt is figuring out how to manage GE. If GE keeps beating expectations, its stock could keep rising.

Should You Buy Medco Health?

Medco Health Solutions (NYSE: MHS) is poised to be bought for the second time. Merck (NYSE: MRK) paid $6 billion for it in 1993 and then took it public a decade later. Now Express Scripts (NYSE: ESRX) is reportedly about to offer to buy it for $29 billion. But what if the deal falls through? Should you buy Medco stock?

Medco was founded as a mail-order drug distributor and its change in ownership over the last nearly two decades is a map of how the health care industry has changed. As I wrote in my first book, The Technology Leaders, Merck bought Medco because of a change in the way drugs were sold.

The old model was for big pharmaceutical companies to invest billions in R&D to develop patented drugs and hire thousands of sales people who would give doctors trips to exotic locations to explain the benefits of prescribing the drugs. The doctors would dutifully prescribe the ones that they thought would help their patients.

But in the 1980s, the decision-making power shifted from doctors to pharmacy benefit managers (PBMs). PBMs acted on behalf of corporate health plans to make sure that their members got the lowest priced drugs that did the job. Thanks to the emergence of generic drug manufacturers who made lower priced versions of popular off-patent drugs, those cheaper substitutes were widely available.

Merck bought Medco, which is now the largest PBM, because its old model of selling to doctors was falling apart and it wanted to control its channel of distribution. Unfortunately, this did not work all that well because often a Merck product was not the PBM's choice so there was conflict between Merck's interests and those of the PBM's clients.

So Merck sold off Medco and it operated independently for eight years. Now Express Scripts, a big PBM is offering to pay $71.36 in cash and stock for each Medco share, a 28% premium. If the merger goes through, the combined company will control 1.7 billion prescriptions and about $110 billion in revenue. Moreover, they expect to cut $1 billion in costs through the combination.

Medco is selling out because it's losing market share. The Associated Press reports that Medco "has currently lost more business than it has booked for 2012." For example, UnitedHealthcare will not renew its 2012 contract and other clients -- the Federal Employees Health Benefit Program, the California Public Employees' Retirement System, and a Universal American unit have already announced that they will take their business elsewhere.

If this deal goes through, it won't happen until some time in 2012. So should you buy Medco stock before the deal closes?

• Reasonably priced stock. Medco price to earnings to growth (PEG) ratio of 1.08 makes it not-overly expensive (a PEG of 1.0 is considered fairly priced). However, since it's up 24% in pre-market trading, it's price is getting into the expensive range. Medco's P/E is 17 and its earnings are expected to grow 15.7% to $4.74 in 2012.
• Out-earned its capital cost. Medco is earning more than its cost of capital – but it’s not improving. How so? It produced no EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In the first half 2011, Medco’s EVA momentum was 0%, based on first six months' 2010 annualized revenue of $65.4 billion, and EVA that rose from $796 million annualizing the first six months of 2010 to $1 billion annualizing the first six months of 2011, using an 8% weighted average cost of capital.

Here are two negatives for the stock:

• Disappointing second quarter earnings. Medco earnings for the second quarter were less than expected. Its reported $342.8 million in net income on revenues of $17.07 billion and EPS of 85 cents a share. Medco's net income was 4% below what it earned in 2010's second quarter, its EPS was 10% below analysts' expectations and its revenues were $40 million less than forecast. Medco's mail-order prescriptions rose 0.7%, and 6% "on a generic basis."
• Rapid growth but deteriorating balance sheet. Medco has grown solidly. Its $66.7 billion in revenues have increased at an average rate of 11.7% over the last five years and its net income of $1.4 billion has risen at a 18.9% annual rate over that period. To finance acquisitions, its debt has skyrocketed while its cash has barely budged. Its debt skyrocketed at 55% annual rate from $866 million (2009) to $5 billion (2010) while its cash inched up at a 0.6% annual rate from $887 million to $910 million.

This stock could do better if a hostile bidder enters the picture. And with acquires like CVS Caremark (NYSE: CVS) likely to feel threatened by this deal, I would not be surprised to see a bidding war. Meanwhile, there's no guarantee that this deal will go through -- after all the Justice Department will need to decide whether the combination will have too much market power.

The best hope for Medco to rise further is a bidding war. Absent that, I would avoid the stock due to its disappointing earnings and loss of market share.

Nalco Gets Bought -- Yielding 33% Return in Eight Days, Who's Next?

On July 11, I wrote that investors should consider buying shares in Nalco Holdings (NYSE: NLC), the $4.3 billion maker of cleaning chemicals, because it was a takeover candidate and its stock price was low relative to its projected earnings growth.

If you took my advice, congratulations! That's because you just made a 33% return on your investment in just over a week. How so? Ecolab (NYSE: ECL) announced Wednesday that it will acquire Nalco for $5 billion, or $38.80 a share -- 33% above its July 11 price of $29.17. Who's next?

