Features/Cover Stories/1999 Investor's Guide
Ten Safe-Harbor Stocks 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.
Nelson D. Schwartz Reporter Associate Len A. Costa
12/21/98
Fortune Magazine
Time Inc.
Page 76+
(Copyright 1998)
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:
SAY YES TO DRUGS
In stressful markets, veteran Wall Streeters tend to acquire a drug habit.
Who wouldn't? Pharmaceuticals companies are almost unique in their ability
to generate strong earnings growth in any economic climate. So no matter
which way the economy goes, drug stocks have you covered.
Which brings us to Pfizer. You already know the company's hottest product,
Viagra. The drug's boffo launch earlier this year made it the most successful
new drug in history. In recent months, though, sales have faded a bit, and
Pfizer's stock gave up some of the gains it made earlier in 1998. What's been
overlooked amid the hoopla is that Pfizer has plenty of other potential hits in
the pipeline. "I don't think there's much doubt that Pfizer is the best
company in the industry," says J.P. Morgan analyst Carl Seiden. "They've
got a series of blockbusters coming out in the next few years. It's almost an
embarrassment of riches."
The most important of these new medicines is Celebrex, a revolutionary
painkiller developed by Monsanto that's safer than conventional remedies
like aspirin or ibuprofen. For example, Celebrex doesn't carry side effects of
long-term aspirin use, such as stomach bleeding.
Pfizer and Monsanto have formed a partnership to market Celebrex, which
Deutsche Bank Securities analyst Mariola Haggar predicts will gain final
FDA approval by the end of January. She estimates that by 2004, Celebrex's
total sales could equal $2 billion. Pfizer's share: 40% to 50% of the profits.
Haggar adds that Pfizer will launch several potential blockbusters from its
own labs in 1999, including migraine-remedy Relpax and Tikosyn, a
treatment for cardiac arrhythmia. And while Viagra may be off the front
pages, it hasn't gone away. Pfizer recently unleashed the little blue pills on
Europe and is set to do so in Japan in late 1999.
Altogether, says Seiden, Pfizer's earnings should grow by roughly 20%
annually for the next few years, well above the drug industry average of
15% to 16%. Revenues are also growing by about 20% annually, he says,
and the company is taking excess cash and plowing it into research to
maintain its supply of future blockbusters. "Pfizer is investing now so it can
grow by 20% forever," he says. "In the long run, that's going to be great for
investors." Over the next 12 months, Seiden says Pfizer could rise 25% from
its current level of $111 a share.
Our second pick in this group, Pharmacia & Upjohn, used to be the drug
stock Wall Street loved to hate. The 1995 merger between Swedish
pharmaceuticals giant Pharmacia and U.S.-based Upjohn got off to an
awkward start, with executive offices in four countries and constant turf
wars.
That all changed when Fred Hassan took over as CEO in the spring of 1997.
A well-regarded industry veteran, Hassan streamlined the company's
sprawling bureaucracy and installed a new management team that's finally
earning the company respect on Wall Street.
"Hassan has really made a difference," says Michael Kagan, manager of the
$1.7 billion Salomon Brothers Fund, which owns about $25 million of PNU.
"This company had been an utter disaster." The turnaround hasn't gone
unnoticed: Pharmacia & Upjohn shares are up more than 20% since this past
June. But Kagan, along with analysts Haggar and Seiden, argues that PNU
still has plenty of upside left. Kagan notes that the company's P/E multiple is
10% below that of the typical drug company, while earnings are expected to
grow by 14% in 1999.
At the same time, analysts are excited about new drugs from PNU like
Detrol, an eight-month-old incontinence remedy that has already grabbed a
big share of the market. Incontinence affects more than 30 million people
worldwide, and Detrol doesn't cause the severe dry mouth that patients
experience with other treatments. By 2002 it could generate $800 million in
worldwide sales. Haggar estimates that drugs like Detrol could help drive
PNU shares to $65 by the end of 1999, for a gain of 22%.
If our final pick in this group, American Home Products, seems familiar,
that's because we recommended it this past August in our annual Retirement
Guide. Since then AHP has gone through some tribulations--most notably the
collapse of its planned merger with Monsanto in October. The breakup of the
deal sent AHP shares skidding, and it's now well off its 52-week high of $59.
But even without the union with Monsanto, AHP is still a good long-term
pick. That's especially true for bargain-minded investors who have been
scared off by the drug sector's sky-high P/Es. AHP's 1999 P/E of 27 makes
it the cheapest of the major drug stocks by far, says Haggar. Meanwhile the
company is quietly preparing a bevy of potential hits, including Sonata, a
sleep aid due out in April that doesn't have the side effects of existing drugs.
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