Proceed With Caution

Alfred Jackson isn’t excited about the economy just yet. A partner at Davis Hamilton Jackson & Associates L.P. (DHJA) in Houston, Jackson believes that, in this cycle of economic uncertainty, the country has already realized its highest levels of growth. His stock-picking strategy, therefore, has been to proceed with caution. “It is becoming apparent that economic growth and corporate profit margins have probably peaked for this recovery phase,” Jackson observes. “Slower but still positive growth is the best bet for the next 12 months as the Federal Reserve raises short-term interest rates. Chances are that current earnings expectations are too high for next year.”

To lower the investment risk for DHJA’s institutional investors (which includes pension funds, endowments, and foundations), Jackson, along with a team of analysts, looks for companies with rising earnings, focusing on whether their future earnings growth is sustainable over the long term. Their stock-picking approach also involves pinpointing the catalyst of that growth: unique products, market niche, increased market share, pricing, or profit margin improvements.

Jackson and his team are keen on selling stocks that are losing value. Each time a stock is purchased, a target price is set using relative P/E analysis and the Graham & Dodd growth stock valuation model, which looks at earnings over a period of time. DHJA’s portfolio is reviewed on a weekly basis and any negative change in a stock’s earnings estimates — or any other factor that might undermine its value — will cause analysts to consider it for potential sale. “Our strong sell discipline is the key to limiting losses and maximizing profits,” says Jackson.

For now, though, the firm’s team of analysts has identified the following stocks as having potential earnings growth:

Petsmart Inc. (NASDAQ: PETM), the Phoenix-based company that provides products and services for pets through its retail stores, is likely to experience consistently strong earnings growth. According to Jackson, “Growth will come from increased pet ownership, increased spending on pets, and Petsmart’s initiatives to expand its services.”

Jackson also stands behind Johnson & Johnson Inc. (NYSE: JNJ), which manufactures and markets a range of products in the healthcare field. He says J&J has the opportunity to increase its revenues, primarily through continued innovations in medical devices such as its artificial spinal cord disc.

General Electric Co. (NYSE: GE) is another company that Jackson says is experiencing a turnaround. It manufactures products and provides services across a broad selection of industries, including transportation, media, and commercial and consumer finance. “Performance will come from near-term strength in GE’s short-cycle industrial business, the re-emergence of aircraft, automotive, and locomotive [engine-making], and [the production of] electricity generation equipment, which have struggled over the past several years,” Jackson says.

Jackson also likes Microsoft Corp. (NASDAQ: MSFT), which develops, manufactures, and licenses software products. He says Microsoft will continue to grow its core operating system franchise and will experience continued growth “with help from the relatively near-term introduction of its next generation operating system, and continued innovation with Internet-related software products.

Finally, Jackson says to watch Schlumberger Ltd. (NYSE: SLB),