The reason I noticed Nalco was that a rival had been acquired the day before. As I wrote, Arch Chemicals’ (NYSE:ARJ) stock was up 11.3% on the news that it would be bought by Swiss specialty chemicals and biotechnology company Lonza for $1.2 billion in cash. But it turns out that Nalco is not the only medium-sized player in the pollution cleanup business.

I'd consider buying shares in Clean Harbors (NYSE: CLH) -- it doesn't make cleanup chemicals but it does offer environmental cleanup services. And the beauty of investing in the $1.8 billion sales Clean Harbors is that it is doing quite well without needing to be acquired. The question for investors is whether there is still upside in its stock if it remains independent.

Here are four reasons why:

• Excellent first quarter earnings. Clean Harbors reported first quarter 2011 EPS of $0.86 -- 32% above analysts' estimates. And it raised its 2011 revenue forecast to a range between $1.62 billion and $1.67 billion, up from its previous forecast and ahead of analysts' expectations of $1.60 billion, according to Thomson Reuters I/B/E/S.
• Inexpensive stock. Clean Harbors price to earnings to growth (PEG) ratio of 0.80 makes it inexpensive (a PEG of 1.0 is considered fairly priced). This is particularly impressive given that it just it an all-time high of $112 a share. Clean Harbors P/E is 21 and its earnings are expected to grow 26% to $4.35 in 2012.
• Rapid growth and solid balance sheet. Clean Harbors has grown quickly. Its $1.8 billion in revenues have increased at an average rate of 19.5% over the last five years and its net income of $140 million has risen at a 38.2% annual rate over that period. Its cash has risen faster than its debt -- at a 38% annual rate from $84 million (2006) to $306 million (2010). During that time, its debt rose at 21.8% annual rate from $123 million to $271 million.
• Out-earned its capital cost -- at an accelerating rate. Clean Harbors earned more after-tax operating profit than its cost of capital, and it's gaining ground fast. Clean Harbors EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 8%, based on 2009 revenue of $1 billion, and EVA that rose from negative $73 million in 2009 to $16 million in 2010, using a 10% weighted average cost of capital.

Clean Harbors could be an attractive acquisition candidate for a company interested in environmental cleanup. If not, its stock seems to be doing quite nicely on its own.

Should You Check Out CheckPoint Software?

Check Point Software (NASDAQ: CHKP) has been a great company for decades. But after a great earnings report, is it still a good stock to own?

Check Point is a $1.2 billion revenue Israeli maker of computer network security products -- the world's second largest. And Monday its stock hit a 10 year high after rising 88% in the last year. Thanks to rising demand for its products resulting from well-publicized hacking attacks at Sony Corp. (NYSE: SNE), EBay (NASDAQ: EBAY) the Central Intelligence Agency and the Pentagon, Check Point raised its 2011 EPS forecast from $2.75 to $2.84.

Here are three other reasons to own its stock:

• Out-earned its capital cost -- at an accelerating rate. Check Point earned more after-tax operating profit than its cost of capital, and it's gaining ground fast. Check Point's  EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 11%, based on first six months' 2010 annualized revenue of $1 billion, and EVA that rose from $145 million annualizing the first six months of 2010 to $261 million annualizing the first six months of 2011, using an 8% weighted average cost of capital.
• Excellent second quarter earnings. Check Point's second-quarter net income climbed 24% to $128 million -- beating nine analysts' estimates of  $125 million. Its EPS of 68 cents a share beat expectations by two cents. Its operating margin widened from 46.7% to 50.1%. And Check Point's revenues of $301 million were 15% higher than in the previous year.
• Rapid growth and solid balance sheet. Check Point  has grown quickly. Its $1.1 billion in revenues have increased at an average rate of 13.6% over the last five years and its net income of $502 million has risen at a 7% annual rate over that period. And its cash has remained constant at around $1.1 billion with no debt.

One problem is that Check Point is an expensive stock. Check Point's price to earnings to growth (PEG) ratio of 2.53 makes it over-valued (a PEG of 1.0 is considered fairly priced). Check Point's  P/E is 26.6 and its earnings are expected to grow 10.5% to $2.91 in 2012.

The best justification for buying this stock is that if its earnings keep growing at 24% or more, then its current stock price will look reasonable. This is one stock that has good odds of continuing to grow fast because highly publicized hack attacks seem to be growing. And this will just boost demand for its products.

News Corp Economic Value-Added Analysis of Businesses

Most of News Corp.'s businesses earn less than their cost of capital as measured by their Economic Value Added.

Based on their their performance over the last two years from its most recent SEC quarterly filing, one News Corp. business unit looks like a keeper to me:

Cable network programming -- with $5.9 billion in sales in the last nine months and $2.1 billion in operating income -- it generated positive EVA in the nine months ending March 2010 and March 2011. And that level of EVA more than doubled from $333 million to $673 million.

Filmed entertainment -- with $4.9 billion in last nine months sales and $717 million in operating income -- it generated positive EVA in in the nine months ending March 2010 of $343 million and slightly negative EVA ($15 million) in the same 2011 period. This business is far more volatile than cable network programming but it could generate positive EVA in the the future. So I would consider selling this one after the ones listed below.

