“The Ultimate Buy Signal: Two Stocks Every Investor Should Be Loading Up On Right Now.”

by Travis Johnson, Stock Gumshoe | January 31, 2011 12:31 pm

Today’s tempting teaser is from the Motley Fool[1] brothers, Dave and Tom Gardner[2] — well, they didn’t write the ad, that fell to the publisher so they didn’t have to get their hands dirty with hucksterism, but they’re the ones recommending the stocks.

The ad’s theme is an update on one that they’ve been using for years at the Motley Fool: that there’s a special indicator that lets you know when stocks are going to be huge winners. Essentially, it boils down to the fact that when the Motley Fool Stock Advisor[3] (that’s their flagship newsletter) re-recommends a stock, it’s going to be even more successful than the stocks they’ve recommended just once.

So naturally, both David and Tom Gardner are re-recommending older picks right now, and we’re told that these might be the next Netflix or Quality Systems or Marvel, all picks that the Fool brothers have been pitching and re-pitching for several years (and yes, with excellent results — I unfortunately was too price-cautious to catch the Netflix bandwagon myself, but it was teased years ago by them[4] and I wrote about it, and Netflix is now the single best performer on any of the Stock Gumshoe spreadsheets with a gain of over 1,000% since mid-2007 when they teased it). Of course, having a huge winner like that means you can pick a lot of stinkers and still get a good average, so one should never assume that history will repeat — but it also means that I’m willing to give their ideas a look.

This time, they’re teasing different stocks in a format that is otherwise very similar to past ad letters — so let’s look at the hints they provide and identify the stocks for you, shall we?

The first one is easy — one that you will almost certainly guess just skimming the ad. Here’s a taste to test you:

“As I mentioned earlier, you’re probably already quite familiar with the stock that David Gardner[5] is re-recommending right now — and there’s a good chance you may even be a regular customer…

“After all, this is a company that millions of people around the world turn to every day to buy everything from books to shoes… diapers to cereal… golf clubs to cell phones… and digital cameras to power tools.

“Not to mention, it boasts both the number one most-visited retail website in the world and the 13th most popular website overall — trumping even giants like eBay, Microsoft, and Apple.

“And given this incredible global popularity, it probably comes as no surprise that this company brings in a whopping $30 billion per year in sales.

“But here’s something that probably will surprise you…

“Despite the fact that this stock has soared 1,149% since he first recommended it to Motley Fool Stock Advisor[6] members in September 2002 (and an amazing 5,876% since he recommended it for The Motley Fool’s real-money Rule Breaker Portfolio in 1997) David Gardner is convinced that there’s actually never been a better time to get invested in this company….

“In fact, in the most recent quarter earnings climbed an impressive 16% and sales soared an incredible 39%. Not to mention, the team behind its increasingly popular “e-reader” recently reported that the company has already sold more of these highly-profitable devices this holiday season than it did in all of 2009.

“Plus, given its dominance over the world of e-commerce, you can bet that as more and more retail spending moves online, this company will be in the perfect position to rack up astronomical profits and deliver blowout returns to its shareholders.”

OK, so you know who this is — but just to be clear, I’ll also tell you. It’s obviously Amazon (AMZN)[7]. And yes, this is yet another stock that I’ve been skeptical of for years, so another opportunity to have egg on my face — I don’t think I’ve ever written in detail about Amazon, and I do love the company as a customer (I also use their payments system for paid membership to this site), but I have told plenty of people over the years that I thought there was no way their tiny profit margin and high valuation could work out well forever. That’s still the impression I get when I look at Amazon shares, so you probably want to seek out an AMZN opinion from someone else. David Gardner loves stocks that other people think are overvalued (in fact, that’s one of his key “rule breaker” criteria), so I guess I’m helping him out on that front — I thought it was expensive at $50, which makes me the fool on this particular stock.

Perhaps the second stock teased, the one that’s re-recommended by David’s brother Tom, won’t be an idea that gives me feelings of regret? Let’s hope (and for what it’s worth, David’s more value-focused bent means he more often picks stocks that are likely to appeal to me). Let me pull out a few clues for you.

Gardner calls this stock “a quiet monster of a winner,” and we get a few hints in the text of the tease:

“… most investors have no idea this company even exists — despite the fact that BusinessWeek called it out as one of the fastest growing companies of the past decade and its stock shot up more than 1,100% over the same period.

“But I guess that’s no surprise when you consider that this company operates in a highly technical behind-the-scenes industry that quietly rakes in over $55 BILLION per year.

“So, what exactly does this company do?

“Well, that’s a bit complicated and honestly, I don’t have time to explain it all to you here. But I will say that if you’ve ever been to a hospital or seen a doctor, you have almost certainly used this company’s services.

