With positive U.S. economic data hitting the wire on an almost daily basis, we thought this would be a good time to gauge the state of corporate earnings for U.S. companies and look ahead to how improved economic reports might be impacting analysts’ estimates. More specifically, we’ll look at expectations for the current quarter and for fiscal year 2012 in the context of the earnings season just ended and the trend of corporate earnings in the last year. As companies get ready to close the current quarter, investors begin to anticipate the upcoming season and the impact it will have on full year earnings, ultimately the biggest driver of stock prices; in this context, it is MarketGrader.com’s goal to serve as a guide during upcoming earnings seasons to help investors follow specific sectors, industries and stocks that might be affected by changing expectations. MarketGrader.com’s analysis of corporate earnings, tallied in our “Earnings Season Report Cards,” is based on a bottom-up approach by which we measure reported and diluted earnings per share and aggregate the values across our broad coverage universe as well as for broad market indexes, particularly the S&P 500 and the equally-weighted Barron’s 400. By tracking on a daily basis earnings reports relative to analysts’ expectations we are able to maintain a running total of quarterly and annual earnings that help investors understand whether companies are collectively reporting ahead or below expectations and what sectors and specific stocks are contributing the most to the upside and downside.  This particular report will focus on corporate earnings for the S&P 500.

By MarketGrader.com’s account, earnings for the S&P 500 were virtually flat relative to the fourth quarter of 2010. With 475 of the 500 companies (or 95%) reported to date, index components are on pace to report $21.33 in fully diluted earnings per share in Q4 2011, putting it 0.5% below the $21.43 earned in the equivalent quarter a year earlier. Sequentially, when comparing the results against Q3 2011 earnings per share of $22.32, the drop was 4.4%. It’s important to note that MarketGrader.com’s tally of fully diluted EPS is lower than the tally of EPS as reported by the companies since the share base across most companies based on full dilution is larger than the number of shares used to calculate reported EPS. The trend of companies beating their consensus estimate last quarter was also negative compared to the third quarter, with 59% of all companies surpassing analysts’ expectations compared to 69% during the previous earnings season. While the number of companies that met estimates remained unchanged at 11%, the deficit in positive earnings surprises showed up in the earnings miss category, with 30% of companies failing to live up to their consensus estimate vs. 20% in the prior period. Despite a flat fourth quarter, S&P 500 companies reported a healthy 11.8% increase in diluted earnings per share for all of 2011 to $87.48 compared to $78.25 earned in 2010. Such increase is what has kept stock valuations within reason despite a gain of over 20% since early October in the main market benchmarks, along with rising estimates for the quarters ahead, which make forward P/Es appear relatively benign.

On a sector-by-sector basis, Consumer Discretionary was the big winner of 2011’s fourth quarter, with diluted EPS up 78% in the aggregate compared to the comparable period in 2010. It was followed by modest gains of 8% for financials, 6% for Industrials and 4% for Technology. The quarter’s biggest laggard was Materials, with diluted EPS coming in 71% lower than the Q4 2010 reports. Nominally, Telecommunications companies fell in the aggregate by more than 100% but this is simply an arithmetic quirk as the group as a whole reported negative diluted EPS. The two other sectors that reported earnings below the year earlier period were Consumer Staples, down 31% and Utilities, down 15%. Health Care was essentially flat with a 1% gain.

Some notable names that were upgraded by MarketGrader.com following their earnings report were Yahoo (YHOO – Hold), Ford (F – Buy), Humana (HUM – Buy), American International Group (AIG – Hold) and Paccar (PACR – Buy). Notable downgrades included Chevron (CVX – Sell), First Solar (FSLR – Sell), Alpha Natural Resources (ANR – Sell), Newmont Mining (NEM – Sell) and Hewlett-Packard (HPQ – Sell). For the complete list please visit our Earnings Season Report Card.

In contrast to last quarter’s flat earnings, analysts continue to sound bullish about earnings prospects for the S&P 500 both in the first quarter of 2012 and for the full fiscal year. Consensus estimates show the index earning $23.63 per fully diluted share this quarter, an increase of 11% from 2011’s first quarter. Full year 2012 earnings expectations are even rosier, with analysts polled by FactSet Research expecting aggregate S&P 500 diluted EPS of $103.99, up 19% from the $87.48 earned in 2011. On a quarter-by-quarter basis, S&P 500 companies are expected to report diluted EPS gains of 15% in the second quarter, 20% in the third quarter and 30% in the year’s last quarter. All else being equal, if analysts’ forecasts materialize into actual reported earnings for S&P 500 companies, the index would need to climb an additional 19% from current levels to 1,643 to maintain the exact same trailing P/E of 15.8 it sports today (based on fully diluted earnings.) With European sovereign yields for peripheral countries still dangerously high, the potential for U.S. rates to start climbing sooner than the Fed anticipates and what promises to be a highly contested November election, equity investors would no doubt sign off on such a bet today with over three quarters of the year still left. While we can’t predict the future, we do look forward to tracking and reporting the results in quarters to come.

With the U.S. stock market at or near 52-week highs, depending on which benchmark you look at, and an uneasy complacency among investors seemingly setting in, we thought an update on our MarketGrader Sentiment Index might serve as a reality check. For those not familiar with the index, or MGSI as we call it, we suggest a quick read of our October 5th, 2011 introductory post, available here. To summarize: MGSI tracks the ratio of stocks in the MarketGrader.com coverage universe with a positive sentiment to those with a negative sentiment. Such ratings are based on our four sentiment indicators that track price momentum, price trend, earnings guidance and short interest. Any reading of the MGSI ratio above 2.5 suggests excessive investor optimism, while a reading below 1.5 suggests excessive pessimism. Extreme readings above 3.0 or below 1.0 suggest extreme scenarios. Which brings us to our current state of affairs.

Before discussing what MGSI is saying today it is worth noting how we got to our current state of collective enthusiasm for stocks. Since our October 5th warning of an extreme reading of 0.14 (with seven stocks in negative sentiment territory for each one with positive sentiment) the market has rallied strongly as the risk premium in risk assets has fallen significantly. Since our article, the S&P 500 Index has gained 20.8% with the Dow up 19.4%, the NASDAQ Composite up 23.1% and the Russell 2000 up 28.0%. We’ll take this opportunity, of course, to highlight the performance of the MarketGrader-powered Barron’s 400 Index, up 29.2% since Oct. 4th 2011. In rising periods such as this one the B400 clearly continues to outperform. Perhaps more telling than the rise in these benchmarks has been the fall in the VIX, the now ubiquitous measure of implied volatility in S&P 500 options, which closed Thursday 53% below its Oct. 4th level.