And News Corp. ought to sell the rest. Here's why it should sell the following units (below I've included my reasons):

Digital and other -- with $834 billion in last nine months sales and negative $477 million in operating income -- it generated huge negative EVA in in the nine months ending March 2010 of ($1.1 billion) and ($1.3 billion) during the same 2011 period -- a big deterioration. This is a grab-bag of different operations each of which ought to be analyzed separately.

Publishing -- with $6.5 billion in last nine months sales and $594 million in operating income -- it generated negative EVA in the nine months ending March 2010 of ($776 million) and ($640 million) during the same 2011 period -- a slight improvement.

Satellite TV -- with $2.7 billion in last nine months sales and $87 million in operating income -- it generated negative EVA in in the nine months ending March 2010 of ($105 million) and ($153 million) during the same 2011 period -- a big decline. This one looks like it may be difficult to make EVA-positive but I am guessing that News Corp.'s recently scuttled effort to acquire the 60% of BSkyB it does not already own would have helped this business.

Television -- with $3.7 billion in last nine months sales and $448 million in operating income --it generated negative EVA in in the nine months ending March 2010 of ($404 million) and ($142 million) during the same 2011 period -- a huge improvement. This one could be ripe for restructuring -- for example, while FoxNews may be earning more than its cost of capital, can the same be said for Fox Business?

This analysis offers some guidance of where further research could be useful for the businesses that appear marginal on an EVA basis -- such as Satellite TV, Television, and Filmed Entertainment. For these businesses, I would take a look at future EVA projections and would also consider ways of cutting costs or otherwise restructuring them to see if they could be turned EVA-positive.

But two businesses appear poised for prompt divestiture -- digital and other and publishing. It is hard to put a value on the first one since it consists of so many different units. But the value of its publishing unit is easier to estimate.

Applying a newspaper industry average Price/Earnings ratio of 11.7 to the Publishing Group's estimated 2011 net income of $490 million (calculating by annualizing the Group's first nine months' 2011 estimated net income) yields a value of $5.7 billion.

If News Corp. shuttered or sold off its money-losing digital and other units -- that could boost its 2011 net income by $636 million to $1.5 billion.

And the resulting restructuring moves might convince investors to assign News Corp. a higher P/E.

With Clorox in Icahn's Sites, Should You Buy Its Stock?

Clorox (NYSE: CLX) rose almost 9% Friday on news that Carl Icahn had offered $11.6 billion to buy the bleach-maker. But what if the deal does not go through -- would Clorox still be a good addition to your portfolio?

Icahn's $76.50 a share cash offer was designed to spur a corporate deal that could take advantage of cost savings that would result from sharing marketing and logistics. Icahn's 12% premium for Clorox -- it also makes Burt's Bees lip balm, Glad trash bags, Brita water filters -- was intended to spur a competing offer from Procter & Gamble (NYSE: PG) or Colgate-Palmolive (NYSE: CL).

I agree with Icahn's logic here but his efforts could fail. Therefore, it's worth considering whether to buy Clorox if it remains independent.

One reason it might be worth buying is that is has out-earned its capital cost -- but at a slower rate. Clorox earned more after-tax operating profit than its cost of capital, however it's losing ground. Clorox's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was negative 1%, based on 2009 revenue of $5.5 billion, and EVA that fell from $352 million in 2009 to $322 million in 2010, using a 7% weighted average cost of capital.

The reasons to avoid this stock are more compelling:

• Disappointing third quarter earnings. In May, Clorox reported an 8.5% decline in its earnings for the quarter ending March 2011 and its earnings and sales ($1.02 and $1.3 billion, respectively) both missed consensus expectations ($1.04 and $1.32 billion). Clorox also lowered its outlook for the fiscal year ending June 2011 and issued 2012 guidance that was below analysts' expectations. Clorox's problem is that its costs for inputs like resin, pine oil, and diesel are rising faster than it can raise prices to cash-pinched consumers -- in May it raised the price on Glad bags by 9.5%. In May Clorox raised its estimates for commodity cost increases from $75 million to $85 million for fiscal 2011 and up $170 million for fiscal 2012.
• Slow growth with shakier balance sheet. Clorox has grown very slowly. Its $5.2 billion in revenues have increased at an average rate of 3.6% over the last five years and its net income of $268 million has risen at a 0.4% annual rate over that period. And its cash has been falling while its debt has risen a bit. Specifically, Clorox's cash fell at an 18% annual rate between 2006 ($192 million) and 2010 ($87 million) while its debt rose slightly between 2006 ($2.0 billion) and 2010 ($2.1 billion)
• Expensive stock. Clorox's price to earnings to growth (PEG) ratio of 4.09 makes it very over-valued (a PEG of 1.0 is considered fairly priced). Clorox's P/E is 18.8 and its earnings are expected to grow 4.6% to $4.06 in 2012.

