At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and “initiating coverage at neutral.” Today, we’ll show you whether those bigwigs actually know what they’re talking about. To help, we’ve enlisted Motley Fool CAPS to track the long-term performance of Wall Street’s best and worst.
Wading into the steel sector Wednesday, Longbow Research announced a series of four new stock initiations — three buys, and one hold. Now, there’s nothing unusual about that on its face. After all, across the length and breadth of Wall Street, multiple analysts make dozens of picks (and pans) every day of the trading week.
What’s significant about Longbow, though is that it’s actually good at this stock picking thing. (Well, usually. As you’ll see in a moment, even good stock pickers sometimes make boneheaded calls). Ranked in the top 5% of investors we track on CAPS, Longbow gets the majority of its stock picks right, and tends to outperform the market by about 11.9 percentage points per pick. That seems like statistically significant outperformance, folks. So today, let’s take its picks one at a time, beginning with…
Nucor Corporation (NYSE:NUE)
According to Longbow, one of the better steel buys out there today is mini-mill specialist, and maxi-market-cap operator Nucor Corporation (NYSE:NUE). According to Longbow, checks on inventory and pricing at distributors suggest the steel market is approaching a “near-term bottom” in pricing. If second-half 2013 non-residential construction projections hold up, this could be good news for Nucor.
This is, however, a big “if.” Last week, the Steel Market Update newsletter reported that market giant U.S. Steel has raised its base prices for all flat-rolled steel by at least $50 a short ton. According to SMU, the last time USX made a move like this, it “marked the bottom, and list prices moved higher almost immediately.” AK Steel Holding Corporation (NYSE:AKS) quickly followed USX’s lead, announcing its prices for carbon flat-rolled steel are going up “at least” $50 a ton.
Needless to say, price hikes at competitors bode well for Nucor Corporation (NYSE:NUE), offering breathing room for the company to raise its own prices, and offering the prospect of fatter profit margins for all concerned. That said, if projections don’t bear out — if the revival in steel pricing should turn out to be a mirage — then a rally in Nucor’s share price could turn into a rout.
Already, the stock looks overpriced at a P/E ratio of nearly 29, but only 8% long-term earnings growth projected. Meanwhile, free cash flow at Nucor Corporation (NYSE:NUE) is exceedingly weak — barely $0.50 in FCF for every $1 the company reports as net income. Suffice it to say that a price-to-free cash flow ratio of more than 57, I’m not optimistic about Longbow’s first pick.
Steel Dynamics, Inc. (NASDAQ:STLD)
Moving on then to the analyst’s second recommendation, we find Nucor twin Steel Dynamics — again, a mini-mill operator, albeit smaller in both market cap and apparent overvaluation.
Steel-D costs only about 20.8 times earnings. What’s more, the company’s producing much healthier cash profits than its larger rival. Free cash flow for the past 12 months came to $222 million — 35% ahead of its $164 million in reported income. At 15 times free cash flow, growing (faster than Nucor) at 15%, and paying a 2.7% dividend yield, I’m inclined to favor Steel Dynamics.
