This year has provided a lot of encouragement for investors. A bull market hoofed its way through all the major stock indexes, boosting the Standard & Poor’s 500 and the Dow Industrials some 12% or more by the end of August, and treating Nasdaq investors to a gain of more than 30%. The good news aside, investors still have reason to feel apprehensive. They remember the sheer ferocity of the bear market that ended earlier this year — it lasted about 31 months and ripped 49% out of the S&P 500 alone, making it the second longest and most volatile bear market we’ve seen since World War II. At the three-year anniversary of the end of the prior bull market (March 2000), S&P investors had suffered through a 16% compound decline each year.
Now, as we approach the end of 2003, there are mixed signals surrounding both the U.S. economy and the equities markets. Because of these mixed signals, BLACK ENTERPRISE decided to pick the minds of market observers and money managers alike, looking for clues as to what might lie ahead. Using the guidance of these investment professionals, we sifted through the stock and mutual fund markets with a series of screens. Our goal was to find investment opportunities — stocks and funds alike — that would encourage those who may have suspended their investing to get off the sidelines and back into the financial markets.
A BULL WITH LEGS?
A bull market needs at least three legs to stand on: (1) company shares that have climbed for extended periods due to rising profits, or what Wall Street calls earnings; (2) big stock market gains that occur when investors don’t get lured away by sure returns from the bond market or other fixed income holdings; and (3) reasonably valued (or even cheap) stocks, compared to historical averages, that give the market a greater chance to climb.
Over the past few years, a recession has hampered corporate profits. However, indications are that the U.S. economy is starting to rise from its slumber, thanks to aggressive efforts by the Federal Reserve to stimulate business activity. This past August, the Conference Board reported that its Index of Leading Economic Indicators, which measures where the nation’s economy is headed in the next three to six months, rose for the fourth month in a row, reaching their most favorable levels since the recession started two years ago. “We believe that a growing economy causes earnings to rise, and [there are] signs [that] the massive fiscal and monetary stimulus will trigger economic growth and consumer spending as well,” says Sam Stovall, chief strategist for Standard & Poor’s. In turn, a strong economy should trigger a 17% year over year increase in operating earnings for the S&P 500 by the end of 2003 and a 13% increase by the end of 2004, says Stovall.
Also, recent interest rates have given stock market investors reason to be cautiously confident. Low interest rates have spurred companies to borrow and expand, which should help pull profits out of their rut. When rates are low, as they have been this year, there is little incentive for big institutional investors to push stocks aside and opt for Treasury or corporate bonds, which provide sure and steady interest income over time. In fact, the 10-year U.S. Treasury note, the benchmark bond experts use to chart the market, offered a mere 3.1% interest as of June 2003 — a 45-year low. Late this past summer, money market accounts, often a convenient short-term haven for cash, offered very little to arouse investors: They averaged only 1%. The S&P 500 averaged about 1.75% interest. Chances are the big money in the market probably won’t entirely abandon stocks any time soon.
A SPOONFUL OF CAUTION
The outlook for the market would be extremely bright if not for a few dark clouds. Perhaps the biggest worry is interest rates. Recently, there have been stirrings in the bond market indicating that rock-bottom rates may soon rise. Higher rates mean that the cost of borrowing money for
Another concern is the market’s overall value. Morningstar showed that, if measured by the preceding 12 months worth of profits, company shares comprising the S&P 500 were priced 22 times their reported earnings this past September. Historically, the market fetches no more than an average 14 times its earnings, indicating possible overvaluations.
Green says a number of mitigating factors could well come to the market’s rescue, even if a correction does take place. He says the Fed will likely reinforce its commitment to keep inflation low, and “tradition shows that years [in which] presidential elections are held tend to be the most bullish.” Green adds, “Indications are [that] the economy is poised to help us follow that pattern.”
LESSONS FROM THE BEAR
The truth is, as humbling as they can be for investors, bear markets are great teachers. And if there’s a lesson to be learned from the past three years, it is this: Diversifying your assets into a variety of investments can help cushion your portfolio against sudden shocks. “If you step back and look over the market, there really aren’t any slam-dunk opportunities out there right now,” says Kunal Kapoor, an associate director of fund analysis at Morningstar. “The point, though, isn’t to chase hot trends; it’s to stay diversified to minimize risk.”
One sure way to broaden your portfolio is to look overseas or to venture into small- and mid-size companies. These categories provide a good counterbalance to large company shares and mutual funds, often holding their own or posting solid gains when the S&P 500 runs into trouble.
“International stocks might be some of the best performing shares in the next few years,” says Lou Holland, CEO of Holland Capital Management in Chicago, “as could financial services, healthcare, and technology stocks. Small- and mid-cap stocks also do well whenever we exit a bear market.”
To put the advice of the experts to good use, we turned to Morningstar, the Chicago mutual fund monitoring company, to generate a list of mutual fund opportunities. First, we sought to provide a list of six core holdings with mutual funds that would provide investors a good starting point in light of the current market. Using Morningstar’s Principia software, we hunted for funds investing in rock-solid, large-cap companies — corporations that deliver steady performance no matter what the economic environment.