This stock looks like it would not be good to own in the absence of Icahn's efforts to spur a takeover. However, if Icahn ends up buying Clorox at this stated price, the shares still have a few points of profit left. I am guessing that the stock's failure to rise a full 12% reflects investors' uncertainty about whether a deal will be concluded.

Unless commodity prices plunge, I do not see a catalyst for these shares beyond the possibility of a takeover.

Is MicroStrategy Still a Buy?

Two months ago I concluded that after a 53% rise between early January -- when I first recommended it -- and May 12, 2011, MicroStrategy (NASDAQ: MSTR) -- a $1.8 billion market capitalization analytical software maker -- had further to rise. Since then, MicroStrategy stock has risen 24% more and is up a whopping 85% so far this year after hitting a new 52-week high Thursday. Are MicroStrategy's best days behind it?

Behind MicroStrategy's rise is an implicit put option -- that is the possibility that the company might be acquired by a company interested in expanding into MicroStrategy's analytical software industry.

A case in point it IBM (NYSE:IBM) which is flush with cash that it intends to use for acquisitions. IBM, in particular, is very interested in analytical software, a topic about which I posted in April, and the company expects to generate $16 billion in revenue from selling analytical software by 2015. One way for IBM to achieve that goal would be for it to acquire analytical software companies — such as MicroStrategy.

Of course, there is a good chance that MicroStrategy will remain independent. If so, does its stock still have further to run or is now a good time to take the 85% profit you would have earned if you had bought the stock in January?

There are two recent product announcements that could propel MicroStrategy into rapidly growing markets, according to Information Week:

• Gateway for Facebook would let companies trying to market to Facebook users target the most frequent communicators and influencers. Gateway for Facebook would do this more efficiently than competing products and thus enable marketers to get the highest return on their marketing investment.
• MicroStrategy Cloud would let companies analyze their data on MicroStrategy's computers -- taking advantage of the rapidly growing demand by companies to outsource their computing -- so-called cloud computing.  

However, there is one reason to pause -- first quarter earnings that missed expectations. MicroStrategy's first-quarter earnings might investors might reason to pause. Although its revenue was up 31%, its earnings per share of 10 cents a share badly missed the Thomson Reuters consensus estimate of 39 cents a share. However, investors appear to view this big miss as an aberration.

On the other hand, there are three offsetting factors that strengthen the case for investing:

• Long-term growth and solid financial position. MicroStrategy has grown steadily. Its $483 million in revenues have increased at an average rate of 11.2% over the last five years; however its net income of $38 million has been falling at a 7.7% annual rate over that period. However, its cash has been falling while its debt has risen. Specifically, MicroStrategy's cash rose at a 22% annual rate between 2006 ($79 million) and 2010 ($174 million) and it has no debt.
• Out-earning its capital cost but more slowly. MicroStrategy earned more after-tax operating profit than its cost of capital, however it's losing ground in that quest. MicroStrategy's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was -5%, based on 2009 revenue of $378 million, and EVA that declined from $40 million in 2009 to $23 million in 2010, using a 9% weighted average cost of capital.
• Inexpensive stock. MicroStrategy's price to earnings to growth (PEG) ratio of 0.93 makes it under-valued (a PEG of 1.0 is considered fairly priced). MicroStrategy's P/E is 52.6 and its earnings are expected to grow 56.5% to $4.50 in 2012.

It looks like MicroStrategy still has further to rise -- with one big caveat. If it does not exceed earnings expectations when it reports second quarter results, investors could suffer. Based on its ability to introduce new products that customers want, a drop in its stock price might be an opportunity to invest at an even lower price in this solid company.

Will Aqua America Give Life To Your Portfolio?

Every day I drive into a town next door to my house that is rationing water. This made me think about whether there are companies that make money off the vital liquid. A leader among such companies is Aqua America (NYSE: WTR) -- the $3.1 billion market capitalization water utility holding company. Should you add it to your portfolio?

53% of Aqua America's revenues come from its Pennsylvania subsidiary; however it also owns water utilities in Texas, North Carolina, Ohio, Illinois, New Jersey, New York, Florida, Indiana, Virginia, Maine, Missouri, and Georgia. And it makes acquisitions -- 19 in 2010 alone -- including one last month of a water utility in Texas.

There is one good reason to consider owning shares of Aqua America -- its rising dividend. Aqua America has had 65 years of consecutive dividends with 20 cash increases in the last 19 years. And it has been raising its dividend 4 cents every year since 2006 -- resulting in a 7% increase in 2010 to a dividend yield of 2.8%.

