Stocks 2009 The Investor's Guide to the Year Ahead

[Pages:32]STOCKS 2009

The Investor's Guide to the Year Ahead

Published by

The Motley Fool, LLC 2000 Duke Street, Alexandria, VA 22314, USA Published November 2008

The studies in this book are not complete analyses of every material fact regarding any company, industry, or investment, and they are not "buy" or "sell" recommendations. The opinions expressed here are subject to change without notice, and the authors and The Motley Fool, LLC, make no warranty or representations as to their accuracy, usefulness, or entertainment value. Data and statements of facts were obtained from or based upon publicly available sources that we believe are reliable, but the individual authors and publisher reserve the right to be wrong, stupid, or even foolish (with a small "f"). It is sold with the understanding that the authors and publisher are not engaged in rendering financial or other professional services. Readers should not rely on this (or any other) publication for financial guidance, but should do their own homework and make their decisions. Remember, past results are not necessarily an indication of future performance.

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Editor: Rik Silverman

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STOCKS 2009

Contents

I n t r o d u c t i o n ................ .......................................................... i v

by tim hanson

Colfax: An acquired taste for success........................................... 1

by tim hanson

Dolby Laboratories: sounds like a winner........................................................... 4

by tom gardner and rex moore

Domino's Pizza: g e t yo u r pi e c e o f t h e pi e . .................................................... 7

by ron gross

Guess: o pp o r t u n i t y n e v e r lo o k e d s o g o o d ................................. 1 0

by seth jayson

Netflix: t w o t h u m b s u p f o r t h i s p r o f i t pi c t u r e . .......................... 1 4

by david gardner and tim beyers

Parker Hannifin: S e t yo u r p o r t f o l i o o n Au to pi lot ..................................... 1 7

by andy cross

Tenaris: A pip e l i n e to p r o f i t s . ......................................................... 2 0

by james early and joe magyer

XTO e n e r g y: n at u r a l g a s to f u e l yo u r p o r t f o l i o ................................ 2 3

by philip durell and michael olsen

Rydex Equal-weight materials: A n ETF m a d e f o r t h e Lo n g R u n ........................................... 26

by shannon zimmerman

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STOCKS 2009

Introduction

by tim hanson

Dear Fellow Fool,

What a year, huh?

In no short order, 2008 brought us the collapse of the housing bubble, a global credit crisis, the disappearance of once-emerging markets, and government intervention at Bear Stearns, Fannie Mae, and Freddie Mac. Then came bankruptcy at Lehman Brothers and the end of Merrill Lynch as a public company. We witnessed an energy bubble and bust; rising food prices; political instability in Argentina, Bolivia, and Venezuela; nationalization in Venezuela and Russia; a historic presidential election; and a $700 billion rescue package that may or may not do enough to jumpstart the U.S. economy.

yielded 9% annual returns. More impressive, however, is that the 14 years immediately after the 1929 crash rewarded investors with greater than 12% average annual returns. Similarly, though David and Tom Gardner's stock picks got off to a rocky start at the launch of the Fool's flagship Stock Advisor service in 2002, today they'll tell you that it was a great stroke of luck to be recommending stocks at a time when so many great companies were on sale. That's because there are two ways to measure success in investing. The first -- and more obvious -- is by your returns. The other is by how many high-quality companies you're able to add to your portfolio on the cheap.

This Is the Place

Ready for 2009?

At the Fool, we sure are. The events of 2008 have weighed on our minds, and no less than Jim Cramer, the Booyah Bull himself, told America that the next five years is no time to be in the market. Put it all together and we're overloaded with FUD -- Fear, Uncertainty, and Doubt. You'll read it in the headlines, hear it on the evening news, and when it comes to making financial decisions, feel it pushing you to sell your stocks, take your losses, and move on to safer pastures.

That, however, is precisely the wrong course of action.

