Table of Contents

1.  Market Outlook
2.  Discover (DFS)
3.  Peabody Energy (BTU)
4.  Additional Investing Ideas
5.  Investor Trivia -- Operating Margins
6.  Featured Topic -- Income Trusts
7.  Free Investing Resources

Today's Top Stock Picks

This Credit Card Company Trades at a Sharp 22% Discount
Discover (DFS) was recently spun-off from its parent firm and now looks enticing from a value standpoint.
Read More. . .

The World's Thirst for Energy Means a Bright Future for Peabody
With operations in the western U.S. and Australia, this firm is well-situated for future growth.
Read More. . .

Market Outlook

In the midst of a strong rally, the Dow's 1,000-point growth spurt from 13,000 to 14,000 took less than three months.

Now, the Dow has retraced more than half of that advance in just two days!

For months, housing-related worries have plagued Wall Street, and there has been increasing evidence that the subprime mortgage meltdown has begun to impact corporate lending. That could throw cold water on the heated private equity wheeling and dealing that has propelled the market to new highs.

Stocks managed to gain ground while those fears slowly simmered on the backburner, but they finally boiled over last Tuesday following poor quarterly results and lowered guidance from mortgage lender Countrywide Financial (NYSE: CFC). A fresh batch of lukewarm earnings reports from other big names didn't help either, and the market tumbled in heavy trading. The Dow gave back more than 220 points (-1.6%) on the session, and the other major averages finished with even steeper losses. Market breadth was decidedly negative, as 29 of the 30 Dow components retreated and declining stocks on the NYSE outnumbered advancers by a wide 10-to-1 margin.

The Dow recouped some of its losses on Wednesday, extending an "up one day and down the next" pattern that has been in place since mid-July. Unfortunately, the see-saw pattern held again the following day, which meant another downhill session -- and this one was brutal.

Feeding off a disappointing read on the housing market, stocks were pummeled on Thursday. According to the Commerce Department, median home sale prices backtracked again last month, while new home sales slipped -6.6% -- three times the decline that economists were expecting. Meanwhile, sales of existing homes dropped
-3.8% for the month and are now running at the slowest pace in five years.

That news sent the Dow free-falling almost 500 points before bargain hunters finally stepped in to stop the bleeding. Still, the major averages all finished the day with hefty losses of around -2% or more -- and $300 billion in market capitalization was wiped out in the S&P 500. That is the worst showing since late February, when a sudden sell-off in China's Shanghai Index incited a global wave of panic selling. This time though, the U.S. was the catalyst, and exchanges throughout Europe and Asia followed our lead and headed lower.

On Friday, a robust GDP report did little to calm the nerves of rattled traders. The latest data showed the economy expanding at a healthy +3.4% pace last quarter, bouncing back from an anemic first-quarter performance. But soaring energy prices, tighter credit, and other key issues continue to weigh heavily, and the relentless selling pressure accelerated into the close. That left the Dow with another hefty triple-digit setback, capping off the worst week in years.

The one glimmer of good news from this week's sell-off -- consumer sentiment remains much more buoyant than many expected, and the latest numbers suggest that consumers will continue to keep their pocketbooks open. That's good news for credit card companies. Below, I'll profile the new kid on the block, Discover Financial Services (NYSE: DFS, $23.33), which just made its public market debut a few weeks ago.

Also in today's issue, energy guru Elliot Gue makes a case for leading coal miner Peabody Energy (NYSE: BTU, $41.08). We all know that booming economic growth in emerging markets like China and India is driving up demand for electricity -- but not everyone realizes that coal is the most important source of electric power. That should make Peabody a key beneficiary of continued global economic expansion.

Good Investing!

-- Nathan Slaughter
Co-Editor
TopStockAnalysts Digest

Discover Financial Services (NYSE: DFS, $23.33) -- Just a few short weeks ago, the Discover network was still owned by brokerage and investment banking firm Morgan Stanley (NYSE: MS) -- but no longer.

Morgan Stanley made the decision to spin-off the company several months ago, and Discover now trades on the NYSE as a stand-alone entity for the first time. Unlike MasterCard (NYSE: MA), the stock has been greeted with a lukewarm reception thus far, suggesting that many Morgan Stanley shareholders have been quick to cash out.

However, as the selling gradually subsides, we think the company will have some appeal. Though the Discover network trails its rivals by a wide margin in terms of cardholders, spending volume, and merchant acceptance, it does have several advantages.