This forceful rise in equities in the last four and a half months has expectedly pushed the MGSI to and all-time high of 4.96, solidly in what we call “Extreme Optimism” territory. Today there are 1,175 stocks in MarketGrader.com with positive sentiment and only 358 with negative sentiment. To put this into perspective, since MGSI’s inception in November 2008, the index has spent only 20 days above 3.0 and three days above 3.5. And this rise has been powered by stocks across the board, as seen from our individual sector MGSI sub-indexes. These essentially track the same ratio of positive-to-negative sentiment stocks MGSI tracks but on a sector by sector basis across nine sectors. Of all nine MGSI sectors tracked by MarketGrader, seven are currently scoring above 2.5, inside our “Excessive Optimism” territory. Six of the seven currently score above 3.o, inside of our “Extreme Optimism” area. These are all at 52-week highs. The seventh, Energy, is not at a yearly high but is only a stone’s throw away from getting there. The sector with the most extreme reading is Financials with an off-the charts MGSI level of 9.61. Of the 15 stocks in the sector with a sentiment score above nine (out of 10) only three have a ‘Buy’ rating based on underlying company fundamentals. The only two sectors not in the overly optimistic camp are Telecommunications, which only counts a very narrow 109 companies and Materials, a somewhat broader group. Telecommunications, at 0.88, is actually in “Extreme Pessimism” territory and Materials, at 2.11, is in neutral, or ‘Goldilocks’ territory, not too hot,not too cold.

The MarketGrader Sentiment Index readings should be seen as tactical, rather than strategic market calls, considering they are based on a very narrow view of the market, namely through investor sentiment. Investors should place the MGSI readings in the context of macroeconomic trends and overall earnings-driven trends for U.S. companies. From the perspective of company fundamentals we feel generally bullish about the case for equities in the years ahead, particularly given the lack of earnings multiple expansion despite the aforementioned increases in stock prices. With three quarters of the S&P 500 and 83% of the Barron’s 400 companies having already reported results this earnings season, both indexes are still trading at below historical P/E ratios of 13 and 14 times 12-month forward earnings respectively. And while corporate earnings gains have slowed down from the early 2011 pace, U.S. companies continue to show productivity gains and are sitting on piles of cash and mostly sound business models. This will, however, be the subject of a separate story. For now cautious investors might want to keep an eye on MGSI, available for free here at MarketGrader.com.

With the stock market up 20% since October (MarketGrader Sentiment Index Flashes ‘BUY,’) we thought this would be an appropriate time to highlight some of our best values stocks, available this week to MarketGrader.com guests in our featured Value Honor Roll.

One company in particular that caught our attention this week is Power-One, Inc. (NASD: PWER), a California-based manufacturer of power supplies and equipment used in the communications, semiconductor, health care and industrial sectors. In our view the company’s business segments put it in a strong position to benefit from two ongoing growth trends: the development of alternative sources of energy and the ongoing ‘cloud’ build out. The company manufactures solar and wind inverters, equipment that transforms energy from those two alternative sources into usable electricity. Exposure to this market segment, while promising, brings with it volatility given the nascent state of this industry, its dependence on venture capital and government incentives and the resurgence of the oil and gas industries in the U.S. On the other hand, its lineup of power supplies puts the company in the very real and very profitable position of providing critical equipment to the build up of data centers and the ‘cloud’ as companies from Amazon to Google race furiously to expand their networks.

The stock, currently at $5.15 a share, trades 43% below its 52-week high, mostly as a result of lowered guidance by management in the last quarter of 2011. However, since then, the company had a strong earnings report on February 2nd, beating analyst estimates by 50%. Its fiscal year 2012 consensus estimate is up now to $0.90 per share from $0.76 three months ago, an increase of 18%. And while the company’s revenue fell 27% last quarter from the year earlier period, its overall financial position is very strong. Trailing 12-month revenue is up 89% in three years, when the company was posting full year losses. In the last 12 months it earned $127 million. It is clear that the company is not only growing, but doing so profitably while systematically fortifying its finances. It has been trimming its debt load, which peaked at $110 million in 2008 and is down now to a mere $36 million, accounting for only 8% of total capital. All of it has long term maturities. Power-One generated $178 million of free cash flow in the last 12 months and now has $204 million in cash on hand. Also on a trailing 12-month basis its return on equity was 31% and its return on capital was 40%. The company generates almost $300,000 in revenue and $37,000 in net income per employee, both above the industry average.

The stock trades at a meager 5.5 times trailing earnings and 7.6 times next year’s estimates. It also trades at 0.5 times trailing 12-month sales, a fraction of the 3.5 price-to-sales ratio industry average for its peers in the Electrical Products industry. A few investors seem to be catching on; the stock’s Sentiment score has been climbing rapidly in recent weeks from a December low of 3.8 to its current 6.6 (out of 10.) But long term investors need not hurry as this is still, by our account, a value play. While Power-One has an overall MarketGrader grade of 77.8, when graded from the value perspective (where our system emphasizes value indicators over growth indicators) the overall grade jumps to an impressive 91.8. It is worth mentioning also that 12% of the company’s float is sold short, which, in combination with a small market cap of $630 million could represent unwanted volatility for the more conservative types. Long term, however, the stock looks solid from our vantage point. Please click here for our complete analysis.

With the stock market off to a solid start two weeks into the new year and following a string of mostly positive economic reports, investors have warmed up pretty quickly to U.S. equities. This, of course, has been playing out for a couple of months as market pundits and equity strategists developed and announced their predictions for the new year. While we mostly subscribe to the view that U.S. stocks seem well positioned for a decent run in the years ahead, especially as the U.S economy continues to recover and the Europeans slowly sort out their fiscal mess, we have started to look at European equities as perhaps the best place to hide from the crowd. More specifically, as investors shun the stocks of European companies simply by virtue of their domicile, we think several companies offer compelling investing opportunities for those willing to tune out all the noise.

MarketGrader.com does not yet grade companies listed in European exchanges, so our analysis is mostly limited to those with American Depositary Shares. More specifically we have looked for companies with strong MarketGrader scores, of course, but also with compelling valuations and a significant share of their business generated outside of Europe’s sickest areas in the continent’s indebted south. And those domiciled in countries with their own currencies, and thus monetary policies independent of the ECB, seem to us to offer even greater appeal. Among them we find a handful we’ll be highlighting in this column in coming days. The first one, and perhaps one of our three favorites, is Statoil ASA ADS (NYSE: STO).

Statoil is Norway’s national oil company. It generates 78% of its revenue in Norway, 10% in the U.S. and another 10% across the rest of the world. While Brent crude has traded around $110 a barrel for the better part of the last year, the Norwegian Krone has depreciated by approximately 15% in the last six months against the U.S. dollar, mostly because of the strengthening of U.S. economic indicators, a dynamic that boosts the value of the company’s dollar-based revenues. And as it happens to be, Statoil, with an overall grade of 78.8 (out of 100,) is the highest ranked company among the 18 oil ‘majors’ followed by our system and classified in the Integrated Oil industry. Chevron and Suncor Energy round out the top three in the group.

Statoil’s 12-month trailing net income of $11.4 billion is up 25% from three years ago, which might not seem like a hit-it-out-of-the-park number but considering that in the depths of the global recession two years ago, for the 12-month period ended in September of 2009, the company earned $2.08 billion, the latest results reveal a remarkable comeback as energy demand roared back to life. Of particular importance is the fact that even though capital expenditures have been growing at a year-over-year clip of about 25% in the last four quarters, the company’s free cash flow last quarter almost tripled from the year-earlier period. This helps explain an across the board margin expansion in the last 12 months, with EBITDA margin at an impressive 41.7% and operating margin of 29%.

