Solid stocks for a shaky market

Don't let recent corporate scandals fool you—reliable companies do still exist. Here are some worth betting on for the long term.

By Jack Pierce

In the fast-moving '90s, when technology and large-cap stocks were flying high, it wasn't difficult to pick winning stocks. But clearly circumstances have changed. Trampled by a growing parade of corporate accounting scandals, the threat of another terrorist attack, conflict in the Middle East, and news that the economy is still faltering, investors remain skittish.

Ironically, the market's scariest times are often the times when investing in carefully selected stocks can prove most rewarding. The key is to focus on companies with the strength and stability to not only survive the current crises but prosper over the longer term—quality companies that increase their profits year after year, have a long history of solid earnings growth, and are selling for reasonable or even bargain prices.

Well-established companies in cyclical industries are also worth a look now. Even though their sales, profits, and ultimately their stock prices tend to suffer when the economy falters, once it starts recovering cyclicals typically rebound first.

Stocks you can count on for long-term growth

If you're ready to wade back into the market with some stocks, you'd be wise to look hard at equities that most closely fit these criteria. Here are some to consider:

Caterpillar is a cyclical play and should bounce back well and start generating an above-average return for shareholders as the economy revives. Caterpillar's main business is construction machinery; it's the world's largest producer of earth-moving equipment. Sound management, a broad product line, and an international reach have helped the company generate stronger sales and earnings than many competitors.

John McGinty, an analyst with Credit Suisse First Boston in New York City, predicts Caterpillar will post earnings of $2.35 in 2002 and $3.25 in 2003. The stock's price should reach 59 within the next 12 months, he says, and he foresees even faster growth in the years ahead. "The longer term earning power of $8 a share in 2006 to 2007 remains unaffected by the economy's current sluggishness," he says.

Johnson & Johnson is a true stalwart—a large health care company that sells consumer items and prescription drugs worldwide. Johnson & Johnson also has a history of making excellent acquisitions. For example, in 2001 it bought ALZA Corporation, a pharmaceutical company that develops innovative drug delivery technologies in the field of urology, oncology, and central nervous system products, among others. With this important purchase and a substantial pipeline of new drugs, the company is poised for more strong growth in the years ahead.

"Johnson & Johnson has been delivering double-digit growth for many years," notes money manager Don Hill of D. P. Hill & Co. in Paradise Valley, AZ. "It should continue to be a leader in the pharmaceutical industry. The company is a good holding over the long term. It's an investment you can live with, particularly in the current market environment."

With an excellent balance sheet (over $5 billion in cash and relatively small debt) and demonstrated leadership in its industry, Johnson & Johnson should prosper in the long term, despite recent publicity over a lawsuit alleging fraudulent record keeping at a plant in Puerto Rico.

SBC, which has been increasing profits for more than a decade, does business in 13 states and 25 countries. It includes two of the seven Baby Bells spun off from AT&T—Southwestern Bell and Pacific Bell—and those form the solid base from which SBC operates local and long distance phone service plus a variety of newer services. For instance, SBC is the leading provider of high-speed Internet access using DSL (digital subscriber line). And it owns 60 percent of Cingular Wireless, the second largest provider of wireless service in the US, making SBC a leader in that field as well.

Brooks Nelson of Nelson Capital Management in Palo Alto, CA, likes SBC. "The company recently increased its dividend, giving it a yield of 4.3 percent. The telecom business has been going through a difficult period for some time now, but look for SBC to be one of the survivors. Its profits have been increasing modestly even during the downturn, and they should pick up speed after the business recovery."

For other promising telecom investments, see Investment Consult: Time to dial up telecom stocks?.

Washington Mutual, the largest US thrift institution and a leader in the loan and mortgage servicing industry, has increased earnings per share every year since 1997 and dividends every quarter since 1995. Assuming that that impressive track record continues, you can expect significant price appreciation in the future.

Bill Nygren, portfolio manager of Oakmark Fund, believes the company will continue to prosper. "Washington Mutual is my favorite long-term idea," he says, noting that at its current price, the stock is also a bargain. "It was recently trading at nine times expected 2002 earnings, yet it has historically grown earnings at a double-digit annual rate."

The depressed stock price likely reflects concerns about the potential effect any increase in interest rates might have. But the company's purchase of Bank United, a Texas thrift, and Dime Bancorp, based in New York City, will aid the company's national expansion efforts over the next few years and should give the stock price a push.

Champions that also pay dividends

Dividend-paying stocks were out of favor for years, particularly while tech stocks boomed. Now they're coming back into fashion. One place to turn for healthy dividends is real estate investment trusts, which allow you to invest in large income-producing properties such as shopping centers, apartments, offices, and industrial properties.

REITs are publicly owned companies that generally trade on stock exchanges and invest directly in real estate, mortgages, or both. By law they must pass 90 percent of their earnings on to their shareholders, so they tend to pay generous dividends. They also deliver moderate growth that can lead to significant price appreciation in the long term.*

"The trend in the real estate market looks good—particularly over the next three to five years," says Rick Imperiale, portfolio manager of Jefferson Growth & Income Fund and Forward Uniplan Real Estate Investment Fund. His favorite REITs are SL Green Realty and Washington Real Estate Investment Trust.

SL Green Realty is a large New York-based REIT that specializes in mid-Manhattan real estate. It has prospered over the years by buying "Class B" buildings—those one step down from the top rung, but in solid condition and desirable locations. This type of real estate is very attractive, he says, because an astute manager can find favorably priced buildings that, with minor improvements, can quickly become profitable investments. SL Green's rents are lower than those for "Class A" buildings, which makes the properties particularly attractive in the pricey Manhattan area.

None of SL Green's buildings or tenants were affected by the Sept. 11, 2001, terrorist attack, notes Imperiale. In fact, he says, "The tragedy eliminated a tremendous amount of office space from the New York market, and the demand remains strong."

The company aims for annual earnings growth of at least 10 percent, and it currently pays a dividend of 5.2 percent. Imperiale anticipates excellent dividend growth ahead.

Washington Real Estate Investment Trust concentrates on properties in Washington, DC, and Northern Virginia. As of December 2001, it owned and operated 24 office buildings, 16 industrial properties, 10 retail centers, and nine apartment houses.

"Washington Real Estate Investment Trust has done well by diversifying its property mix," says Imperiale. "It's built a good record in recent years using this approach, and its future looks promising."

The federal government's stabilizing presence is one reason for the company's bright prospects. Uncle Sam's influence should help spur growth in the local economy over the next few years. Just as important, Washington Real Estate Investment Trust keeps a tight rein on debt and costs, and it has a long history of dividend increases. It's currently paying a 5.1 percent dividend.

The author, a freelance writer in Greenbrae, CA, is co-author of J.K. Lasser's Pick Winning Mutual Funds (John Wiley & Sons, 2001).

These sound stocks can help you profit and rest easy

All stocks trade on the New York Stock Exchange. Data through Sept. 25, 2002. Source: Morningstar.com

*See "REITs: solid dividends and gains," Sept. 9, 2002.

 

Jack Pierce. Solid stocks for a shaky market. Medical Economics 2002;20:34.