And there are four causes for concern:

• Long-term growth with shakier balance sheet. Aqua America has grown steadily. Its $726 million in revenues have increased at an average rate of 8% over the last five years and its net income of $124 million has risen at a 7.7% annual rate over that period. However, its cash has been falling while its debt has risen. Specifically, Aqua America's cash fell at a 39% annual rate between 2006 ($44 million) and 2010 ($6 million) while its debt rose at a 12% annual rate between 2006 ($952 million) and 2010 ($1.5 billion).
• First quarter earnings that beat expectations with disappointing revenues. Aqua America's adjusted income was $26 million or $0.19 per share -- a penny ahead of analysts polled by Thomson Reuters; however, revenues for the quarter grew 6.7% to $171 million -- 1.4% below analysts' consensus revenue estimate.
• Under-earning its capital cost. Aqua America earned less after-tax operating profit than its cost of capital, however it's improving. Aqua America's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 1%, based on 2009 revenue of $671 million, and EVA that improved from negative $70 million in 2009 to negative $66 million in 2010, using a 6% weighted average cost of capital.
• Expensive stock. Aqua America's price to earnings to growth (PEG) ratio of 3.15 makes it somewhat over-valued (a PEG of 1.0 is considered fairly priced). Aqua America's P/E is 23.3 and its earnings are expected to grow 7.4% to $1.06 in 2012.

People need water and Aqua America supplies lots of it. But to get more, the company is larding up its balance sheet with debt and is not able to achieve sufficient cost savings from its acquisitions to out-earn the cost of the capital it's using to finance them.

I don't see a compelling reason to buy this stock.

Is Salesforce.com Over-valued?

Salesforce.com (NASDAQ: CRM) -- the $20 billion market capitalization provider of customer-relationship management services -- is famous for being an expensive stock. Should you buy it anyways?

Goldman Sachs (NYSE: GS) says you should. According to Barron's, Goldman analyst Heather Bellini believes that Salesforce.com will ride the wave of so-called cloud computing in which companies outsource their IT operations. She wrote that the company has “the potential to be a key beneficiary of enterprises modernizing their data centers. We see platform as a service offerings as being an integral component to this more modern architecture.”

The question for investors is whether Bellini did any financial analysis to substantiate her optimism on the stock. Here are three pieces of such analysis that would justify buying the stock.

• Long-term financial strength -- but weak margins and rising debt. Salesforce.com has grown steadily. Its $1.8 billion in revenues have increased at an average rate of 39.8% over the last five years and its net income of $47 million has risen at a 17.8% annual rate over that period. And its cash grew at an 18.5% annual rate between fiscal 2007 ($252 million) and fiscal 2011 ($497 million). The bad news is that Salesforce.com makes very little profit -- its net margin is 2.6% -- and at a debt/equity ratio of 0.38, Salesforce.com has more debt than its industry (it sports a 0.30 debt/equity ratio). Salesforce.com had no debt two years ago and now has $473 million worth.
• Mixed fiscal first quarter earnings that beat expectations. Salesforce.com's adjusted net income of 28 cents/share was a penny above estimates and its $504.4 million in revenues beat expectations of $482.4 million. But the bad news was that Salesforce.com's net income fell 97% to $530,000 (0 cents/share) vs. $17.7 million (13 cents/share) a year earlier.

But this somewhat tarnished good news is offset by some unalloyed bad news:

• Under-earning its capital cost. Salesforce.com  earned less after-tax operating profit than its cost of capital and it's getting worse. Salesforce.com's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was down 2%, based on fiscal 2010 revenue of $1.3 billion, and EVA that declined from negative $87 million in fiscal 2010 to negative $117 million in fiscal 2011, using a 10% weighted average cost of capital.
• Expensive stock. Salesforce.com's price to earnings to growth (PEG) ratio of 2.29 makes it over-valued (a PEG of 1.0 is considered fairly priced). Salesforce.com s' P/E is 444 and its earnings are expected to grow 194% to $0.68 in its fiscal 2013. And this earnings growth forecast is optimistic given that earnings are expected to shrink 65% in fiscal 2012 ending next January.

Do not take Goldman Sachs' advice on this stock.

Will Westport Innovations Let You Clean Up?

Westport Innovations (NASDAQ: WPRT) -- the $1.1 billion market capitalization maker of technology that let engines run on natural gas or hydrogen that sells to 50 commercial vehicle makers in 19 countries -- has attracted institutional investment and the stock is rising. Should you follow the smart money into Westport?

The smart money has been buying up the stock. Nasdaq.com reports that 2.4 million net institutional shares purchased in the second quarter amounted to 7.46% of Westport's 32.2 million outstanding shares. And the stock is trading well above its moving averages -- specifically 14.6% above its 20-day moving average, 11.7% above its 50-day moving average, and 30% above its 200-day moving average. So far in July, the stock is up 17.7%.

Westport Innovations is a money-losing company but this momentum reflects two facts that appear to be fueling institutional interest:

• George Soros has made this stock one of his biggest holdings, according to SeekingAlpha. This naturally attracts other big investors who assume that Soros will make money on the stock and they want to go along for the ride; and
• Shifting focus to lighter vehicles. Westport is beginning to diversify from just selling to makers of big trucks to car companies. For example, Westport announced a project with General Motors (GM) to develop natural gas engines for light-duty vehicles opening up a big opportunity -- .GM sold 200,000 vehicles to commercial fleets in 2010. Wesport also could enter the large Chinese market for heavy and light vehicles through a joint venture -- Weichai Westport JV, reports SeekingAlpha.