Statoil’s stock trades at only seven times trailing 12-month earnings despite a two-year EPS growth rate of 134%. Its P/E based on the next 12 month’s earnings estimates is only 9. Furthermore, if the company’s $17.04 billion in cash is subtracted from its valuation, the stock’s trailing P/E would fall to a ridiculously low 5.7.

It’s important too that investors understand the company’s ownership structure, which we think adds to its appeal. The number of shares outstanding has remained virtually unchanged in the last five years, at 3.18 billion, probably as its largest shareholder, the Norwegian government who owns 71% of them, prefers to avoid diluting its stake considering how important the company’s contribution is to national coffers. To put this into perspective, Statoil’s 12-month trailing revenue of $110 billion is the equivalent of 41.5% of Norway’s GDP of $265 billion, according to the IMF’s most recent figures. With such a small float (29%) owned by shareholders other than the government, even a small increase in demand for the stock, such as what would happen once it’s clear that Europe will sort out its current troubles, could drive up the share price pretty quickly. And while at $80 billion in market cap the company’s valuation might seem too high to move to the upside too quickly, at $25 (today’s close) the stock is trading 40% below its pre-Lehman high of $41.68, reached in May of 2008. And yet when the company reports earnings next month February 9th, if the consensus estimate is somewhat close to the reported number, Statoil is expected to have earned $2.67 per share, above the $2.63 earned in fiscal year 2007, right before the financial crisis brought the world economy to a halt. The company’s return on equity, currently at 26.23% is also almost back to the pre-recession level of 28%.

Statoil’s $20.35 billion on total debt, or $3.3 billion in net debt when cash on hand is subtracted, accounts for only one third of its total capital, giving the company ample room to increase its dividend payout which at current levels translates into a yield of 3.9%. And with interest rates at rock-bottom levels and the company’s excellent return on equity and return on invested capital (52.4%) it would be silly not to continue funding exploration and production projects with additional debt. It would also be silly for investors to assume Statoil is simply another European stock to avoid.

Readers that are not yet MarketGrader.com subscribers may view our complete analysis of Statoil by clicking here or by visiting this week’s featured Honor Roll: Large Caps.

The MarketGrader Indexes turned in another solid showing in 2011, particularly considering the market’s continued uncertainty and resulting volatility. Among all indexes the year’s best performer was the MarketGrader Health Care Index, which was up 17.18% in 2011, comparing very favorably to its benchmark, the Dow Jones US Health Care Index, up 9.44%. Since 2002 MG Health Care has had only one down year, when it lost 26.08% in 2008. This is reflected in its 3 and 5-year annualized returns of 17.13% and 5.45%, besting the benchmark’s 10.20% and 1.59% respectively. For our readers that aren’t MarketGrader.com subscribers yet, you may view the current components of the MarketGrader Health Care Index by clicking here. For all other index components, including the Barron’s 400, please take a free trial.

Two other notable performances among our sector indexes were attributed to the MarketGrader Consumer Staples Index, up 12.96% in the year and the MarketGrader Financials Index, up 2.30%. The latter might not seem like much but it’s impressive considering its benchmark, the Dow Jones US Financials Index lost 14.62% in 2011. MG Financials now sports a 3-year annualized return of 10.46% and a 5-year return of -6.41%, which of course includes 2007 and 2008 when it lost 17.77% and 35.22% respectively. The Dow Jones US Financials Index is up only 2.66% per year in the last three years and down 16.20% on a 5-year annualized basis, a full 10 percentage points below our index. In the case of our Consumer Staples Index its 3 and 5-year annualized returns are 18.70% and 5.00%, handily beating the Dow Jones US Consumer Goods Index, with annualized returns of 13.91% and 2.78% respectively in the equivalent periods.

The Barron’s 400 Index had a flat year, actually ending 2011 down 0.41%, essentially in line with the S&P 500. However, its 3-year annualized return, now that 2008 has fallen off the back of the calculation, is an impressive 19.30% compared to the S&P 500’s 11.66%. Who said money can’t be made in stocks anymore? On a 5-year basis, the Barron’s 400 is up 1.38% per annum, besting the S&P’s -2.38%. Among our Core indexes, who share the Barron’s 400 methodology, last year’s best performer was the MarketGrader 100 Index, up 1.83% for the year and 19.45% annually since 2009. It is worth noting that MG 100, MG 200 and the Barron’s 400 all beat the mutual fund Multi-Cap Core average in 2011 and certainly on a 3 and-5 year annualized basis. Active managers in the category lost, on average, 2.29% in 2011 while still being up 13.86% per year, on average, since 2009. This is an underperformance of almost 550 basis points relative to the Barron’s 400.

A stellar performance worthy of a stand-alone mention was turned in by the MarketGrader Mid-Cap 100 Index, which gained an impressive 8.77% in 2011, beating by a mile the S&P 400, which lost 3.01% and the average of all mutual funds in the mid-cap category, who collectively lost 3.57%. In the last three years the MarketGrader Mid Cap 100 is up an astounding 24.09% per year, compared to 17.77% and 16.95% for the two aforementioned benchmarks.

A thorough analysis of our performance last year isn’t complete without a mention of our laggards. Among them was the MarketGrader Small Cap 100 Index, which lost 3.22% while the S&P 600 Index lost 0.16%. If it’s any consolation (and it’s not,) the loss wasn’t as bad as the 3.75% average decline of all U.S. mutual funds in the small cap category. Among our sector indexes the MarketGrader Consumer Discretionary Index lost 0.22% while the Dow Jones US Consumer Services Index gained 5.50% and the MarketGrader Energy Index lost 3.81% while the Dow Jones US Oil & Gas Index gained 2.32%. In both cases the MarketGrader indexes are still beating their benchmarks on a 3 and 5-year basis.

The year’s worst underperformer was the MarketGrader Technology Index, which fell 10.50% compared to the Dow Jones US Technology Index’s loss of 0.83% and the tech-heavy NASDAQ Composite’s decline of 1.80%. However, MG Technology is still solidly in the black on a 3 and 5-year basis, up 20.14% and 4.20% per annum respectively.

Please click here for our complete 2011 MG Indexes Report Card. Happy investing in the New Year.

Barron’s popular Electronic Investor column published last month a brief article on MarketGrader.com’s sentiment indicator and how we aggregate all companies’ scores of the same into our MarketGrader Sentiment Index. For those who missed it, we first introduced our Sentiment Index, which we’ve dubbed MGSI, in early October when the stock market hit its 2011 lows as measured by the S&P 500, the Dow Industrials and, of course, the Barron’s 400 Index. The S&P 500 closed the prior day at 1,099.23 while the Dow closed at 10,655.30. The Barron’s 400 closed at 268.51 on October 3rd. Our article, which was also published on Seeking Alpha, garnered a good deal of attention and prompted many of our readers and subscribers to ask us for a place in MarketGrader.com where they could follow the new MGSI. We complied and launched our new MGSI page also last month, which you may view here.

