Good com­pa­nies don't al­ways make good stocks

I do not own Cum­mins cur­rently, how­ever. There is a vast dif­fer­ence be­tween a good com­pany and a good stock. At about $108, I think Cum­mins is fully priced.

The Pak Banker - - Editorial5 - John Dorf­man

As 2010 draws to a close, all of the biggest gain­ers in the Stan­dard & Poor's 500 In­dex and most of the biggest losers look like bad bets for next year. As of Dec. 14, the in­dex's best per­former for 2010 was Cum­mins Inc., a Colum­bus, In­di­ana, man­u­fac­turer of en­gines and power gen­er­a­tors. The stock is up about 136 per­cent so far this year. I have owned Cum­mins for clients on and off over the years. I think the man­age­ment team un­der Chief Ex­ec­u­tive Of­fi­cer Theodore Solso is sen­si­ble and takes the long view. An­a­lysts es­ti­mate the com­pany will post di­luted earn­ings per share of $5 this year, a record.

I do not own Cum­mins cur­rently, how­ever. There is a vast dif­fer­ence be­tween a good com­pany and a good stock. At about $108, I think Cum­mins is fully priced. It now trades at five times book value (cor­po­rate net worth) and 23 times earn­ings.

Here is a run­down on some other lead­ers and lag­gards in the S&P 500 this year:

Aka­mai Tech­nolo­gies Inc., lo­cated in Cam­bridge, Mas­sachusetts, helps to de­liver con­tent and monitor traf­fic on the In­ter­net. This is a stock in which for­tunes have been made, and lost.

From a high of more than $327 a share in 1999, Aka­mai fell to less than $1 a share in 2002. Since then it has re­gained trac­tion and risen to about $50. The good­com­pany, bad-stock syn­drome ap­plies here. I con­sider the shares over­priced at 51 times earn­ings and al­most nine times rev­enue.

Then there's Sales­ Inc., which is as pop­u­lar with in­vestors as Aka­mai was 11 years ago. A leader in cloud com­put­ing for busi­nesses, Sales­force saw its rev­enue grow to $1.1 bil­lion last year from $51 mil­lion in fis­cal 2003.

Shares in the San Fran­cis­cobased com­pany have ad­vanced about 86 per­cent so far this year.

Com­put­ing that in­volves stor­ing files and pro­grams on a host's servers is here to stay. It al­lows sales­peo­ple in dif­fer­ent cities to share notes and ob­ser­va­tions eas­ily. Yet I can give you three good rea­sons not to in­vest in Sales­force.

First, at 245 times the past four quar­ters' earn­ings, it has huge ex­pec­ta­tions built into the stock price. Sec­ond, an­a­lysts ex­pect its fully di­luted earn­ings per share to fall more than 20 per­cent this fis­cal year, end­ing Jan­uary 2011, be­fore growth re­sumes in the next two years. Third, Mi­crosoft is tak­ing ex­plicit aim at its mar­ket.

Wynn Re­sorts Ltd. like­wise seems over­val­ued. The op­er­a­tor of lux­ury casi­nos in Las Ve­gas, its head­quar­ters city, and Ma­cao, China, is priced as a hot growth stock at 83 times earn­ings. Yet its best earn­ings re­sult, $ 5.63 a share, came in 2006. This year an­a­lysts ex­pect it to earn about $1.14.

Price­ Inc., based in Nor­walk, Con­necti­cut, is up about 85 per­cent. I think it of­fers a use­ful on­line shop­ping ser­vice, and its ads star­ring ac­tor Wil­liam Shat­ner are funny. But pay 12 times book value and 42 times earn­ings? No way.

One might ex­pect to find bet­ter bar­gains among the S&P 500's lag­gards. This year's crop of un­der­achiev­ers doesn't ex­cite me much, but I do think there is re­bound po­ten­tial in H&R Block Inc. and Apollo Group Inc.

The biggest loser in the in­dex is Dean Foods Co., down about 55 per­cent so far this year. The Dal­las-based food and bev­er­age com­pany is cheap at eight times earn­ings, but its debt-to-eq­uity ra­tio of 271 per­cent is too high.

Yes, I know dairy prod­ucts, Dean's spe­cialty, are sup­posed to be a steady busi­ness that can eas­ily sup­port a heavy debt load. But ex­pe­ri­ence sug­gests that debt never mat­ters --un­til it does.

H&R Block, the largest U.S. tax pre­parer, is down about 43 per­cent this year. The Kansas City, Mis­souri, com­pany has prob­lems --mop­ping up af­ter a messy foray into mort­gage lend­ing, and more com­pe­ti­tion from sell­ers of tax-prepa­ra­tion soft­ware --but I think it has come­back po­ten­tial. At eight times earn­ings, I be­lieve H&R Block is a good can­di­date both for a quick Jan­uary bounce and a good year in 2011.

Apollo Group is down about 36 per­cent. I wrote about this com­pany and its com­peti­tors last month. In my judg­ment Apollo is more ca­pa­ble than most for-profit ed­u­ca­tion com­pa­nies of meet­ing pro­posed fed­eral stan­dards. Shares in the Phoenix-based com­pany go for seven times earn­ings.

Su­per­Valu Inc., a gro­cery and phar­ma­ceu­ti­cal-dis­tri­bu­tion com­pany based in Eden Prairie, Min­nesota, is trad­ing for only five times earn­ings.

That's tempt­ing, but I worry about the com­pany's debt, which is al­most five times eq­uity. The stock is down about 31 per­cent.

Fi­nally, Pul­teGroup Inc., a home builder in Bloomfield Hills, Michi­gan, is down about 30 per­cent.

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