Fortune Investor 12.21.98 Ten Safe-Harbor Stocks
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Excerpts:
Think of stocks that can handle
any economic condition, and
you'll think of blue chips with
solid, sustainable top- and
bottom-line growth. In other
words, stocks just like these.
Mine the data beneath our picks
in Safe-Harbor Stocks: Details
and build your own large-cap
searches.
Nelson D. Schwartz
If there is one thing investors could use
right now, it's a safe harbor. This year will
go down as one of the stormiest in Wall
Street history, with all the swells and
surges of a December nor'easter. Even the
market's remarkable autumn rally hasn't
really calmed the waters; underneath the
relief there's still an undertow of unease.
The confusion is shared even by the best
brains on the Street. Some, like Morgan
Stanley's Byron Wien, believe earnings
growth will pick up next year, helping stock
prices to move higher. Others, like Merrill
Lynch strategist and self-described bear
Rich Bernstein, foresee prolonged earnings
weakness for the first time since the early
1990s.
What are ordinary investors supposed to do
if even the big domes can't get a handle on
things? The prudent course is to seek out
what we call "safe harbor"
stocks--companies that seem likely to hold
their own regardless of what happens next.
To help us find these rare vessels, we
talked to strategists such as Bernstein,
Wien, and Lehman Bros.' Jeff Applegate.
We also surveyed top-ranked money
managers like John Hancock Funds' James
Schmidt. Finally, we ran our picks by top
analysts like telecom expert Kevin Moore of
BT Alex. Brown and Carl Seiden, who
follows the pharmaceuticals industry for
J.P. Morgan. (See the boxes later in the
story for these two analysts' outlooks on
their respective industries.)
We decided first that we would stick with
large-cap names. Although they currently
trade at higher valuations than their
small-cap brethren, large-company stocks
in general hold up better in market hiccups,
as they did during the recent
unpleasantness. While the large-cap S&P
500 fell nearly 20% between mid-July and
early October, the small-cap Russell 2000
fell 33%. What's more, as of Thanksgiving
the blue-chip Dow Jones average and S&P
500 had both surpassed their old records,
while the Russell was still well below its
April high.
The first attribute we looked for in our
blue-chip universe was consistent earnings
performance. Jeff Applegate points out that
steady growers are especially valuable
when overall earnings growth is running out
of wind--which is where we seem to be
now. "If profits get scarce, people are
going to pay up for earnings predictability
and stability," he says.
At the same time, we wanted to make sure
the earnings growth was sustainable. So
we avoided companies in industries tied to
unpredictable commodities like paper or oil.
Even in groups we liked, such as
pharmaceuticals, we were careful to steer
clear of companies that are overly
dependent on one product. That's why we
shied away from strong growers like Eli Lilly,
for example, whose income hinges heavily
on sales of Prozac.
As a final backup we insisted on highly
reliable revenue growth. That way future
profits won't depend on cost cuts--a
strategy that can take you only so far--or
worse, on Hail-Mary passes from corporate
accounting. Companies with weak revenue
growth, such as Coke and Gillette, were
among the hardest hit in the summer
correction, which underscores the
importance of a healthy top line.
In this market, though, fast growers don't
come cheap. Some of our picks have
relatively high P/Es, but that doesn't
necessarily mean they are overvalued. It all
depends on whether they will deliver the
growth the market expects of them. We
think they will. Wharton School finance
professor Jeremy Siegel, who has studied
the performance of U.S. stocks since 1802,
concludes, "Over time, companies with
above-average growth will do well even if
they look expensive right now."
That doesn't mean our picks can't go down.
They can. In a steep downturn, even the
best merchandise gets marked down. But
our sources are confident that these
stocks offer a close-to-ideal mix of upside
potential and downside protection. Now on
to the picks:
Phone it in
If drug companies are the No. 1
safe-harbor stocks, phone companies are a
close second. True, the advent of
deregulation made telephone shares a lot
less predictable: Just look at the recent
volatility in AT&T. Nonetheless, they remain
a reasonably safe choice--as long as you
go with stocks that are profiting from the
new trends in telecom, not fighting them.
No company fits that description better
than MCI WorldCom. WorldCom CEO Bernie
Ebbers stunned the telecom establishment
when his company bid for long-distance
giant MCI last year. With the completion of
the merger this past September, it seems
that the synergies Ebbers has long talked
about will come to fruition. WorldCom now
has the world's largest Internet-services
business. It is also the nation's
second-largest long-distance company, as
well as a major player in everything from
local phone service to high-speed data
communications. The company's scale and
potential make Salomon Smith Barney's
top-ranked telecom analyst Jack Grubman
almost rapturous. "There are few, if any,
companies anywhere in the S&P 500 that
are as large as WCOM, that have WCOM's
growth potential--and more importantly,
that have the visibility that WCOM has for
continued top-line growth," he says. "This
company remains the must-own large-cap
growth stock for anyone's portfolio."
It's hard to argue with him. Revenues are
expected to hit $41.8 billion in 2000, a 17%
increase from the 1999 level. (Microsoft's
2000 revenues, by contrast, are expected
to equal $20.7 billion.) Profits, meanwhile,
should jump 48%, to $5.5 billion. Even
better, the company's already capacious
profit margins should widen even more as
the famously cheap Ebbers trims the fat
left over from MCI. Analysts are convinced
that the company could see $2.5 billion in
cost savings in 1999, and Grubman believes
the stock could be at $80 to $90 by the
end of 1999, up from $59 now.
BellSouth, our other telecom pick, has also
succeeded by focusing on high-growth
businesses while keeping costs low and
margins wide. Not only does it have the
fastest revenue growth of any of the Baby
Bells, says BT Alex. Brown analyst Kevin
Moore, but it's also the most efficient.
BellSouth generates revenues of $271,000
per employee, putting it well ahead of
competitors like Bell Atlantic, which
generates sales of $226,000 per employee.
Plus, says Moore, BellSouth's high-margin
businesses like data and digital services,
along with wireless communications, are
growing by over 30% a year.
It doesn't hurt that BellSouth enjoys a
commanding presence in one of the
country's fastest-growing regions.
"Economically and demographically, the
South is one of the top places to be for a
Baby Bell," says Moore. BellSouth has also
made some shrewd overseas moves, such
as building a major cellular business in Latin
America. In the third quarter BellSouth's
Latin American wireless revenues jumped
from $206 million to $442 million, a 114%
rise.
The efficient, steadily growing domestic
business and the new opportunities abroad
should help BellSouth's profits increase by
12% annually over the next few years,
Moore estimates. "We see this stock in the
$95 to $100 range in about 12 months, a
20% gain. That's pretty good upside for a
Baby Bell." Or any other stock, for that
matter. |