For those who didn’t catch the Barron’s article, published in the December 24th issue, you may read it here.

As for the MarketGrader Sentiment Index itself, we’d like to note that last night the index crossed the 1.5 mark for the first time since May 2011, which put its Market Call (based on the MGSI overall value) in ‘HOLD’ territory. For a better understanding of how MGSI works and what it means, please refer to our original October article, which you may read here. Since our October call, through last night’s close, the S&P 500 is up 16.2%, the Dow is up 16.5% and the Barron’s 400 is up 21.2%. Investors concerned about the market’s ongoing volatility, particularly given Europe’s lingering debt woes and looming recession, would be well served to check the MGSI periodically as a gauge of overall investor optimism or pessimism as we continue to toggle between risk-on and risk-off.

Being a successful contrarian investor takes skill and preparation; yet many talented and hard working contrarians are often proven wrong for too long before eventually being proved right in the long run, their portfolios paying a steep price in the process and often jeopardizing hard-earned gains–John Paulson comes to mind here. In a market as treacherous and volatile as today’s stock market, dominated by high frequency traders and double and triple inverse or leveraged ETFs, playing contrarian to investor sentiment can be disastrous. Good examples of this are Netflix and MF Global Holdings, two companies that could hardly be any more different from each other. One, a (once) high-flying Internet darling and the other a self-styled up-and-coming investment bank with more ambition than capital to support it. Yet they have at least one thing in common: they are both members of MarketGrader’s Declining Sentiment list, currently featured on our web site as the free stock idea list of the week. This list highlights the 100 stocks with the biggest four-week drops in Sentiment score.

While Netflix’s story reached a climax this week with the company’s disappointing earnings announcement, in which the it revealed a jaw-dropping loss of 800,000 subscribers in one quarter, the tug of war between NFLX bulls and bears has been playing out for months. And while today’s rock bottom Sentiment score of 1.1 (out of 10) might seem like yesterday’s news, NFLX has been a member of this not-so-select group for more than a month. Actually, signs of deteriorating Sentiment first surfaced based on MarketGrader.com’s analysis as early as June, when the stock’s Sentiment rating was first downgraded from Positive to Neutral. While the score stayed in a Neutral Sentiment range for most of the following two months a second major decline occurred in mid September when the Sentiment rating was downgraded from Neutral to Negative. This should have given cautious investors warning a month ahead of the company’s earnings announcement. While many would argue today that the company still has a solid business, generally strong fundamentals (we won’t argue with that) and a clear plan to steer its business away from DVD deliveries and towards streaming digital content (can’t argue here either,) such deterioration in Sentiment should have given investors pause in waiting for a better entry point given the stock’s lofty valuation (here our Rating Style Change feature comes in quite handy.) And for long term owners of the stock it should have served as a sign to take some money off the table and wait for the storm to pass. A history of Netflix’s Sentiment rating in the last two years is illustrated below.

MF Global’s story played quite differently in the last few months yet it had a similar (and scarier) ending this week. While MarketGrader.com has rated MF a ‘Sell’ since 2008, unlike NFLX which we rate a ‘Buy’ based on its fundamentals, a similar decline in the stock’s Sentiment score took place two weeks before yesterday’s earnings announcement. On October 11^th MarketGrader.com downgraded MF’s Sentiment rating from Neutral to Negative and added the company to the Declining Sentiment list. The chart below illustrates the decline in Sentiment earlier this month. The stock fell 47% yesterday following the company’s earnings report and is down again today more than 32% at the time of this article’s publication.

Investors without a MarketGrader.com subscription wondering who else might be on our Declining Sentiment list may view it for free for a limited time by clicking here. They may then view our complete analysis, both top-down (Sector, Industry and Sentiment) and bottowm-up (Fundamentals) for every company on the list. Subscribers may, of course, always access this and all other daily-updated lists in the Stock Ideas section under the StockGrader tab in MarketGrader.com.

We have written somewhat extensively in the past about our Sentiment score as a measure of, well, general investor sentiment surrounding a stock, irrespective of the company’s fundamentals. In some cases we have found it to be a decent leading indicator indicative of short-term price performance, especially in cases in which the qualitative story outweighs the quantitative story. This would be the case of, say, Netflix shares falling as the company very publicly sorts out its streaming vs. mail delivery businesses and corresponding prices, while continuing to report very strong financial results. Its Sentiment indicator started falling in June into ‘neutral’ territory after being positive, almost without interruption, since 2009, eventually turning negative in September as shareholder and subscriber backlash over its new pricing policies reached an almost hysterical climax. While Netflix is a widely followed story with ample media coverage many other stocks offer significantly fewer clues about their unfolding qualitative story and yet their stock price fluctuates making one think: “somebody knows something I don’t.” Our Sentiment indicator was designed, in a way, to provide such missing guidance. As we have followed—and written about—our Sentiment indicator on individual stocks (such as our recent post on ‘10 Value Stocks with Improving Sentiment,’) we have also followed the indicator across broad groups of stocks, including sectors and industries, and have identified certain patterns that we thought would be of interest to our readers and subscribers. More specifically, we have constructed a new indicator which we have called the MarketGrader Sentiment Index, that we hope will help investors navigate today’s manic-depressive, risk-on/risk-off stock market.

The MarketGrader Sentiment Index

The new MarketGrader Sentiment Index (we’ll call it MGSI for short) simply tracks the ratio of stocks with a Positive Sentiment indicator to stocks with a negative Sentiment indicator in MarketGrader.com. Unfortunately today we only have a little less than four years of history, essentially since our Sentiment indicator was first introduced in 2008. Fortunately, however, that was four months before a 10-year market low as stocks reeled from the financial crisis. While ideally we would want to look at the index in 2006 and 2007 leading into the market decline, the data we do have today, particularly from the first quarter of 2009, offers interesting parallels with today’s market, which, as being extensively reported, is nearing bear market territory.

Today MarketGrader.com covers 6,058 North American stocks, including more than 4,600 listed on U.S. exchanges and over 1,400 in Canadian exchanges. Collectively this coverage offers a pretty broad picture of the North American stock market. Of all stocks currently under coverage, 489 now have a positive Sentiment indicator and 3,449 a negative Sentiment indicator. The result is a ratio of 0.14. Considering that in the last four years the MGSI has moved in a range from 0.13 (March 2009) to 3.41 (January 2011,) the fact that its current level is very near the all-time low should not be overlooked by those wondering where we’ll go from here. A few historical points help put these values into perspective.

As mentioned above the all-time low for the MGSI was reached right around the 2009 market bottom, specifically on March 20^th, 2009. That day the S&P 500 closed at 832.86, which we now know was ten days after it reached a decade-low of 676.53 on March 9^th, 2009. MGSI stayed at 0.13 for a brief week, through March 26^th,before beginning a steady, almost uninterrupted climb that would peak seven months later on the back of a furious stock market rally. While the MGSI would dip into three distinct troughs after the October 2009 peak, it never breached what we now know is the important level of 0.5 again until a month and a half ago as the recent sell-off began to gain momentum (more in this later.) Please refer to the chart below for a four-year history of the MGSI plotted against the S&P 500 Index.