Much like American Express (NYSE: AXP), Discover has eliminated the middleman and "closed the loop." In other words, the company issues its own cards, so it not only collects fees from merchants, but also pockets interest income from cardholders. Other companies like Visa and MasterCard simply operate the payment networks and earn transaction fees from merchants, while issuers like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) actually collect the interest income. Furthermore, the company has teamed up with third-party issuers like Wal-Mart (NYSE: WMT) without giving up interest income. This is a big distribution channel to get Discover cards in consumers' pockets, and we expect to see more of these beneficial arrangements in the future.

Discover may be fourth in a four-horse race, but high barriers to entry have effectively prevented any new players from joining the game -- and we think there is ample demand for all four firms to prosper going forward.

As consumers increasingly turn to plastic payment options, credit card transactions have climbed around +12% annually. Meanwhile, debit cards have become even more popular -- providing Discover with another key growth driver. Discover owns the Pulse debit network, which is used by 4,400 financial institutions and nearly 260,000 ATM machines.

In short, Discover only needs to hold its ground to do well, and considering the brand has ranked #1 in customer loyalty for the past ten years in a row, we think it is up to the task. The company currently boasts a base of more than 50 million cardmembers, many of which stick with Discover for its award-winning cash rewards program.

Furthermore, recent studies have shown that nearly nine of every ten spin-offs outperform the broader market in the two-year period following the spin-off. We think DFS has a good chance to be part of that 90%.

The shares are currently trading at a 22% discount to our $30 fair value estimate (our estimate of what the shares are really worth based on our proprietary discounted cash flow methodology), giving value investors an attractive entry point.

Coal is far and away the world's most important source of electric power and has been for decades. There are two good reasons for this: coal is more abundant than oil or gas, and it's also inexpensive.

Coal stocks had a rough run in the latter half of 2006. But now they're cheap, and a great deal of negative news flow on coal prices has been priced in. It's time to increase your exposure to the group.

My favorite play on coal is America's largest coal miner, Peabody Energy (NYSE: BTU, 41.08). Peabody has the largest exposure to the low-sulphur coal reserves in the Powder River Basin (PRB) in the western U.S., the region of the country that will see the strongest growth in coal production. Peabody has historically had some mines in Appalachia, but the firm will soon spin off these operations into a separate company. Peabody intends to re-focus its resources on the PRB and its international operations.

I view this as a positive step. Eastern U.S. mining companies have seen particularly rapid growth in labor costs and have been suffering from high employee turnover. This is particularly true with younger miners -- several companies operating in Appalachia have noted that young miners tend to leave within one year of starting work. This is a big problem. Young miners require a large investment in training, and that investment can't be recouped when turnover is so high.

The disaster at the Sago mine in early 2006 offers a clear example of why labor costs are rising so rapidly in the eastern U.S. Underground coal mining is dangerous and unpleasant work. To achieve the dramatic safety gains of the past few decades, coal companies have had to (and must continue to) spend big on advanced training. Big, well-publicized disasters like the explosion at Sago also further discourage potential workers from entering the industry.

The strip mining that goes on in the PRB is another matter entirely. Fewer accidents have occurred in this region, and workers require less training. Thus, companies like Peabody haven't seen the rapid cost inflation of the eastern miners.

And international operations are becoming an ever-larger part of the Peabody story, moving from 1% to 30% of earnings before interest depreciation and amortization (EBITDA) in just five years. While the picture in the U.S. is rapidly improving and there are signs that Peabody is betting on continued strength, the situation internationally is even more bullish.

The key production market internationally is Australia. The nation's proximity to important Asian markets, including China and India, makes it a natural fit for meeting rapidly rising coal demand. Peabody has always had operations in Australia, but it recently beefed up its presence by purchasing Excel Coal, an Australian producer with a large Asian export business.

China and India are fueling a tremendous surge in the demand for coal. With their economies growing in the upper-single to low-double digits, you can imagine the wall of new demand for electricity every year. Literally millions of new consumers are buying their first TVs and refrigerators each year, adding up to more power demand.

Peabody is now a major producer in Australia. And there's plenty of room for the company to make improvements to Excel's mines and generate more output. This coal will be in high demand for export to Asia. 

Bottom line -- I think Peabody Energy is a solid "Buy" at any price under $57 per share.