But betting on Westport requires you to ignore its financial track record. Here are three negative elements:

• Poor fourth-quarter earnings report. For its fourth quarter, ending March 2011, Westport's revenues rose 10.4% to $38.1 million while it lost $14.4 million ($0.31 loss per share) -- 23% more than the year before.
• Long-term financial weakness. Westport has grown steadily while losing money and burning through cash. Its $152 million in revenues have increased at an average rate of 27.7% over the last five years and it lost $43 million in the last 12 months. And in the absence of selling $134 million in stock during the year ending March 2011, its cash balance would have been close to zero. Fortunately, its $10 million in debt is down from $12 million the year before. But Westport is clearly depending on its ability to sell stock to keep its lights on.
• Under-earning its capital cost. Westport earned less after-tax operating profit than its cost of capital and it's getting worse. Westport's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was down 12%, based on fiscal 2010 revenue of $122 million, and EVA that declined from negative $31 million in fiscal 2010 to negative $46 million in fiscal 2011, using a 10% weighted average cost of capital. 

This stock is a classic momentum play -- it's rising on press releases about future deals and big-name investor involvement. Once Soros get out, all bets are off. So if you know the day before that he is going to dump his shares, get into the stock and sell when he does.

If you're like everyone besides Soros, be wary of Westport.

Is Starbucks Right For Your Portfolio?

Starbucks (NASDAQ: SBUX), the $29.8 billion market capitalization (up 57% in the last year) coffee retailer, announced that it would reorganize to capture global growth opportunities. If that helps the company accelerate earnings growth, it should make the company more valuable. Is now the time to invest?

Starbucks CEO Howard Schultz wants to boost the company's global revenues. Currently 25% of its $10.7 billion in annual revenues come from overseas and Schultz wants that figure to hit 50%. To do so, Starbucks will probably need to add to the 6,000 stores it operates outside North America where it has 11,000 stores. Starbucks hopes to achieve that 50% by growing in China, Brazil and India.

Starbucks has a mixed record with expansion so its success is hardly guaranteed. For example, it added stores during the 2000s and then suffered a big slowdown during the financial crisis. Schultz stepped back in to right the ship and is now focusing on how to accelerate growth.

But global expansion has its challenges. As I pointed out in my forthcoming book, Export Now, co-authored with Frank Lavin, CEOs seeking to boost exports ought to consider the five Cs -- country, customers, competition, capabilities, and closing the capability gap -- before making their global move.

To assess whether Starbucks will succeed with its effort to make international revenues 50% of the total, investors should consider how well Schultz is addressing the following issues:

• Are the countries that Starbucks targets attractive based on their size and familiarity with its brand?
• Can Starbucks adapt its product line and service style to the needs of each country?
• Does Starbucks understand the competition in each country and why customers will chose its products over competitors'?
• Does Starbucks recognize which of its strengths in North America will help it in those new countries and which might turn into weaknesses?
• Can Starbucks bolster its weaknesses and get the capabilities it needs to succeed in the new country?

While it is too soon for answers to these questions, here are three reasons to consider investing in Starbucks now:

• Long-term financial strength. Starbucks has grown steadily. Its $11.2 billion in revenues have increased at an average rate of 11% over the last five years and its net income of $1.1 billion has risen at a 13.9% annual rate over that period. And its cash grew at a 33.7% annual rate between 2006 ($454 million) and 2010 ($1.4 billion). And at a debt/equity ratio of 0.13, Starbucks has little debt.
• Strong fiscal first quarter earnings that met expectations. Starbucks' net income rose 20.4% from the same quarter of 2010 to $261.6 million. Its EPS of 34 cents/share met analysts' estimates -- while revenue was up 9.9% to $2.8 billion.
• Out-earning its capital cost. Starbucks earned more after-tax operating profit than its cost of capital and it's improving, Starbucks's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 5%, based on 2009 revenue of $9.8 billion, and EVA that improved from negative $6 million in 2009 to $476 million in 2010, using a 10% weighted average cost of capital.

The problem for investors now is that Starbucks is an expensive stock. Starbucks' price to earnings to growth (PEG) ratio of 1.33 makes it somewhat over-valued (a PEG of 1.0 is considered fairly priced). Starbucks' P/E is 27.8 and its earnings are expected to grow 20.9% to $1.81 in 2012.

Given the volatility in the market related to concerns with Italy's debt and the status of U.S. debt ceiling negotiations, I would not be surprised to see a better entry point for the stock. And if Starbucks can achieve its global growth goals, its stock is likely to provide investors with upside surprise in the medium term.

Is Nalco A Good Buy?

Arch Chemicals (NYSE: ARJ) -- the $1.6 billion maker of chemicals to kill microbes in consumer products -- is getting acquired. Does this mean that competitor, Nalco Holding Company (NYSE: NLC) could also be an acquisition candidate? If not, should you buy its stock?

