10 stocks that will lead the recovery

By virtue of their deep pockets and global reach, these blue chips should do very well as the economy rebounds.

By Dennis Murray
Senior Editor

When a basketball team's in a bind, the coach urges his players to get the ball to their best shooter. Smart investors, too, have star players—companies they can count on for strong, consistent performance.

With the help of several investment pros, we've identified 10 such stocks that will likely help lead the way as the economy bounces back. All of these multibillion-dollar companies have diverse product lines and a global presence. They're well-managed and recognized leaders in their respective markets. And they have the financial resources to remain on solid footing during rocky times.

Not all of them are cheap right now, but your patience will be rewarded, our experts say. Treat these stocks as long-term vehicles to anchor and strengthen your portfolio.

Applied Materials

Applied Materials makes the equipment that produces chips. Not the greasy snack food. Microchips.

This company is the uncontested leader in its business. Its new service, called Ramp Performance Management, offers chip makers equipment that will allow them to upgrade their current systems to speed up production and shipment of orders. The service has been successful in Europe, Singapore, and the US.

With a current price-earnings ratio of 147, Applied Materials appears overpriced at 53. But the P-E is misleading, argues James F. Ferrare, a senior portfolio manager with Pinnacle Associates in New York City. "The P-E ratio is high because earnings have bottomed out," he explains. "For a cyclical company like Applied Materials, an earnings trough is actually a sign to buy. A low P-E indicates that the earnings have ramped up and don't have much room to increase.

"Although the stock isn't selling at a bargain price, Applied Materials will be a dynamic player in the economy's resurgence over the next three to five years," he says. "The next wave of technological innovation will enable chipmakers around the world to produce smaller, faster, more affordable chips."

Costco

If the owners of warehouse retailer Costco Wholesale have their way, another Costco might be coming to a town near you. But do consumers really need one more place to find jars of mustard the size of a schnauzer? Costco thinks so, and it's hard to argue with its success: In just 18 years, it has grown to an $18 billion company with 350 stores in the US, 59 in Canada, and 20 overseas. It plans to open 35 more this year, close on the heels of its biggest rival, Wal-Mart Stores' Sam's Club.

Costco stores are like a walk down Main Street. Under one roof, you can buy groceries and electronics, refinance your mortgage, even plan a vacation. "This speaks to management's ability to think creatively about how to get more people in the door—and how to get them to leave with a higher bill," says Mike Porter, an analyst with Morningstar (www.morningstar.com), the stock and mutual fund tracking firm.

One-stop shopping is all well and good, but what about data that show people are spending less?

"I expect that any pullback in consumer spending will be short-lived," says Louis Navellier, CEO and President of Navellier & Associates, in Reno. Moreover, a large percentage of Costco's sales come from consumer staples—groceries, clothing, toiletries. Revenues from these tend to smooth out dips in discretionary spending.

General Mills

How could a company that's best known for breakfast cereals be worth, at last count, almost $18 billion? By aggressively acquiring and partnering with other companies. In addition to creating joint ventures with Frito-Lay and Nestlé, last year General Mills added Pillsbury to its brand list, immediately doubling the volume of General Mills' international sales.

Although the Pillsbury deal will ultimately make General Mills a stronger company, it didn't come without a cost. General Mills had to assume $5 billion of Pillsbury's debt—a heck of a lot of dough, if you'll pardon the expression. The good news: General Mills' annual sales have increased steadily since 1997, to more than $7 billion in 2001. Moreover, the company's return on equity, a measure of how effectively it uses shareholders' money, consistently places it in the top echelon of food companies. As proof, its stock dished up double-digit total returns in 2000 (28.5 percent) and 2001 (19.7 percent), years when stocks in flashier industries struggled.

"Operating margins are expanding again, after a stagnant period," Navellier says. "Plus," he jokes, "General Mills has managed to get adults to eat Cheerios. That's got to mean something."

Lockheed Martin

The more aggressively the US and its allies pursue terrorists, the better the future looks for this $27 billion aerospace company.

"Military spending will be a priority for several years," says Navellier. "That means Lockheed will continue to get its share of government contracts." A recent feather in Lockheed's cap is the "Joint Strike Fighter" contract, a program to develop the next wave of aircraft weapons systems. The largest military contract ever awarded, it may ultimately be worth $400 billion, according to Morningstar.

Although the stock's not cheap, it should still reward investors who buy it now. "Lockheed's communication and electronics units should enjoy strong growth—8 to 10 percent, we think—as the Pentagon works to improve its ability to gather intelligence and control the battlefield remotely," says Morningstar analyst Jonathan Schrader.

In addition, he reports, Lockheed made the smart move of getting out of the telecom business, which had been losing the company millions. This will allow the company to focus on its core business of defense contracting—a move that should improve profit margins.

McDonald's

This cash-rich, ubiquitous restaurant chain, which has some 28,000 stores worldwide, has been hurt by the one-two punch of a US recession and, abroad, fear of mad-cow disease. Not surprisingly, McDonald's stock has suffered. It posted negative returns in each of the past two years and is off significantly from its five-year high of 49.

Still, a lot of investment pros recommend McDonald's to their clients. Among the positive signs they point to: The company is buying back shares, adding nonbeef items to its menu in Europe, and implementing a new system for evaluating its US stores.

"Investors focus too much on domestic performance," says Paul Palazzo, a financial planner with L.J. Altfest & Co. in New York City. Sales have been somewhat flat here and abroad, but the company has been making substantial investments overseas. One obvious key to its expansion plans is Asia, Palazzo says. Another is Latin America, where a large population of young people represents an attractive target.