What happened to the S&P 500 from MGSI’s trough to peak? Between the MarketGrader Sentiment Index all-time low of 0.13 first reached on March 20^th, 2009 and its peak of 3.17 first reached on October 23^rd, 2009, the S&P 500 rose 40.5% from 768.54 to 1079.60. From the October 2009 peak MGSI fell for nine months to a trough of 0.69, which it first reached on July 16^th 2010. In this case, from peak to trough, the S&P 500 fell to 1064.88, a decline of only 1.4%. This nine-month decline was not, however, a straight line down as has been the case this year. In between the aforementioned peak and trough the MGSI had two temporary multi-month lows and two subsequent, multi-month highs, all while the market moved sideways. Worth noting is that never during this time did the indicator climb above 3.0 or fall below 0.5. This would change, though, in the next year, bringing us to where we are today, having breached this high and low point for the first time since 2009.

Following the July 2010 low, MGSI climbed almost in a straight line, breaching the 3.0 mark on January 31^st, 2011, which is now its all-time high. From bottom to top the S&P 500 rose to 1286.12, a 20.8% increase. The index stayed above 3.0 for only four days before beginning a steep, almost uninterrupted decline to its current level of 0.14, only 0.01 away from the all-time March 2009 low. In other words, today for every stock with a positive Sentiment indicator in MarketGrader.com there are seven stocks with a negative Sentiment. From top to bottom, since the January 31^st top, the S&P 500 fell 14.5%.

While it might be overly simplistic, and perhaps treacherous, to call a market bottom based only on the current level of the MGSI, putting it into the context of current company valuations helps illustrate how broad and steep the recent sell-off has been. On March 7^th, 2009, two days before the S&P 500 Index’s bottom, Barron’s cited in its cover story a Citigroup report that estimated full year 2009 profits for the S&P 500 of $51, not far from the consensus estimate at the time of $52. Based on the S&P 500 Index’s close of 683.38 on March 6^th, 2009, the forward multiple for the index based on 2009 estimates at the time was 13. The companies in the S&P 500 went on to earn, collectively, $62.20 in 2009 according to FactSet. Thus, with the benefit of hindsight, 13 times forward earnings was a good buying point for the S&P 500, particularly after its gut-wrenching decline of the prior year and a half. In contrast, analysts polled by FactSet Estimates today expect the S&P 500 to earn $95.40 in fiscal year 2011, putting the index’s P/E ratio at 11.5. This is not only 1.5 points lower than the March 2009 bottom multiple of 13 but it has the benefit of three quarters of reported earnings already in the books for 2011, compared to estimates in March 2009 before a single quarter of corporate earnings had been recorded. So, while the global economy might grind to a halt as buyers of U.S. government paper seem to imply today, it is pretty unlikely that the margin of error for 2011 corporate earnings would be such as to throw the current multiple off by more than a half a point or so.

But before we get ahead of ourselves it is worth looking a little further ahead into 2012. According to FactSet Estimates analysts expect, on average, the S&P 500 to earn $104.72 in 2012. If so, at today’s level, the index would be trading at 10.5 times 2012 estimates. Yes, we know, skeptics will yell: “no way, these estimates are too high!” Fair enough; if so we suggest then looking at the lowest estimate for S&P 500 earnings for both 2011 and 2012 among all firms polled by FactSet to compute their mean, which, courtesy of Jefferies, would be $82.33 in 2011 and $95.07 in 2012. Based on these estimates today’s S&P 500 would be trading at 13.4 times 2011 and 11.6 times 2012 estimates. Which brings us squarely back to the March 2009 P/E on the S&P 500 of 13 times full year estimates. Combined with the recent low in the MGSI described above, current stock market valuations spell B-U-Y.

There are a few points we would like to make in concluding. First, we understand the shortcomings of such a small data sample when referring to the MarketGrader Sentiment Index. As such expect additional research in the coming weeks on the index for the period before November 2008. Finally, while we don’t intend to track or use the MGSI as a market timing indicator, we do think there are a couple of levels worth watching for in the future, namely 3.0 on the high end (we think as an indicator of excessive bullish sentiment) and 0.5 on the low end (as an indicator of excessive pessimism.) From the brief history covered in this report both levels have only been breached twice in each case. On the high end both were followed by significant declines in the S&P 500. On the low end, the first came in March 2009, in one of the biggest buying opportunities in history. The second one, well, we’re about to find out.

While company valuations seem to have taken a back seat to global macroeconomic concerns in Septmeber, investors would be well served by identifying buying opportunities among stocks that in addition to having strong fundamentals are also showing resilience to the market’s recent turmoil as measured by investor sentiment toward their stocks. In this vein we have put together a list of ten value stocks that have high overall fundamental grades and a strong and rising sentiment indicator, as measured both by MarketGrader.com.

Our selection criteria is simple: we looked for companies with an overall grade above 70 (out of 100 total possible points) with a Value grade at least as high to their Growth grade. For context, MarketGrader.com’s 24-indicator analysis is broken down into Growth, Value, Profitability and Cash Flow indicators (six each) which are then aggregated into our final overall grade. Additionally, and perhaps more importantly in the context of today’s volatile environment, we looked for companies with a high Sentiment score in our zero to ten point scale. MarketGrader.com’s Sentiment Analysis is broken down into four indicators: Price Trend, based on a MACD analysis, Price Momentum, based on a relative price strength analysis, Earnings Guidance, which tracks the rate at which companies and the analysts that follow them change their next fiscal year EPS forecasts and Short Interest, based on monthly changes to short interest as a percentage of float. The top ten stocks to pass our filter are listed below.

1. Simulations Plus Inc. (NASD: SLP)

This micro-cap, worth only $48.6 million, designs and builds software used in the development of new drugs by biotechnology and pharmaceutical companies. The stock’s overall Sentiment score is 8.8 (out of 10.) Its Price Trend is Positive and based on its Price Momentum its relative strength is at the 90^th percentile, or better than 90% of the stocks in MarketGrader.com’s coverage universe. Today the analyst consensus estimate for the company’s fiscal year 2012 EPS is $0.31 per share compared to $0.25 three months ago.

Fundamentally the company’s overall grade is 79.8 (out of 100) which ranks it as the third highest stock out of 90 in the Packaged Software industry followed by MarketGrader.com. The company’s trailing 12-month net income is almost twice as high as what it was three years ago on trailing 12-month revenue of $11.81 million. During this same period Simulation Plus generated $3.1 million in free cash flow and produced a 20.8% return on equity and a 32% operating margin. The company has no debt and the stock trades at 17 times trailing and 13 times forward earnings per share.

2. Nike Inc. (NYSE: NKE)

Nike’s Sentiment score of 8.9 is based partly on a positive Price Trend indicator and Price Momentum at the 89^th percentile of all stocks followed by MarketGrader.com. Today’s earnings consensus estimate for fiscal year 2012 is $4.96 per share vs. $4.81 three months ago. Only 1% of the company’s share float is sold short.