Now Is the Time

Instead, you need to be willing to tighten your budget, set aside some savings, and put new money to work in a market where almost every company -- even the great ones -- has been treated like toxic waste. The truth is, we're going to get through this. Even better, a select group of companies is going to pick up market share, streamline their businesses, and put themselves in great positions to earn outsized profits down the line. As investors, we just need to work hard to identify those companies today and then be patient as the economy sorts itself out. We learned the lesson -- again -- that unsustainable practices simply do not result in sustainable growth.

Thankfully, our economy has a very good record when it comes to recovery. The Great Depression eventually ended, as did stagflation, the savings and loan crisis, and the malaise that set in after the double-whammy of the dot-com bust and Sept. 11, 2001. While each of those events generated significant FUD in real time, what they have in common is that each turned out to be a very good time to buy stocks.

That latter opportunity is what's available to us today, and Stocks 2009 is here to make sure you don't miss out. You're going to hear from David and Tom about two of our country's best emerging brands. These companies also happen to be led by dedicated founders with admirable track records of delivering high performance and rewarding shareholders along the way.

You'll also hear from Hidden Gems co-advisor and retail industry expert Seth Jayson about an out-of-favor company that isn't getting the credit it deserves. Several of us, including myself, will tell you about companies that stand to benefit from the megatrend that is the increasing global demand for energy. These great companies have seen their stock prices slashed as the recent drop in oil and gas prices has sent momentum investors scurrying for the exits.

But this is The Motley Fool, where we're more than happy to take advantage of short-term panic to earn long-term profits.

As you're reading, however, recognize that this collection of stocks is not a model portfolio. Rather, these are the top ideas from our top investors, and we've brought them together to help you supplement your overall portfolio. Your job is to read the recommendations and decide which are right for you. If you don't have any energy exposure in your portfolio, you may decide to buy a couple of those stocks. If you already have energy, you may opt for one of our other recommendations. Ultimately, though we stand behind all of these companies, the decision is yours.

I hope you'll think of that as an opportunity rather than a challenge. After all, the only person who can know the portfolio that suits you best is you. So enjoy Stocks 2009, and please accept our Foolish best wishes for a successful investing year.

Fool on!

Wharton finance professor Jeremy Siegel teaches us that while it took 25 years for the Dow to return its pre-1929 crash level, a dollar-cost averaging approach to investing from 1926 to 1960

Tim Hanson

page iv | the motley fool | Stocks 2009: The Investor's Guide to the Year Ahead

STOCKS 2009

Colfax: An Acquired Taste for Success

by tim hanson

Colfax

NYSE: CFX Headquarters: Richmond, Va.

Motley Fool co-founder Tom Gardner has his own pick here in Stocks 2009, but I think my idea will out-Tom the master himself. When I started working at the Fool, Tom told me time and time again that the best investments are small, fast-growing companies in dull industries that receive little to no analyst coverage, led by founders with large ownership stakes who report to outstanding boards of directors.

FINANCIAL SNAPSHOT

Recent Price: . . . . . . . . . . . . . . . . . . . . . . . . . $8.70 Market Cap: . . . . . . . . . . . . . . . . $382.9 million Dividend Yield: . . . . . . . . . . . . . . . . . . . . . . . . n/a Cash / Debt: . $27.1 million / $101.1 million CAPS Rating: . . . . . 4 Stars (75.37 out of 100) Buy Guidance: . . . . . . . . . . . . . . . . . . . . . . . $8

Data as of 11/5/08

What it Does

Colfax manufactures pumps, fluid handling systems, and specialty valves for industrial, energy, and military applications.

Why BuY

?? Specialty pump-maker stands to benefit from worldwide increases in trade and massive energy infrastructure build-out. ?? This acquisition specialist learned its trade from Danaher -- a company with an impressive 20-year track record for integrating acquisitions. ?? Long-tenured management team and extremely qualified board give Colfax a leg up on the competition.

That list of winning traits describes Colfax (NYSE: CFX) to the letter. And if Tom's track record is any guide, these traits will reward you handsomely in your portfolio.

