re: Jim Jubak on Nokia & 5 Others
This is a tough stock market for anyone to put money into, and I think we’ve got plenty of volatility ahead of us over the next six months. But for the long-term investor, dollar cost averaging into these six stocks is a sound strategy. I’m giving Intel, Citigroup, American International, Procter & Gamble and Unilever -- the five that are members of my 50 Best Stocks in the World -- buy ratings for long-term investors who pursue a strategy of dollar cost averaging. The sixth stock, Nokia, is a member of my more risky Future 50 portfolio. At recent prices I also think it’s a buy for patient long-term investors interested in building a position in the stock.
>> 6 Stocks That Will Lead The Recovery
Jim Jubak
Jubak's Journal
9th May 2002
moneycentral.msn.com
These companies dominate their markets, are tops in efficiency and have strong balance sheets -- and they're poised to grow even before the economy turns.
So where’s the leadership going to come from to drive the stock market sustainably higher?
Bounces don’t require leadership. In fact, stocks that perform best when a market rebounds from a long bout of selling -- such as the one we’re in now -- are often those facing the most troubled futures. They climb because they reach lows that make them seem cheap enough so that they discount well-known problems. But once the prices of stocks such as these climb, they become sells again, since the higher prices no longer discount the problems at the companies.
But sustainable rallies do require leaders, bellwether stocks that convince investors that tomorrow will be better than today. Leaders aren’t attractive simply because they’re temporarily cheap. These are stocks that promise future growth strong enough to keep the price rising -- not necessarily quickly, mind you -- even after the stocks are no longer cheap on past performance.
Investors know where that leadership usually comes from in a stock market that’s recovering from an economic slump. Cyclicals, stocks such as Caterpillar (CA), Alcoa () and Exxon Mobil (XOM) are supposed to lead the way and then pass the baton to groups such as financials and technology stocks as prospects for an economic recovery increase and the stock market gains some momentum.
The Cycle For Cyclicals
Cyclicals certainly played their assigned part. Exxon Mobil, like other energy stocks, rallied at the end of 2001 (the stock climbed 20% from Dec. 14 through April 1, 2002). Caterpillar was one of the best performers of early 2002, with the price climbing 25% from Feb. 7 through April 10.
But there’s been no follow-through. Financial stocks have lost ground over the last month: Citigroup (C) is down 10% and Merrill Lynch (MER) 21%. And tech stocks? Well, former market leaders Intel (INTC) and Cisco Systems (CSCO) are down 15% and 25%, respectively, in the month.
That’s caused investors, who already have enough to worry about, another dollop of anxiety. If the traditional leadership groups and stocks aren’t up to their former roles, how is this market going to mount a real rally instead of just another trading bounce? The most pessimistic of investors even see this as an indicator that stocks aren’t going anywhere for quite a while. Looking at the lack of potential leaders, they hypothesize a replay of the trading-range market that kept the Dow Jones Industrial Average trapped between 750 and 1,000 for a period stretching from the end of the 1973-74 bear market to 1982.
I have a different read on the performance of the traditional leadership groups to date. Just as this has been an unusual recession, I think we’re headed into an unusual recovery. And in this unusual recovery, leadership won’t come from whole groups of stocks related by industry or place in the economic cycle. I think leadership will be found across industry groups in stocks that share the traits of dominant market share, manufacturing or service efficiencies, and balance sheet strength. That formula, I believe, will add up to an ability to increase profit margins at these companies to a degree that will be impossible at the average company.
A New Definition For Leaders
Let me explain why these traits will define the leadership in the next sustainable market uptrend.
This recession has been so unusual that economists are divided over whether or not the economy “officially” met the definition of a recession. Consumers kept on spending, even as corporations cut back, and the Federal Reserve quickly cut interest rates. Sales of cars and homes soared to record levels, preventing the collapse of industries such as telecommunications equipment from spreading to the general economy.
Normally, recessions are led by a collapse in consumer demand, which then leads to a collapse in business spending. In this one, though, business overinvestment in capital equipment created a corporate-side recession, while consumer spending remained strong throughout the period.
The strength of consumer demand and the shallowness of this recession are likely to produce a shallow recovery. In the “normal” recession, the collapse of consumer spending leads to pent-up consumer demand so that sales soar once the recession has ended. That doesn’t seem likely this time. Forecasts in demand for everything from wireless phones to PCs to cars to credit cards shows only modest growth at best in the second half of 2002 and into 2003.