Our screen honed in on portfolios run by the same managers for five years or more (as a measure of stability and experience) through the roaring bull market of the 1990s, as well as the vicious bear we have just exited. We looked for outstanding track records to boot, limiting our sights to funds whose average annual total returns for the last five and 10 years ranked in the top 20% of their Morningstar category. Finally, we narrowed the field to two funds each from three Morningstar investment styles: large-cap growth funds, which invest in companies that are booming; large-cap value funds, which invest in companies that are underappreciated or worthy of notice; and large-cap blend funds, which invest using a combination of growth and value criteria.
Our second group of funds focused on diversifiers: portfolios investing in overseas stocks and shares of small and mid-size companies. Again, we put Morningstar’s database through the same track of hurdles, including management tenure and long-term track records.
STOCK SCREENS
Next, we tackled the long list of individual stocks with two screens that were run
on the Zacks Investment site (www.zacks.com), a Chicago stock market and brokerage data firm. For criteria, we revisited the same screens we used to select stock picks in our January 2002 issue (“22 Stocks for 2002”). Only this time we added a few twists.
As in early 2002, we sought out
large companies with stock market values of $2 billion or more. We essentially wanted to play it safe: The larger a company, the less likely its stock will be shaken in a turbulent market. We also looked to see if company officials liked their own businesses, limiting our picks to companies where inside management had either made substantial stock purchases in the last quarter or held their stakes intact. And we looked to snare companies already profiting from a potential economic turnaround.To capture stocks that are showing sparks, we checked for earnings surprises — instances where quarterly company profit reports may have exceeded Wall Street’s expectations. From there, our two screens took divergent paths.
Our screen of growth stocks looked for companies that had yet to reflect the full value of any business upswing, shares whose price-to-earnings growth (PEG) ratio was 1.5 or less. A PEG is the market’s way of measuring a stock’s price per share against its earnings per share growth rate. Observers feel that a stock with good business prospects tends to be a bit expensive once its PEG hovers near 2, so we aimed considerably lower than that mark. Finally, we targeted companies with long-term average annual earnings growth rates of 8% or more.
Our screen of value stocks took a different slant. We angled for stocks with substantial dividend yield. Dividends provide a way to harvest income from shares whether a company’s stock appreciates in value or not. It’s a potential cushion if the economy continues to stall.
The stocks and mutual funds we targeted have the potential for significant gains over the next 12 months. Remember to diversify your holdings, and, hopefully, 2004 will bring you many happy returns.
Why You Should Pick These Stocks
| Commerce BCP-NJ (NYSE: CBH) | With a long-term record of lifting profits, the Mid-Atlantic bank has used expansion into the New York area to boost deposit and earnings growth. | ||||||
| Convergys (NYSE: CVG) | A leading provider of billing services for the mobile phone industry, Convergys is looking toward revenue growth in the coming year. | ||||||
| Goldman Sachs (NYSE: GS) | A stock market rebound could provide a strong lift to one of Wall Street’s leading brokerage firms. | ||||||
| JetBlue (NASDAQ: JBLU) | Rapidly expanding JetBlue is turning profits in a dragging industry. Market share gains | ||||||
| and new routes should keep profits soaring. | |||||||
| Lowe’s Cos. (NYSE: LOW) | Home improvement supplies retailer Lowe’s is giving Home Depot strong competition by pushing into the nation’s major markets. | ||||||
| Brunswick Corp. (NYSE: BC) | A boating equipment and engine maker, Brunswick stands to benefit from a surge in consumer spending if the economy picks up. | ||||||
| Public Service Enterprise Group Inc. (NYSE: PEG) | A steady New Jersey utility, PSE&G boasts a 5% increase, despite a payout that’s below industry peers. | ||||||