About the Company

Pumps, fluid handling systems, and specialty valves -- check the box for dull, but somebody's got to make them. Colfax designs, manufactures, and sells this equipment for the industrial, marine, oil and gas, and power generation markets, as well as for the Navy. Its brands are some of the best in the industry, including a few whose origins date back to the 19th century. The pumps are heavily engineered and designed to move viscous liquids (such as oil), and they're often installed in engine rooms or as part of complicated industrial lubrication systems for machines that generate lots of friction (such as oil rigs).

That's the dull part. The exciting news is that these are attractive niches that are out in front of strong macroeconomic tailwinds. The products that Colfax sells to commercial marine companies are used in container ships and oil tankers -- fleets that are growing alongside global trade and the need to ship crude oil around the world. Colfax will benefit by selling new parts to manufacturers, but it will do even better by selling replacement parts to ships that must stay in constant operation. Those aftermarket parts generally have higher profit margins than original equipment, because they don't require any additional R&D.

It's much the same story for power generation and oil and gas. Colfax's pumps keep oil rigs running, and that's more important than ever with relatively high energy prices and demand. Power plants are still going up; China alone is facing a 10-gigawatt energy shortage this year and already plans to build the equivalent of one power plant per week over the next decade. In the United States, the calls are getting louder about the importance of upgrading our energy infrastructure. These projects will all benefit Colfax and enable the company to continue its healthy growth.

Colfax's brands are recognized worldwide, giving it a leg up on competitors in what is an otherwise fractured market. In fiscal 2007, the company made more than 65% of its sales outside the United States. Though the company's business in Asia grew more than 56% from 2006 to 2007, that promising region represented just 2.3% of sales. Given its energy infrastructure demands, Asia presents an enormous opportunity for Colfax. In 2005, the company opened a manufacturing facility in Wuxi, China, which lowered manufacturing costs and provided an important presence in a country whose government is looking to support domestic manufacturers.

Investment Thesis

That all makes for a good story -- but it's just part of the Colfax story. I'm really excited about this company because its opportunities go beyond the promising core

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STOCKS 2009

business. Colfax is also on a mission to be a serial acquirer of complementary small industrial businesses. Now, before you tell me that serial acquirers are risky, know that Colfax has a system -- the Colfax Business System. Management is following the model of Danaher (NYSE: DHR), one of the market's most successful serial acquirers of small industrial businesses. This has Colfax lined up for success.

The market, however, has grown concerned after one-time IPO costs swung the company to a loss and previously healthy free cash flow got tied up in inventory increases. Further, with falling energy prices, a looming global recession, and a tightening credit market, investors fear that demand for Colfax's products will plummet -- particularly in the oil and gas and commercial marine markets -- making that inventory a significant liability.

Although I'm not recommending Danaher, a short history of that company will shed some light on Colfax's acquisition strategies and opportunities. Danaher was founded by brothers Steve and Mitch Rales in 1983 with the goal to acquire a portfolio of cyclical industrial businesses that together would form a noncyclical industrial conglomerate. Moreover, they believed that by applying the Japanese teaching of kaizen, which focuses on continual improvement and lean business practices, they could make the companies they acquired much more efficient and profitable than they were under their original management. They called this approach the Danaher Business System.

Putting that abstract business theory into practice has yielded tangible results: Since 1991, Danaher has increased its top line from $837 million to more than $11 billion -- a compound annual growth rate of 17.5%. Even more impressive is that shareholders have earned a 22% annual return, enough to turn a $1,000 investment in 1991 into nearly $35,000 today.

I can't predict whether Colfax will match Danaher's success, but Colfax does have the opportunity to be very profitable, thanks to its close ties to Danaher. First, Mitch Rales co-founded Colfax with CEO John Young in 1995. Second, Steve and Mitch Rales each own 20.8% of Colfax, and Mitch continues to serve as the company's chairman. Third, the Colfax Business System is modeled on the Danaher Business System not just in name but for its essential strategy. Finally, Colfax's board is now stocked with talent, including Markel chief investment officer Tom Gayner and longtime Danaher CFO Patrick Allender, who can help Colfax accurately price acquisitions and integrate them using the Colfax Business System. They should help Colfax continue with a strategy that has already helped it acquire and integrate 12 businesses since its start in 1995.