Nike’s overall grade of 76.1 makes it the fifth highest ranked company among the 45 that we follow in the Apparel/Footwear industry. Last quarter it reported revenue and net income that were up 13.6% and 13.8% respectively from a year earlier. Its trailing 12-month revenue and net income through the period ended last quarter were $20.85 billion and $2.13 billion, with $858 million of free cash flow. Nike is virtually debt free despite total debt of $663 million considering its cash on hand last quarter was $4.54 billion. Based on its operating results from the last 12 months its operating margin was 12.9%, its return on equity was 21.7% and its return on invested capital was 26.6%. When its cost of equity and debt are subtracted, on an after tax basis, from this number, the result is an economic value added of 18.8%. This reflects the return to investors after accounting not only for the company’s operating costs but also to the opportunity cost of investing in its shares. The stock’s dividend yield is currently 1.4%; it trades at 19 times trailing and 17 times forward earnings per share (the richest valuation on our list.)

3. Microsoft Corp. (NASD: MSFT)

Microsoft’s shares trade currently in a positive Price Trend and have better Price Momentum than 70% of all stocks in our coverage universe. Analysts following the company expect, on average, fiscal year 2012 earnings per share of $2.86, up from the consensus estimate of $2.76 three months ago. 1% of the company’s float is sold short.

Based on an overall grade of 86.0 Microsoft is ranked eighth out of 873 Technology companies followed by MarketGrader.com. Despite its size the company continues to record outstanding net income growth, up 30% last quarter from a year earlier and up 31% in three years based on trailing 12-month net income of $5.87 billion. During this period Microsoft generated a remarkable $19.46 billion in free cash flow. With its recent 25% dividend increase the stock now yields 3%, about in line with 30-year U.S. government bonds. In addition to its payout the company has bought back 15% of its outstanding shares in the last five years even after accounting for newly issues shares used as compensation. The stock’s trailing and forward P/E are 9.5 and 8.2 respectively.

4. Metropolitan Health Networks Inc. (AMEX: MDF)

Metropolitan Health Networks is a provider of health care services to the elderly and to patients with certain disabilities. Its stock currently has a Sentiment score of 8.7 with a stock price trend that, while still positive, seems to be flattening out, despite price momentum that is better than 76% of the stocks in our coverage universe. Its fiscal year 2011 consensus estimate of $0.65 per share is lower than the $0.67 consensus from three months ago. Its short interest is 4% of float.

The company’s overall fundamental grade of 78.9 makes it the highest ranked stock in the Medical/Nursing Services industry, in which we cover 36 companies. It also makes MDF the 12^th best stock out of 625 in our entire Health Care sector coverage list. The company’s market cap is $192 million. Its trailing 12-month revenue of $374.56 million is 26% higher than it was three years ago while its net income of $26.7 million is three and a half times higher over the same time period. The company has no debt, a return on invested capital of almost 52% and operating margins of 11.46%, above the 10.76% industry average. The stock trades at only 7.3 times trailing and 6.5 times forward earnings per share.

5. Eli Lilly & Co. (NYSE: LLY)

LLY’s Sentiment score of 8.0 is based on a Price Trend indicator that is positive, even though the chart has flattened out recently, and a Price Momentum indicator that ranks the stock’s relative strength at the 78^th percentile of all stocks under coverage. The EPS consensus estimate for the 2011 fiscal year is for $4.33 per share compared to $4.28 three months ago. Short interest stands at 3% of float.

Eli Lilly’s overall fundamental grade of 70.6 ranks it third among the 18 Major Pharmaceutical companies followed by MarketGrader.com. While the company’s revenue increased by 8.8% last quarter its net income fell 11.2%, both relative to the year earlier period. However, its trailing 12-month net income of $4.73 billion is 24% higher than it was three years ago. It generated $1.35 billion in free cash flow last quarter alone and $4.36 billion in the last 12 months. Total debt of $6.73 billion is only slightly higher than its $6.33 billion in cash on hand, which helps explain the company’s generous payout. The stock, which trades at 8.8 and 10 times trailing and forward EPS respectively is currently yielding an incredible 5.3% based on a $0.49 per share dividend.

6. Intel Corp. (NASD: INTC)

INTC’s current Price Trend is positive, apparently reversing a recent negative trend. The stock’s Price Momentum ranks at the 90^th percentile and its short interest is 3% of its public float. Analysts following the company expect a fiscal year 2012 report of $2.37 per share compared to $2.27 just three months ago. All of this results in a Sentiment score of 7.1, a recent upgrade from ‘Neutral’ to ‘Positive.’

The company’s current fundamental grade of 89.1 makes Intel the highest ranked stock in the Semiconductor industry, where we follow 94 stocks and the second highest ranked company in the entire Technology sector, where we follow 872 companies. Its revenue increased 21% last quarter alone while net income increased only 2.3% given that capital expenditures jumped 137% as the company continues to invest in the development of processors geared towards mobile devices, diversifying it away from its PC-focused business and putting it in a favorable position for future market share gains. Despite its ongoing investments Intel still generated $526 million in free cash flow last quarter and $4.96 billion in the last months. Its total debt of $2.16 billion is dwarfed by its $11.55 billion in cash on hand. It continues to operate very profitably with a remarkable 34% operating margin on trailing 12-month sales of $48.4 billion. The stock trades at 10 and 9 times trailing and forward earnings per share and, at current its price, yields 3.24%.

7. Hi-Tech Pharmacal Co. Inc. (NASD: HITK)

The stock’s Price Trend is positive and its Price Momentum ranks at the 95^th percentile of all stocks in our database. The consensus estimate for fiscal year 2012 of $3.05 per share is 35% higher today than the expected $2.26 three months ago. Short interest is 13% and the stock’s Sentiment score is 8.9.

Hi-Tech Pharmacal’s overall grade of 92.1 currently makes it the highest graded company in all of MarketGrader.com, across all sectors. Its revenue and net income increased by 39% and 59% respectively last quarter, when it also generated $16.75 million in free cash flow on sales of $56.2 million. Free cash flow in the last 12 months was $35.37 million. The company has no debt and operating margins of 31.42% compared to the pharmaceutical industry average of 16.67%. The stock trades at 9.2 times trailing earnings and 12 times forward estimates.

8. j2 Global Communications Inc. (NASD: JCOM)

JCOM, which offers clod-based communications services such as e-faxes, voicemail, conference calling and data storage is the second highest ranked stock in the Internet Software & Services industry behind Google. It also ranks ninth overall among all Technology stocks. It has a market capitalization of $1.35 billion.

The stock’s Sentiment score is 8.3, based on a positive Price Trend and Price Momentum ranked above 83% of all stocks in our coverage list. Consensus fiscal year 2011 estimates of $2.52 exceed the $2.37 estimate from three months ago. Short interest is 11%.

The company had strong report last quarter with a 40% jump in sales and 52% increase in net income. Trailing 12-month revenue of $292.86 million is up 26.3% in the last three years and net income is higher by 55% at $106.15 million. The company has no debt, $151 million in cash on hand and it generated $40.5 million in free cash flow last quarter and $126.2 million in the last year. Its return on equity in the last 12 months was 21% on 39% operating margins. The stock’s trailing and forward P/E are 12.8 and 11.1 respectively.