And the shallowness of this recession has meant that while individual companies made painful decisions to close individual plants and service centers, the pain never reached a level that encouraged significant numbers of whole companies to go out of business. The one exception (and a very large one it is): telecommunications, where the recession was severe enough to produce multiple bankruptcies. Look at the DRAM industry. There are simply too many memory-chip makers producing too many chips to let any of them make money. But a deal that would have reduced the number of players and taken some capacity out of the market died last week when the directors of Hynix Semiconductor turned down a buyout offer from Micron Technology (MU, news, msgs). Hynix has instead decided it can stay in the memory business if it sells off non-memory chip assets.
Margin Crunch
This combination of modest growth in demand and failure to reduce excess capacity has the power to radically lower corporate profitability in any upturn. Gross profit margins in this case would climb from the low levels of 2001 and 2002 so far, but they wouldn’t come close to the margins that companies racked up in 1999 and 2000. And with margins substantially lower, any recovery in stock prices would be severely damped.
Consider the numbers reported by Texas Instruments (TXN, news, msgs) on April 15. For the first quarter of 2002, gross margin jumped to 33%; that’s quite a recovery from the 23% recorded in the fourth quarter of 2001. “We have turned the corner toward growth,” said Tom Engibous, Texas Instruments CEO.
Well, yes, but exactly how far will that corner extend? The recent 33% gross margin is still significantly below the 41% recorded in the first quarter of 2001, and it’s way below the 48% and 49% gross margins that Texas Instruments was reporting regularly in its peak sales year of 2000. Knowing how far Texas Instrument’s margins will rebound is critical for any investor looking to value the stock.
Answering that question for Texas Instruments depends on making projections about how fast growth will pick up in the company’s key wireless and telecommunications market. If the economy is stronger than expected, gross margins see 2000 levels. If not, 40% or even lower might be a top. In other words, Texas Instruments will follow the economy, not lead it.
Those That Lead Rather Than Follow
That’s true of most companies, of course, and not a knock on Texas Instruments, which has done a good job of hanging onto market share in the downturn. But there are a few companies that, because of their dominant market share, manufacturing or service efficiencies, and balance sheet strength -- the three factors that I mentioned earlier -- could lead the economy instead of follow it. These companies look able to increase their gross margins to something close to their 2000 peaks even if the economy just muddles along.
Intel is the poster child for this small group of companies. By the end of 2003, gross margins could be back to nearly where they were at the company’s 2000 peak even if revenues grow by just 10% this year and 15% in 2003.
How is that possible? Morgan Stanley figures that Intel’s transition of the majority of its production to Pentium 4 chips that use smaller 0.13 micron designs on larger and more cost efficient 300mm wafers will drive Intel’s capital cost per chip down by 42%. And that will drive gross margins to 61% in 2003. Gross margins had fallen below 50% in mid-2001 after hitting a high of 64% in the third quarter of 2000.
What ingredients make it possible for Intel to have this kind of potential? Well, dominating the market for microprocessors used in personal computers doesn’t hurt. That enables Intel to spread its manufacturing costs across a huge production run. And it doesn’t hurt that Intel has made highly efficient manufacturing a key to its corporate strategy for generations of chips. And finally it doesn’t hurt that Intel has a balance sheet -- one of the few in the chip industry -- that can support heavy capital investment even in bad times. Intel, like the companies that I wrote about in my last column -- “6 bubble survivors with ‘Fantastic’ futures” -- knows how to use the down part of the economic cycle to push its competitors to the limit.
Among The Winners: Nokia, Citigroup, AIG
I can name a few more companies that belong in this leadership class along with Intel. Nokia (NOK) in wireless phones combines the manufacturing efficiency, the dominant market share (35% or more in handsets) and the balance-sheet strength.
And these traits aren’t limited to technology companies. In the financial world, Citigroup (C) and American International Group (AIG) have built the kind of market share, efficient distribution networks and solid financials that are the equivalent of Intel’s.
And in consumer goods, Procter & Gamble (PG) and Unilever (UN) seem to be in the middle of reorganizations that will give them the global consumer-goods-company version of these other leaders.
This is a tough stock market for anyone to put money into, and I think we’ve got plenty of volatility ahead of us over the next six months. But for the long-term investor, dollar cost averaging into these six stocks is a sound strategy. I’m giving Intel, Citigroup, American International, Procter & Gamble and Unilever -- the five that are members of my 50 Best Stocks in the World -- buy ratings for long-term investors who pursue a strategy of dollar cost averaging. The sixth stock, Nokia, is a member of my more risky Future 50 portfolio. At recent prices I also think it’s a buy for patient long-term investors interested in building a position in the stock. <<
- Eric - |
