Finding the Right Chemistry - A Look at a Historical Analyst's Approach

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Emil Weiss, of Bache & Co., has developed an excellent pattern for projecting chemical earnings and stock prices on the basis of historical data.

According to Weiss, earnings are a function of: profit margins, which vary directly with changes in the business cycle; and sales per dollar of gross plant, which also vary directly with changes in the business cycle. In other words, both of these ratios decline together during recessions and rise together during recoveries.

Stock prices, contends Mr. Weiss, are a function of historical price-earnings ratios, which in the case of well-seasoned chemical stocks, have been quite firmly established for years. Thus, after determining the potential peak earnings attainable by individual companies during the expansion phase, we next apply the average price-earnings multiple range of high and low recorded during the past five years.

In Mr. Weiss' opinion, earnings of companies in the chemical industry reached bottom in the first quarter of 1961, which should serve as a base for rebound into a new business recovery.

"Using historical data as a guide to the future," he said. "We believe the chemical industry's earnings could rise about 20 percent from the previous peak in 1959, while the prices of the five stocks included in this survey could rise as much as 50 percent without in any way exceeding the bounds of well-established historical precedent."

The five stocks used in the survey were Rohm and Haas, Union Carbide, Olin Corporation, Monsanto Chemical and Hooker Chemical. Should this projected earnings rise materialize, Mr. Weiss believed "the price-earnings multiple for the entire chemical group will move from 18.5 times (peak estimated earnings) where it is now to about 26.2 times earnings, the average peak level of the past five years for this group as a whole."

Historically, chemical stocks enjoy comparatively high price multiples, ranging from 18 to 26 times earnings. According to Mr. Weiss, these high multiples are due to (a) above-average growth in earnings and (b) the dependability of an earnings growth pattern, since all major chemical companies are highly diversified and are seldom, if ever, seriously hurt by severe trouble in more than one or two products at any given time.

The term "profitable selectivity" is used by market analysts to describe the "new approach" to chemical stocks and can be applied to other industry groups.

As most industry leaders represent rather broadly diversified areas, which sometimes have the effect of offsetting one another in earnings variations, more profit should be found in the smaller companies specializing in more attractive product areas. Such a company is Onyx Chemical, which Hugo Kappler of Boenning & Co. called a growing firm with an exciting future.

Onyx Chemical makes surface-active agents, resin-polymers, catalysts and wax emulsions. Its growth will probably come from new products, new applications of existing products, and acquisitions. Its antistatic compound, for instance, is new; there is nothing like it on the market. And its emulsifying agent for rocket fuels demonstrates a new use for an existing product.

In the medium-sized group, Tennessee Corporation is an example of specialization in some attractive product areas. With an outstanding growth record, it engages in a major expansion program aimed at increasing demand for concentrated phosphatic chemicals. According to Shirmer Atherton & Co., the company has grown in the past 10 years at the annual rate of about nine percent, or 16 percent compounded, and is expected to grow at least that fast for the next five years. An annual growth rate of even six or seven percent in the chemical industry is considered good.

Does the current market offer the same chemistry? Taking a careful look at the past may help you decide!

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