9. DSW Inc. Cl A (NYSE: DSW)

DSW is the number one stock in the Apparel & Footwear industry according to MarketGrader.com based on an overall grade of 80.0. The stock’s Sentiment score of 8.7 is based on an EPS consensus estimate of $2.87 for the fiscal year ended January 2012, up from $2.79 three months ago, a positive Price Trend, Price Momentum ranked higher than 93% of all stocks in our system and short interest of 5%.

The company’s trailing 12-month revenue and net income are up 36% and 419% in the last three years to $1.94 billion and $232 million, with TTM free cash flow of $124.5 million. Total debt is $133.4 million and cash on hand is $350.7 million. The company’s operating margin of 10.25% exceeds the industry 9.06% average and its return on equity was 37.04% in the last year. The stock trades at 7.8 and 14.5 times trailing and forward earnings per share.

10. CF Industries Holdings Inc. (NYSE: CF)

Despite all the negativity that has surrounded basic material stocks during September, CF Industries has a Sentiment score of 8.9 based on a positive Price Trend and Price Momentum ranked at the 89^th percentile; additionally the consensus estimate for the company’s fiscal year 2011 has increased from $16.69 in earnings per share three months ago to $21.22 today, a 27% jump. Short interest is 4%.

The company’s overall grade of 82.2 ranks it number one among 16 companies in the Agricultural Chemicals industry followed by MarketGrader.com and the 14^th best stock, based on its fundamentals, in the entire Materials sector. CF Industries has cut its debt by 38% in the last year, down to $1.62 billion, or 25% of total capital. It has $1.36 billion in cash on hand and it generated $1.78 billion in free cash flow in the last 12 months. Both revenue and net income grew strongly last quarter while on a trailing 12-month basis they grew a remarkable 57% and 52% to $5.13 billion and $1.02 billion respectively. Its operating margin of 36.7% exceeds the industry average of 21.8%. Return on equity in the last year was 20.9% and the stock trades at 11 times trailing and 7.9 times forward earnings per share. The company’s market cap is $10.4 billion.

Major bank stocks in the U.S. and Europe fell on Wednesday following Moody’s downgrade of Citigroup, Wells Fargo and Bank of America and the FOMC’s announcement of further monetary stimulus measures in the face of a worsening economic outlook. Financials in general fell again yesterday in sync with a global equity sell-off. Investors rightfully fear that in addition to an already-difficult operating environment bank profitability will suffer as a consequence of the Fed’s new ‘operation twist,’ which seeks to flatten the U.S. yield curve by switching its mix of treasury securities increasingly towards longer dated maturities. Additionally the Fed will reinvest the principal it receives from maturing mortgage bonds into additional mortgage securities in hopes of lowering mortgage rates even further below its current historical lows. While it hopes to boost investment and consumption with these moves, the Fed’s actions could also put pressure on bank profitability by squeezing the margin between the short term rates at which they borrow and the longer term rates at which they lend. In addition to this, much uncertainty remains among banks regarding Dodd-Frank rules still being implemented by regulators.

Ongoing bank weakness in the United States is still evident in industry-wide metrics followed by MarketGrader.com, such as average return on assets, currently at 0.43% and a still elevated solvency ratio of 55.6%, which represents banks’ non-performing assets as a percentage of tangible equity plus loan loss reserves. However, despite all the work still ahead for the banking industry in the United States, many banks today are in much better shape than they were three years ago in the throes of the financial crisis as a result of the actions they’ve undertaken during this period. Such actions are beginning to separate a few banks from the pack, putting them in a favorable position to gain market share and rebound strongly when the U.S. economy returns to a path of higher growth. The following three banks are, based on MarketGrader.com’s analysis, the best three major banks in the United States today (JP Morgan Chase, which is highly graded by MarketGrader.com, has been excluded from the report since its business encompasses much more than traditional commercial banking, including wealth management, capital markets and investment banking.)

1. PNC Financial Services Group Inc. (NYSE: PNC)

The highest rated Major Bank in MarketGrader.com, with a grade of 72.4, is Pittsburgh-based PNC Financial Services Group, with $263 billion in assets and a market capitalization of $25.1 billion. Its revenue last quarter fell 10% from a year earlier, mostly attributed to a softening of economic conditions in the U.S., at least from our perspective in which overall bank results reported last quarter seemed to decelerate from higher growth rates in the preceding two years. More importantly, PNC’s trailing 12-month revenue of $16.57 billion was 59% higher than the equivalent period ended three years ago, in the middle of the financial crisis. The bank’s quarterly revenue is now running at an approximate clip of $4 to $4.4 billion, well above the September 2008 trough of $2.3 billion. Trailing 12-month net income is up 150% also in the last three years; naturally a dividend increase has followed these improved results after PNC hiked its payout earlier this year from $0.35 per share from the $0.10 per share to which it had been reduced in 2009 as the company was shoring up its capital base. Still, today’s payout is only a little more than half its pre-crisis payout of $0.66 per share, though the stock yields an attractive 2.9%. The bank’s after-tax payout ratio, on a trailing 12-month basis, is still a very manageable 12.9%.

While the bank’s net interest margin fell last quarter to 4.85% from last year’s 5.18%, the ratio is still solidly ahead of the 4.47% bank average. Net interest margin represents net interest income as a percentage of interest earnings assets. During the 12 months ended last quarter PNC’s return on equity improved to 10.2% from a year earlier while return on assets came in at 1.28%, well ahead the 0.43% industry average calculated by MarketGrader.com. Closely followed capitalization metrics have been improving significantly in recent quarters too. While non-performing assets now account for a still-elevated 20.4% of tangible equity plus loan loss reserves, this ratio fell from 33.2% a year ago, a vast improvement. The bank’s tangible equity ratio, which measures tangible common equity as a percentage of total tangible assets, is very solid at 8.6%. However, one area of concern worth watching closely in coming quarters is PNC’s loan loss reserves level. Today the bank has only $0.06 in loss reserves for every dollar in non-performing assets, a 33% decline from $0.09 a year ago. The bank’s current levels of capital have come at a steep price particularly for long-term holders of the common stock. Today PNC has 50% more common shares outstanding than it did at the end of 2008, right before it started its drive to raise capital. But for new shareholders what matters now is what the bank does with its capital going forward and whether it can capture market share from weaker rivals.

In addition to such adequate capitalization levels, the bank’s operations seem well positioned to absorb the impact that the Fed’s upcoming operations may have on the bank’s profitability. Its total interest expense last quarter represented only 15.6% of total interest income, well below the 43% bank average. The bank currently generates revenue of $0.38 and net income of $0.07 per employee in a 12-month period compared to the averages for Major Banks of $0.30 and $0.01 respectively.

PNC shares look inexpensive, trading at seven times trailing earnings per share and 7.6 times forward full year estimates. At yesterday’s close of $46.74, 28% below the stock’s 52-week high, it is trading also at only three quarters of its book value or 1.16 times tangible book. Yet the bank has $41.06 in tangible equity per share compared to the average bank, which is only $12.67 per share.