Merrill Lynch

Merrill Lynch has had a rough time of late. Adding to the pain of a restructuring that included thousands of layoffs, last month the New York State Attorney General accused the firm of issuing biased stock ratings to win investment banking service contracts. The company vigorously denies the charges.

Merrill Lynch will weather the attack on its integrity, predicts Jim Ferrare. "It's no more guilty of this than the other major brokerages," he says. "The whole industry needs to get its act together." Moreover, Ferrare adds, the accusations don' t change the fact that Merrill Lynch is well-positioned to profit as the first wave of baby boomers nears retirement age. "The demand for investment advice will be unprecedented," says Ferrare.

Although it'll continue to handle individual clients, the firm plans to focus more of its sales and marketing efforts on higher-margin services, including securities underwriting and advising on merger strategies. It also wants to increase the proportion of managed assets in fee-based accounts, which currently stands at 40 percent. This would help to smooth out the company's revenue stream, but Morningstar warns that it may cause some commission-compensated brokers to defect to competing firms.

As the financial-services industry consolidates, Merrill Lynch could be an attractive target for a takeover. "If the company's acquired, the stock could jump to around 80 a share," says Ferrare. (The stock recently traded in the low 50s.) "That price would represent at least three times the company's book value, reasonable given that it's an established franchise."

Pfizer

"Pfizer's projected four-year growth rate is one of the highest of all pharmaceutical companies, thanks in large part to its June 2000 merger with Warner-Lambert," says Joel L. Konigsberg, senior vice president of investments for Salomon Smith Barney in New York City. "In addition, over that four-year span, only 13 percent of Pfizer's sales will face any risk of generic cannibalization."

Another plus for Pfizer: The cost-savings from the merger with Warner-Lambert are beginning to reach the bottom line, improving profit margins. "Combine that with average revenue growth of 10.5 percent, and Pfizer offers a lot of bang for your buck," says Todd Lebor, a Morningstar analyst.

The Pfizer pipeline contains several new drugs, including two expected to be launched this year: Bextra, for arthritis and menstrual pain, and Vfend, an antifungal. Meanwhile, Pfizer continues to spend big bucks on research and development. Some $5.3 billion is budgeted for this year, which represents about 15 percent of the company's total revenue.

Philip Morris

What's in a name, anyway?

In an effort to improve its image, which has been battered by lawsuits against its tobacco business, Philip Morris announced that it intends to change its name to Altria. Nevertheless, the company will remain the same beer (Miller Brewing), food (Kraft), and tobacco (Marlboro, Virginia Slims, etc.) conglomerate. While that's disheartening to some investors, it's comforting to countless others. "It seems like any time the market gets rocky, people run to Philip Morris," says Louis Navellier.

And for good reasons: The $112 billion company has a long history of rewarding investors with a steady stream of dividends coupled with stock-price appreciation. For instance, last year's dividend yield of nearly 5 percent was much higher than the 1.2 percent average for stocks in the S&P 500 index. The five-year average annualized return is a solid 11.8 percent, and there's no reason to think deep-pocketed Philip Morris—er, Altria—can't match or better that average return over the next five years, despite the many lawsuits still pending against the company related to its tobacco business.

"For investors who don't mind the tobacco connection," says Morningstar analyst David Kathman, "this is a fine stock to own."

Viacom

"Media empire" isn't too strong a term to describe Viacom. The company owns TV networks, such as CBS and MTV; premium cable channels, including Showtime Networks; radio stations, such as Infinity Broadcasting; book publisher Simon & Schuster; and film studio Paramount Pictures, among other properties.

This allows for an enormous amount of cross-promotion. Viacom's TV stations, for example, can produce and broadcast interviews with the stars of a Paramount film. Infinity can flog the movie on one of its more than 180 radio stations. And when the film is released on video, Viacom's Blockbuster rental outlets can display it prominently.

Moreover, says Jim Ferrare, "any further deregulation with regard to cross-ownership of radio, TV, and newspaper companies should create opportunities for Viacom that aren't yet reflected in the stock price."

But what of the proverbial head-butting between chief executive Sumner Redstone and president Mel Karmazin? "That's old news that keeps resurfacing," Ferrare says. "Viacom is still well-positioned for good long-term growth, despite the clash of personalities and the current slowdown in advertising."

Wells Fargo

For a rock-solid stock at a nice price, take a look at Wells Fargo, which is trading at a 15 percent discount to its fair value, according to Morningstar's calculations.

Once a mere banking giant, Wells Fargo is now a major player in the mortgage business, too, thanks to its 1998 merger with Norwest. The company also sells mutual funds and insurance, making it as close to a one-stop financial-services firm as you could hope to find. And, with more than 5,600 offices in the US and abroad, finding a Wells Fargo representative isn't difficult.

"Wells Fargo's primary goal is to get their banking customers to do their mortgage business with the company, and vice versa," Joel Konigsberg says.

Lower mortgage rates are helping the company reach that goal, as customers continue to seek good deals on financing. Thanks in part to the fees these services generate, Wells Fargo saw its profits rise an impressive 4.7 percent in the fourth quarter of 2001.

This is the beginning of a strong run, Konigsberg predicts: "Long term, earnings and revenue growth will be 50 to 100 percent higher than the averages for banks. When the economy turns around, Wells Fargo will be in the best position of all banks to benefit."

Big stocks for a big turnaround

 

Dennis Murray. 10 stocks that will lead the recovery. Medical Economics 2002;9:34.