Put this acquisition expertise on top of a strong core business, and you have a stock that should outperform the market for years to come.

Financials and Valuation

Colfax has been a fast-growing company across all of its businesses. Of course, the frequent acquisitions make it important to separate the company's organic growth from what it achieves by paying for a new line of business. The good news is that no matter how you size up Colfax, the numbers look solid. The company increased its top line an impressive 32% in the second quarter over the previous year if we include the effects of its acquisitions and by 18% if we strip them out. Both numbers are quite healthy.

I see it differently, though -- those IPO costs are truly one-time, and that inventory capital is going to purchase raw materials. In other words, this isn't flagging demand causing a build-up of finished goods; it's a bet by the company that demand for its products will continue to remain robust:

Raw Materials Work in Progress Finished Goods

4Q 2007

$29.1 million $31.6 million $16.9 million

1Q 2008

$34.6 million $41.3 million $20.5 million

2Q 2008

$37.8 million $39.7 million $21.9 million

Though the company could be making a bad bet here, the growth in orders gives me reason to be confident:

Commercial Marine Power Generation Oil and Gas Navy General

2Q 2008 Orders

Up 6.3% Up 31.5% Up 63.2% Down 15.0% Up 19.5%

1H 2008 Orders

Up 37.2% Up 19.3% Up 11.1% Up 20.4% Up 15.0%

The market is still skeptical, but the current price reflects just 4% annual growth alongside a 13% to 14% EBIT margin and a normalized corporate tax rate of 39%. If you remember that Colfax grew 32% overall and 18% organically in the second quarter, then you can see why I think the current valuation dramatically understates Colfax's long-term potential.

The fact of the matter is that while there will be near-term dips, Colfax's commercial marine, power generation, and oil and gas businesses will continue to grow. Furthermore, given the company's board and management expertise, I expect Colfax to average one accretive acquisition per year for the visible future. The tightening credit markets may make a 2009 acquisition difficult, but that's a reasonable expectation for Colfax over the longer term.

All in all, I expect Colfax to achieve long-term revenue growth between the market's expectations (4%) and what Danaher has achieved over the past 10 years (17.5%). If we assume that business is flat to down next year but resumes midpoint revenue growth (10.75%) alongside normalized EBIT margins of 13% to 14%, then Colfax has an intrinsic value of $17 per share today.

If you have the patience to hold, I expect it to do even better than that. Within five years, the company should post earnings of $1.40 to $1.50 per share. That would give us greater than 20% annualized returns if the market assigns an earnings multiple of 10, typical for a cyclical industrial company. And

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STOCKS 2009

that could go even higher if Colfax, like Danaher, can become a countercyclical collection of growing industrial businesses.

Risks and When I'd Sell While Colfax has genuine expertise when it comes to acquiring and integrating new businesses, there's no denying that serial acquirers can be risky stocks to own. That's because acquisitions can mask a deteriorating core business. One bad acquisition can destroy a company's balance and cause it to lose focus for years (for dramatic recent evidence, just take a look at what Golden West Financial ended up doing to Wachovia). To account for this risk, keep a close eye on Colfax's organic growth rate (and make sure the company continues reporting it to investors). We'll also want to make sure the company keeps the key people -- including CEO John Young, Chairman Mitch Rales, and director Tom Gayner -- it's counting on to help price and integrate acquisitions. Without them, the Danaher example is irrelevant. If these leaders start to leave or if we see several failed acquisitions, then I'd sell. Finally, there remain operational risks, including a longer market slowdown and an asbestos liability suit that could cause the company to take a charge against earnings. Though both of these risks could lead to near-term volatility, I expect them to lessen over time.