MarketGrader.com Overall Grade: 72.4 (Buy)

MarketGrader.com Sentiment Score: 4.1 (Neutral)

2. Wells Fargo & Co. (NYSE: WFC)

MarketGrader.com’s analysis of Wells Fargo reveals a story not unlike that of PNC, illustrated above, but on a much larger scale considering the bank had $1.25 trillion in assets last quarter. While the bank’s growth was anemic in the last year as the U.S. economy slowed down, its overall financial picture is a lot different than it was in 2008. WFC’s revenue fell last quarter by 5% compared to the year-earlier period while, more importantly, trailing 12-month sales of $90.87 billion were 64% higher than the equivalent period ended in mid-2008. The bank did, of course, absorb all of Wachovia during this period, which accounted for a significant portion of this growth. Based on recent results it’s clear management has been very successful in integrating both bank’s operations profitably and efficiently. While the bank’s net income jumped 29% last quarter from Q2 2010, it increased almost 96% in a three-year period for the 12 months ended in June to $14.46 billion. This allowed the bank to increase its dividend earlier this year to $0.12 per share from $0.05 per share. While this will translate, on a full-year basis, into a 70% increase, it is still well below the bank’s pre-crisis payout of $0.34 per share.

Wednesday’s downgrade of the bank’s debt by Moody’s was, in large part, attributed by the rating agency to its perception that the U.S. government could indeed let a major bank fail should it run into trouble again, which we doubt. Call this the end of the ‘Geithner Put’ if you will, the fact is that Wells Fargo today finds itself in a very different capital position than in 2008-09. In this time frame its tangible common equity has increased almost six-fold to $73.89 billion from a low of $12.51 billion in the third quarter of 2008 while in the same period assets have only increased by a factor of two, including the addition of Wachovia. This translates into a tangible equity ratio of 6.11%. While better than last year’s 5.57%, the ratio is still too low and investors should look for it to continue climbing, especially considering the bank’s non-performing assets account for 34.7% of its tangible equity plus reserves for loan and asset losses. This is significantly better than the 55.6% bank average and more importantly, lower than the 38.3% reported a year ago last quarter. Clearly the bank still has a lot of work to do, particularly with regards to its capitalization and especially if mortgage loans across the country continue to sour. WFC has today $0.07 in loan loss reserves for every $1 in non-performing assets, half of what it had a year ago and a dangerously low level, particularly if housing prices continue to fall and economic indicators continue to worsen. The bank, however, has done much to shore up its capital base in the last three years. Today it has 60% more common shares outstanding than it had in the summer of 2008, right before Lehman’s collapse. Further dilution of existing shareholders on such a scale, while unlikely, seems like the highest risk for investors in the company’s shares. This makes the company’s ability to continue operating profitably and cover potential losses with earnings from operations over the next 12 to 18 months something investors should follow closely. Fortunately, on the profitability front, the bank’s indicators seem to be pointing in the right direction.

Wells Fargo reported operating results last quarter that translated into a net interest margin of 4.75%, which, although lower than last year’s 5.07%, is still indicative of solid profitability in its core operations and well ahead of the 4.47% bank average. Its trailing 12-month results translate also into a return on equity of 11% and return on assets of 1.16%. In contrast, Bank of America’s return on equity and return on assets over the last four quarters were negative while Citigroup’s were 5.6% and 0.5% respectively. JPMorgan Chase, which we also rate ‘Buy,’ reported last quarter a trailing 12-month return on equity of 10.6% and return on assets of 0.91%. Worth mentioning too, based on Wells Fargo’s latest quarterly results, is the fact that its total interest expense accounted for only 13.8% of total interest income, giving it ample room to continue operating profitably in a flat yield curve environment. The bank generates $0.34 in revenue and $0.05 in net income per employee, well above the industry average for both.

The bank’s shares, trading barely above their 52-week low, are currently valued at only nine and seven times 12-month trailing and forward earnings per share respectively. They trade also at book value or 1.7 tangible book and 1.4 times sales. With a 2% dividend yield, at current levels investors get paid almost 30 basis points more than they would lending to the U.S. Treasury at 10 year rates, while they wait for the dust to settle and the U.S. economy to resume growing at a normal rate (2.5% to 4%,) which undoubtedly it will. When it does Wells Fargo seems well positioned to rebound nicely along with it.

MarketGrader.com Overall Grade: 68.4 (Buy)

MarketGrader.com Sentiment Score: 4.4 (Neutral)

3. U.S. Bancorp (NYSE: USB)

Minneapolis-based U.S. Bancorp had $308 billion in assets last quarter, slightly above PNC’s $262 billion and only a quarter of WFC’s $1.25 trillion. The bank has a market capitalization of $44 billion.

While its net income jumped 36% last quarter to $1.2 billion, its revenue was almost flat at $5.27 billion relative to the year-earlier period. It has taken the bank a full three years to return to its pre-Lehman revenue and net income levels, underscoring the impact that the financial crisis had on its business. USB’s trailing 12-month revenue and net income of $20.89 billion and $4.11 billion respectively are virtually unchanged from the 12 months ended in June 2008. However, its capital base is vastly improved.

USB’s $17.63 billion in tangible equity represents 5.71% of its tangible assets, an improvement from 5.5% a year ago and an adequate level of capital. In contrast, its tangible equity ratio at the end of 2008 was 3.0%. Its non-performing assets fell significantly last quarter relative to its tangible equity plus its reserves for loan and asset losses to 28.3% from 45.5% a year ago. However, so have its reserves, which last quarter accounted for 11% of non-performing assets compared to 14% a year ago. This doesn’t necessarily translate into an erosion of the bank’s loss reserves but could mean, instead, that management thinks the worst in asset write-downs is behind them rather than ahead. Nevertheless, further deterioration of the bank’s balance sheet could force it to put aside in reserves more than anticipated if current levels of profitability cannot be sustained in a deteriorating economic environment.

Last quarter USB recorded a healthy 4.79% net interest margin, albeit lower than last year’s 5.2%, with interest expenses accounting for 20% of interest income, trademarks both of an efficient operation. On a trailing 12-month basis the bank’s return on equity was a very solid 13.4% while its return on assets was also a strong 1.34%. USB generates $0.32 in revenue and $0.06 in net income per employee, both well above the Major Bank industry average.

The bank’s shares, trading 20% below their 52-week high, yield 2.2%, based on a per share payout of $0.125, more than double the payout of the last two years but well below the $0.425 it used to pay in 2008. The stock is valued at 11 times trailing earnings per share and 8.8 times next year’s consensus estimate. It trades also at 1.5 times book or 2.5 times tangible book value. With only 10.9% more common shares outstanding than it had in June 2008, USB has diluted its equity base the least among the large banks that were recapitalized following the financial crisis. This speaks volumes of management’s regard for its shareholders.

MarketGrader.com Overall Grade: 61.7 (Buy)

MarketGrader.com Sentiment Score: 6.2 (Neutral)