Fortune Investor 12.21.98 Ten Safe-Harbor Stocks [LU is one of them]
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:
Safe techs
Unlike the drugs or Baby Bells, tech
companies aren't often thought of as
safe-harbor stocks. However, it would be a
big mistake for risk-averse investors to
avoid this group, especially because of the
long-term growth opportunities that the
Internet and other new technologies offer.
The trick is to find tech stocks that
combine rapid growth with proven staying
power. That's why we prefer two of the
biggest names in this sector: Microsoft and
Lucent. Their size, wide range of products,
and record of consistent growth all make
them safer bets than smaller competitors.
And while Lucent and Microsoft may not
promise overnight riches like an eBay or
Amazon.com, we're happy to leave those
two high-fliers to day traders and other
gamblers.
Our picks do have some well-publicized
risks of their own, however, especially
Microsoft. As everyone knows, the colossus
of Redmond is embroiled in the antitrust
trial of the decade with the only other
entity in its weight class, the U.S.
government. To top it off, the stock has
surged 40% since June.
So is this the right time to be buying
Microsoft? Lehman Bros. software analyst
Mike Stanek says he's frequently asked
that question. His answer: "The market is
open from 9:30 a.m. to 4 p.m., five days a
week," says Stanek. "Anytime during those
hours is a good opportunity to buy
Microsoft."
What makes Stanek so confident? "This
company is entering the most lucrative
product cycle in its history," he explains.
"Between Windows 98 right now, the
Microsoft Office upgrade in 1999, and
Windows NT in 2000, you're looking at
annual earnings growth of 25% at a
minimum."
It's Windows NT that has analysts like
Stanek especially excited. While Microsoft
dominates the market for desktop software,
it isn't yet a player in the $40 billion-to-$50
billion market for enterprise software, the
heavy-duty programs that run on big
servers and workstations. Once the new
version of Windows NT comes out in early
2000, Microsoft could siphon market share
from enterprise software sellers like IBM,
Sun, and Oracle.
"Over the next five years, Windows NT will
help sustain the company's annual earnings
growth at 25%," says Stanek. "And you've
still got growth in the high teens or low 20s
from its other products." Moreover, the
licensing fees big corporate customers pay
for Windows NT and Microsoft Office give
Microsoft's profits a predictability that few
companies--tech or otherwise--can match.
But isn't the government's antitrust suit a
real worry? In the short term, yes. Over
the long term, though, Microsoft's stock
price will be determined by the company's
earnings power, and there is no evidence
that the current legal battle poses any real
threat to that. Even a worst-case
scenario--a government breakup of
Microsoft--would likely prove a boon to
investors. Just ask anyone who held on to
the Baby Bells when AT&T split in 1984.
Stanek doesn't see anything so drastic as
that. He predicts Microsoft could hit $140
before the end of 1999, a nice gain from its
current level of $120.
Our other pick in this group, Lucent
Technologies, is already one of the tech
legends of the 1990s. Since its 1996 spinoff
from AT&T, this maker of communications
hardware has risen more than 500%, and
there's nothing to suggest that the glory
days are over.
For starters, the $200 billion market for
communications gear is growing by 12% to
14% annually, spurred by massive
infrastructure investment by companies like
MCI WorldCom and AT&T. The recent wave
of telecom deregulation in Europe has only
heightened demand for Lucent's products,
as giants like Deutsche Telekom modernize
their aging phone networks. Finally, the
explosion in Internet traffic practically
guarantees strong growth for years to
come.
What's more, Lucent is taking market share
from rivals like Nortel and Siemens. "As
General Electric is to the industrial
economy,
Lucent is to the Information Age," says Jim
Parmelee, an analyst with CS First Boston.
"It's already clear that Lucent is one of the
long-term winners out there."
Indeed, Lucent scored the Wall Street
version of a hat trick when it recently
announced its latest results, beating
estimates for earnings, revenues, and profit
margins. Parmelee, who predicts long-term
growth of 20% to 25%, says Lucent could
rise from its current $89 to $110 over the
next 12 months.
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