Arch Chemicals' stock is up 11.3% on the news that Swiss specialty chemicals and biotechnology company Lonza Group Ltd. will buy Arch Chemicals for $1.2 billion in cash. This news got me thinking about other companies in the industry who might be candidates for other companies seeking a foothold in this attractive market segment.

Nalco is not in exactly the same segments as Arch but it has a similar focus on cleaning chemicals. Specifically, Nalco sells $4.3 billion worth of chemicals and technology used in water treatment, pollution control, energy conservation, oil production and refining, steelmaking, papermaking, and mining.

There are three reasons for modest optimism on Nalco's stock:

• Long-term financial strength -- though debt level is worrying. Nalco has grown steadily. Its $4.4 billion in revenues have increased at an average rate of 5.1% over the last five years and its net income of $288 million has risen at a 32.6% annual rate over that period. And its cash grew at a 36.4% annual rate between 2006 ($37 million) and 2010 ($128 million). Nalco still has too much debt. Although it's declining from $3.1 billion in 2006 to $2.8 billion in 2010, Nalco's debt/equity ratio of 3.21 is almost three times the industry average of 1.1.
• Strong, but disappointing first quarter earnings. Nalco first quarter earnings were $0.26 per share -- 16% percent below the $0.31 eleven analysts polled by Thomson Reuters expected. But the good news was that Nalco's first quarter sales grew 11% to $1.06 billion from $956.6 million in the 2010 quarter and ahead of 13 analysts' estimate of $1.03 billion for the quarter. Nalco left unchanged its 2011 EPS guidance of $1.65 -- 2% below analysts' estimates of $1.69
• Under-earning its capital cost-- but that's improving. Nalco earned less after-tax operating profit than its cost of capital but since it's improving, Nalco's EVA momentum was 4%, based on 2009 revenue of $3.7 billion, and EVA that improved from negative $253 million in 2009 to negative $117 million in 2010, using an 11% weighted average cost of capital.

As for the possibility of Nalco being acquired -- it already was back in 1999. On June 27 of that year, Nalco closed a deal to be acquired by Suez Lyonnaise des Eaux, a $32 billion company with 200,000 employees worldwide. But on November 11, 2004, Nalco returned to the New York Stock Exchange as an independent company.

Even without the possibility of being acquired, Nalco is a bargain priced stock. Nalco's price to earnings to growth (PEG) ratio of 0.53 makes it very under-valued (a PEG of 1.0 is considered fairly priced). Nalco's P/E is 14.1 and its earnings are expected to grow 26.8% to $2.08 in 2012.

Even if Nalco remains independent, its very low valuation makes its stock worth considering.

Do Stocks Need to Rise 41% to Reach Fair Value?

With stocks poised to fall Monday, their valuations are low relative to robust earnings. One of the hardest things for investors to do is go against the tide. And buying stocks while gloom prevails is the way to profit from that pain.

One way to look at stock prices is to compare their value relative to their future earnings growth. And by that measure, stocks look inexpensive. Bloomberg reports that analysts expect a 19% rise in S&P 500 net income in 2011 -- including a 13% rise in soon-to-be-reported second quarter earnings. At 13.5 -- compared to the five-year average of 14.7, the P/E on S&P 500 stocks reflects a Price/Earnings to Growth ratio of 0.71 -- where 1.0 is fairly valued.

Projections for 2011 S&P 500 earnings suggest that business profits are just about back to where they were before the financial crisis. Specifically, $99.34 a share in S&P 500 earnings for 2011 would "almost erase the impact of the credit crisis on profits and push the rate of expansion back to its historical average," according to Bloomberg.

So what accounts for the gloomy mood towards stocks. Here are four possibilities:

• Economists are expecting slower growth. Their median forecast for 2011 U.S. GDP fell 0.2 percentage points from 2.7% to 2.5% and economists' 2012 GDP growth forecasts are down the same from 3.1% to 2.9%.
• Decelerating earnings growth forecasts. Analysts estimate that 2012 S&P 500 earnings growth will be 13% and 2013 growth will be 11%. If these estimate prove accurate, they will follow a recent pattern of slowing earnings growth -- after all 2010's Q2 earnings rose 49% while 2011's Q2 earnings are set to rise a relatively paltry 13%.
• Poor employment statistics. June 2011's jobs report reflected ongoing problems with the economy's ability to function properly. Only 18,000 new jobs were created -- 82% below expectations and the unemployment rate rose to 9.2% -- leaving 14.1 million people in search of work.
• Debt-ceiling negotiations. Widespread fear of failed negotiations to agree on an increase in the U.S. debt ceiling could be contributing to a gloomy mood.

Of the four, the one that would most dissuade me from buying stocks is the forecast of slowing earnings growth. But based on the current PEG ratio on the S&P 500 of 0.71, I would estimate that the S&P 500 would need to rise 41% from its current 1,343 to 1,892 (calculated by dividing the current S&P 500 index level by the current PEG ratio) to hit a PEG of 1.0.