“That’s because this company is one of two dominant players that operates in an extremely-vital niche of the healthcare[8] industry. Not to mention, it has over 1,500 offices scattered around the country and serves millions upon millions of patients each year.”

Then we get some more on the numbers:

“In fact, one of the things Tom Gardner is most impressed with is that it has managed to maintain 19-20% operating margins for a full decade — and turn in returns on equity north of 22% for each of the past five years….

“… in the first three quarters of this year alone, management has already bought back 4.3% of the company’s outstanding shares — and it’s authorized some $243 million worth of buybacks in total….

“… projected to bring in a whopping $4.9 billion this year alone — despite being valued at less than twice that…

“And trades for just 12 times free cash flow — which should come in at about $700 million this year…”

And interestingly, Gardner apparently believes there’s a long-term catalyst behind these shares due to our aging[9] population — here’s the quote on that:

“You see, the typical 50-year-old will use the services this company provides an average of five times per year. But that number MORE THAN DOUBLES for those people aged 65 and older.”

So, have you done your reading between the lines? This one is not nearly as obvious as the Amazon idea above, but when you talk about growing usage with age, a large duopoly market, and a large number of offices around the country, it sounds to me like you’re talking about medical testing and diagnostics labs — the places that tell you your cholesterol[10] level, or run drug tests for your business.

And yes, there are really just two big nationwide players in this area, Quest Diagnostics (DGX)[11] and Laboratory Corporation of America (LH) — just as with the insurance companies that are their major customers, there has been heavy consolidation in this business. They’re very similar in both size and valuation (and are both recommended by different Motley Fool newsletters and analysts). And what do you know, one of those companies is a match — given the specific teaser clues, this pretty well has to be Lab Corp (LH).

Yes, Laboratory Corp’s operating margin has very consistently been in the 19-20% neighborhood for many years, usually a percentage point or two better than Quest’s. LH posted just under $4.9 billion in revenue for the last four quarters, far smaller than the $7 billion+ reported by Quest (so it’s a good thing their margins are a bit better). Both companies, for what it’s worth, have been pretty active at buying back their own stock in recent years, though LH carries substantially less debt than Quest (neither carries enough to worry about, in my opinion, given their high and consistent cash flow and profitability numbers). And yes, to further the match, LabCorp has about 1,500 locations and Quest, a little bigger and a smidge less efficient, is up at about 2,000.

In terms of traditional PE valuations, LH is a bit more expensive than DGX — LH has a forward estimated PE of about 14, DGX is about 12. Both have well over a dozen analysts covering the shares, and those analysts have been reasonably close to the numbers over the past four quarters, so those estimates are probably worth considering even if they’ll undoubtedly be off by a bit. Trailing PEs are similarly close, but LH is again a bit pricier, you pay slightly more for the company that has less debt and is a little bit more efficient … and, not inconsequentially, has had a far better stock chart for the past one, two or five years, handily beating Quest’s fairly tepid performance.

Still, if Stock Advisor readers have gotten a 188% gain on these shares, that means they must have bought this one many years ago — 2004 at the earliest. Not that almost tripling in seven years is bad, just wanted to clarify that past gains were not instant, and given the large size and steady compounding nature of the business we’re unlikely to see another Netflix here (or even another Quality Systems, which has done spectacularly over the many years they’ve re-recommended it but was and still is far smaller than LH).

Taking just a pretty quick look at their numbers, and without any real fundamental understanding of any qualitative differences between the two, I’m tempted to call DGX an undervalued stock with a little tiny bit of hair on it, and LH a blue chip grower for which you pay a slight premium … but really, we’re talking about pretty small distinctions among two companies that form a tight (80%+ of the market, reportedly) nationwide duopoly.

If you’re looking for other distinctions, it appears that Quest is actively expanding overseas in Mexico[12], the UK and India[13], and LabCorp, though they have some international partners, seems less active in that regard. And though the distinction is slight because of the paltry size of the payout, DGX does offer a dividend and LH does not.

Given the increasing consolidation in this business, and the continuing focus on efficiency by insurance companies that’s forcing more and more outsourcing to labs like Quest’s and LabCorp’s for everything from basic blood screening to drug testing and genetic testing, along with the increasing dependence on personalized pharmaceutical regimes (which requires more testing), I wouldn’t argue against either of these stocks as long-term winners and likely beneficiaries of the aging population.

In fact, now I’m wondering why I’ve never owned either of these stocks. But I don’t — and for full disclosure, I don’t own any of the other stocks mentioned above either, and won’t trade in any stock mentioned for at least three days.

If you’ve got an opinion on Amazon or the medical laboratory stocks, please let us know with a comment below. And if you’ve subscribed to the Fool’s Stock Advisor newsletter[14], please let us know what you thought by clicking here to review it for your fellow investors[15] today.

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