Foolish Bottom Line In Colfax, you're buying shares of a strong core business with supremely good management using a proprietary system for accretive acquisitions. With Danaher as proof that this model works, the combination should deliver outsized returns. The calamity in the market gives us the opportunity to buy at a price that's not only less than the IPO level but also dramatically understates the company's potential. In times like these, investors should focus on buying excellent companies with superior management teams and significant growth potential. That's precisely what we have with Colfax. As this story unfolds, I think Tom will be proud -- and maybe even a little jealous. Tim owns shares of Colfax. The Motley Fool owns shares of Markel.

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STOCKS 2009

Dolby Laboratories: Sounds Like a Winner

by tom gardner and rex moore

dolby laboratories

NYSE: DLB Headquarters: San Francisco, Calif.

FINANCIAL SNAPSHOT

Recent Price: . . . . . . . . . . . . . . . . . . . . . . . . $29.44 Market Cap: . . . . . . . . . . . . . . . . . . . $3.3 billion Dividend Yield: . . . . . . . . . . . . . . . . . . . . . . . . n/a Cash / Debt: . . . . . $420 million / $10 million CAPS Rating: . . . . . 5 Stars (89.65 out of 100) Buy Guidance: . . . . . . . . . . . . . . . . . . . . . . $40 Data as of 11/5/08

What it Does

Dolby licenses hardware and software to create, distribute, and play top-quality audio.

Why BuY

?? Dolby dominates audio standards, ensuring a place at every step in the content chain. ?? Strong brand opens opportunities to grow into new industries and technologies. ?? Founding management has huge ownership stake and commitment to increasing shareholder value.

Hear what we're saying: Sound specialist Dolby Laboratories (NYSE: DLB) is our kind of company, through and through. It's a three-time recommendation in Motley Fool Stock Advisor, and all the reasons we loved it when we picked it in 2006 still ring true today. The market has knocked the stock down to a compelling valuation, and Dolby gets our attention again as a great company to own for 2009 and beyond.

When it comes to excellent businesses that last for the long term, Dolby comes through loud and clear. The strength starts at the top, with a visionary founder and chairman who's still leading the way. Ray Dolby has a 53% ownership stake -- worth $1.7 billion -- as well as his own name and reputation tied up in the company, giving him plenty of incentive to keep working on behalf of shareholders.

But perhaps the best evidence of a company that's built to last is one that's actually ... lasted. Ray Dolby founded his namesake business back in 1965, so we're at 43 years and counting. This is a company that's thrived through every business cycle imaginable, and there should be no doubt it will survive the latest economic storm in fine fashion.

Of course, none of this would matter much if the business had become irrelevant or was stagnating. But Dolby's innovation is as strong as ever, and with exciting opportunities beyond the audio technology it's known for, this company has the potential for great growth for years to come.

About the Company

Dolby stands for sound quality. Its technology is pervasive in the electronics and entertainment worlds, reaching into almost everything that moves your ears. Besides enhancing your experience in theaters, the technology is at home in your TV, computer, video game system, DVD player, car stereo, and even headphones. At every link in the chain -- creating the audio, distributing it, and actually playing it -- Dolby is setting the standard and making money. Feast your ears on this:

Content creation: Dolby is a critical player in the audio industry because it lets electronics manufacturers make their own products better and cheaper. Dolby has steadily ramped up its research and development spending to reach 9.5% of revenue, or $57.5 million over the past 12 months. What that money buys is a wide range of new and improved technology that allows audio to sound better, stream faster, and fit into smaller spaces. For instance, Dolby's expertise allows original soundtrack-quality audio to fit onto the limited capacity of a DVD, which leaves more room for fun stuff like HD video and bonus features. Because the sound is encoded onto the DVD, that means Dolby's decoding technology is a must-have feature on every DVD player sold today.

Content distribution: Besides software-based compression, encoding, and decoding technology, Dolby sells hardware that allows broadcasters to transmit TV, cable, and satellite audio signals.

Content playback: Let's not forget the cinema! Dolby is huge in movie theaters, selling equipment that carries sound from the master recordings and through the speakers placed around the theater.

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