And with stocks set to decline Monday morning, that valuation gap is likely to get even wider before the gloom lifts.

Should You Add Kohl's To Your Stock Shopping List?

Kohl's (NYSE: KSS) -- a specialty department store offering brand apparel, shoes, accessories, beauty and home products through 1,097 stores in 49 states -- reported an unexpectedly high increase in June same store sales and its stock jumped. Is now the time to add its stock to your stock shopping cart?

Kohl's June sales were much better than expected. Thanks to June's nice weather, Kohl's same store sales were up 7.5% -- better than 2010's 5.9% and analysts' forecasts of 2.9%. Kohl's total sales in June rose 9.2% to $1.75 billion. And its stock was up 7.1% on the news -- which also may bode well for U.S. GDP growth since 70% of it comes from consumer spending.

Here are four reasons to consider adding it:

• Long-term financial strength. Kohl's has grown steadily. Its $18.5 billion in revenues have increased at an average rate of 6.5% over the last five years and its net income of $1.1 billion has risen at a 5.8% annual rate over that period. Its debt is declining from $2.1 billion in 2009 to $1.7 billion in 2010 and its cash grew at a 37.7% annual rate between 2006 ($620 million) and 2010 ($2,227 million).
• Solid first quarter performance. Kohl's first quarter profit rose 6% to $211 million, or 73 cents a share equal to Wall Street estimates and its sales were up 3.1% at $4.16 billion. Kohl’s, raised its full-year earnings forecast to $4.25 to $4.40 a share. Thomson Reuters surveyed analysts expecting $4.36.
• Out-earning its capital cost. Kohl's earned more after-tax operating profit than its cost of capital and it has positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, Kohl's EVA momentum was 1%, based on 2009 revenue of $17.2 billion, and EVA that improved from negative $9 million in 2009 to $111 million in 2010, using a 10% weighted average cost of capital.
• Bargain priced stock. Kohl's price to earnings to growth (PEG) ratio of 0.93 makes it slightly under-valued (a PEG of 1.0 is considered fairly priced). Kohl's P/E is 14.9 and its earnings are expected to grow 16% to $5.07 in 2012.

Kohl's looks inexpensive despite Thursday's rise. And given the gloomy mood on the economy, the odds of upside surprise remain good.

Is JM Smucker Good For Your Investment Portfolio?

As the old tag line goes, "with a name like Smucker's it has to be good!" I featured JM Smucker (SJM) -- the $8.7 billion market capitalization maker of coffee, peanut butter, shortening and oils, fruit spreads, canned milk and baking mixes -- in my 2003 book, Value Leadership, as a solid corporate citizen that treated its employees and communities well and came up with some successful product innovations.

Since the book's Sept. 19, 2003 publication, Smucker's stock has risen 81%, compared to 12% decline for the S&P 500. Should you add Smucker to your portfolio?

Here are three reasons to consider adding it:

• Long-term financial strength. Smucker has grown rapidly. Its $4.8 billion in revenues have increased at an average rate of 17.5% over the last five years although its net income of $475 million has risen at a 27.1% annual rate over that period. A negative is that its $1.3 billion in 2010 debt rose at a 34.9% annual rate since 2006 while its cash grew at a 12.5% annual rate between 2006 ($200 million) and 2010 ($320 million).
• Strong fourth quarter performance. Smucker beat earnings and raised revenue estimates. Its fourth-quarter profit of $94.9 million was down 21% from the year before but its $1.00 a share, adjusted earnings beat analysts' average estimate of 99 cents a share by a penny, according to Thomson Reuters I/B/E/S. Due to higher prices -- it raised coffee prices by a third in the year ending May 2011 -- and its recent acquisition of espresso coffee firm Rowland Coffee Roasters, Smucker forecast a 20% sales rise to $5.8 billion for the year -- 12.4% above analysts' $5.16 billion estimate. But that won't keep up with its 25% rise in cost of products.
• Attractive dividend yield. Smucker's 2.3% dividend yield up an average of 2.4% a year over the last five years is a nice bonus.

Here are two negatives for the stock:

• Under-earning its capital cost. Smucker earned less after-tax operating profit than its cost of capital and it has negative EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, Smucker's EVA momentum was -1%, based on 2009 revenue of $4.6 billion, and EVA that declined from $10 million in 2009 to negative $25 million in 2010, using a 7% weighted average cost of capital.
• High valuation. Smucker's price to earnings to growth (PEG) ratio of 1.85 makes it quite expensive (a PEG of 1.0 is considered fairly priced). Smucker's P/E is 16.3 and its earnings are expected to grow 8.8% to $5.60 in 2012.

While the dividend looks tempting -- the negatives on this stock may quietly creep up on it. For example, higher prices could make consumers buy less and with its higher input costs, the result could be a disappointing earnings performance on this expensive stock. I am also concerned about its growing dependence on debt-adding acquisitions for its growth.
 
It looks like a good company that has enjoyed most of its upward stock run.