| Sara Lee (NYSE: SLE) | A maker of baked goods and a variety of consumer products, Sara Lee is inexpensive and sure to generate strong cash flow. | ||||||
| J. M. Smucker (NYSE: SJM) | Smucker hopes the addition of Jif and Crisco to its roster of brands will widen margins and boost profits. | ||||||
| RJR Reynolds (NYSE: RJR) | Far from a popular pick, the maker of Camel, Winston, and Salem sports a whopping dividend yield at a time courts might ease up a bit on big tobacco. | ||||||
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Stocks To Jump On Now And Beat The Crowd |
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| Company (Ticker) | Industry- Sector | Market Cap. (Millions) |
Recent Price | Price Change YTD |
52 Wk. High | 52 Wk. Low | Long- Term Growth |
PEG | Avg. EPS Surprise* |
Div. Yield |
| GROWTH | ||||||||||
| Commerce BCP-NJ (NYSE: CBH) | Regional Bank | $3,036 | $43.25 | 0.00% | $47.23 | $36.37 | 19% | 0.92 | 2.50% | 1.5% |
| Convergys (NYSE: CVG) | Data Processing- Outsourcing | 2,584 | 18.10 | 19.00 | 19.15 | 11.35 | 13 | 1.60 | 1.75 | 0.0 |
| Goldman Sachs (NYSE: GS) | Investment Banking | 43,011 | width=”9%” valign=”middle”>90.73 | -32.36 | 91.79 | 59.28 | 14 | 1.28 | 13.25‡ | 1.1 |
| JetBlue (NASDAQ: JBLU) | Airline | 3,893 | 58.14 | 115.00 | 59.62 | 20.10 | 31 | 1.43 | 16.50 | 0.0 |
| Lowe’s Cos. (NYSE: LOW) | Home Improvement Retailer | 40,312 | 51.45 | 37.00 | 55.88 | 34.00 | 19 | 1.19 | 8.50†| 0.2 |
| VALUE | ||||||||||
| Brunswick Corp. (NYSE: BC) | Boat & Engine Ma ker |
2,474 | 27.33 | 38 | 28.30 | 17.50 | 13 | 1.67 | 6.75 | 1.8 |
| Public Service Enterprise Grp (NYSE: PEG) | Utility | 9,596 | 42.39 | 32 | 44.40 | 21.76 | 4 | 2.75 | 11.00 | 5.1 |
| Sara Lee (NYSE: SLE) | Food | 15,069 | 19.39 | -14 | 23.75 | 16.50 | 8 | 1.56 | -0.50 | 3.2 |
| J. M. Smucker (NYSE: SJM) | Food | 2,052 | 41.08 | 3 | 41.81 | 32.27 | 9 | 1.96 | 7.50†| 2.2 |
| RJR Reynolds (NYSE: RJR) | Tobacco | 2,851 | 33.81 | -20 | 53.09 | 28.04 | 7 | 2.02 | 5.00 | 11.2 |
SOURCE: ZACKS INVESTMENT RESEARCH, AS OF SEPTEMBER 12, 2003. *FROM DECEMBER 2002 — SEPTEMBER 2003; †FROM JANUARY 2003 — OCTOBER 2003; ‡FROM FEBRUARY 2003 — NOVEMBER 2003
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Funds That Are Too Good To Pass Up |
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| Company (Ticker) | Avg. Annual 10-Year Total Return* |
Avg. Annual 5-Year Total Return |
Avg. Annual 3-Year Total Return |
Morningstar Rating |
Phone | Minimum Initial Investment/IRA/AIP |
|
B.E. CORE FUNDS LARGE-CAP VALUE FUNDS |
||||||
| Dodge & Cox Stock (DODGX) | 14.11 | 12.40 | 8.24 | 5 star | 800-621-3979 | $2,500/$1,000/$2,500 |
| Van Kampen Comstock (ACSTX) | 12.23 | 7.58 | 2.72 | 4 star | 800-421-5666 | NA/NA/$25 |
| LARGE-CAP GROWTH FUNDS | ||||||
| Smith Barney Aggressive Growth (SHRAX) | 15.42 | 16.59 | -8.98 | 5 star | 800-451-2010 | $1,000/$250/$1,000 |
| American Funds Growth Fund of America (AGTHX) | 12.80 | 10.37 | -9.43 | 5 star | 800-421-4120 | $250/$250/$50 |
| LARGE-CAP BLEND FUNDS | ||||||
| Mairs & Power Growth (MPGFX) | 16.21 | 12.28 | 9.04 | 5 star | 800-304-7404 | $2,500/$1,000/$2,500 |
| Thompson Plumb Growth (THPGX) | 15.38 | 12.97 | 8.88 | 5 star | 800-999-0887 | $2,500/$2,000/$1,000 |
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B.E. DIVERSIFIER FUNDS FOREIGN STOCK FUNDS |
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| Tweedy, Browne Global Value (TBGVX) | 10.42 | 8.61 | -0.81 | 5 star | 800-432-4789 | $2,500/$500/$2,500 |
| William Blair International Growth N (WBIGX) | 9.39 | 13.07 | -5.62 | 5 star | 800-742-7272 | $5,000/$3,000/$5,000 |
| Oakmark International I (OAKIX) | 8.12 | 12.55 | 4.37 | 5 star | 800-625-6275 | $1,000/$1,000/$500 |
| MID-CAP FUNDS | ||||||
| Calamos Growth (CVGRX) | 19.92 | 25.02 | -3.68 | 5 star | 800-823-7386 | $1,000/$1,000/NA |
| FMI Common Stock (FMIMX) | 12.23 | 13.81 | 10.70 | 5 star | 800-811-5311 | $1,000/$1,000/$1,000 |
| Lord Abbett Mid-Cap Value (LAVLX) | 13.17 | 14.74 | 8.47 | 4 star | 800-201-6984 | $1,000/$250/$250 |
| SMALL-CAP FUNDS | ||||||
| Value Line Emerging Opportunities (VLEOX) | 13.35 | 20.81 | -0.48 | 4 star | 800-223-0818 | $1,000/$1,000/$1,000 |
| Royce Micro-Cap Investors (RYOTX) | 13.30 | 17.50 | 11.43 | 4 star | 800-221-4268 | $2,000/$500/$500 |
| Heartland Value (HRTVX) | 14.52 | 18.21 | 19.08 | 4 star | 800-432-7856 | $5,000/$500/$1,000 |
SOURCE: MORNINGSTAR, AS OF SEPTEMBER 15, 2003. *AS OF AUGUST 31, 2003