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Profiting from America's best stocks

Here's my market analysis for the rest of the year, along with how to get the most out of the Sivy 70 list.

By Michael Sivy, Money Magazine editor-at-large

NEW YORK (Money) -- Because of changes in my schedule, this will be the last of my weekly columns written specifically for the CNNMoney.com Web site and e-mailed to readers.

We will continue to maintain the The Sivy 70 stock table on the Web site. And the monthly columns I write for Money Magazine will be posted along with the Sivy 70 table.

Since my commentary from the magazine won't be as frequent as the weekly columns for the Web site, this seems like a good time to consider the market outlook for the rest of the year. It's also worth revisiting the rationale behind the Sivy 70 list and the ways in which you can use this list to take advantage of investment opportunities as they develop.

The most important recent news was the Fed's statement last Wednesday. It suggested that the Fed sees economic growth continuing, although perhaps at a slower rate. Fedwatchers also thought they saw signs that the Fed's next move would be to lower interest rates, even if that doesn't happen in the immediate future.

The most likely outcome is a slower economy, less volatility and ultimately some reduction in interest rates. That's a very positive scenario for blue chips, especially conservative growth-and-income stocks with yields above 2 percent.

The earnings outlook for such blue chips is also encouraging. In the third and fourth quarters last year, earnings growth for the typical S&P 500 stock was more than 12 percent, compared with a year earlier.

In addition, the typical positive surprise was more than three percentage points. In other words, reported results were significantly better than what analysts were expecting.

Current expectations are for earnings growth for the next few quarters of 8 percent to 9 percent. If there is again a positive earnings surprise, results could make it into double digits.

Using the Sivy 70

The companies on the Sivy 70 list are the kinds of stocks that should prosper as this economic story unfolds.

I include large stocks with projected earnings growth and current dividend yields sufficient to produce a compound annual total return of at least 10 percent. In addition to total return potential, I look for financial strength and a consistent track record.

Not every great company will be on the list. And not every stock on the list will be a timely buy at every moment. But the Sivy 70 list gives you an excellent universe of stocks to choose from - they are, essentially, America's best stocks.

To encourage maximum diversification, I also try to give you as broad a choice of industries as possible. This means that some fine stocks are left off the list so as not to overweight a particular industry.

The best way to use the Sivy 70 list is to identify stocks that you want to follow. Look specifically for companies that will complement the holdings you already have.

When stocks appear to be undervalued, add them to your portfolio. Favor companies that will do the most to diversify your existing mix. You don't need to buy everything at once. It's more sensible to pick up one stock at a time.

To determine when a stock is undervalued, compare its price/earnings ratio, based on estimated results for the coming year, with the stock's likely total return. You can approximate the annual return potential by adding the stock's earnings growth rate to its yield.

This calculation is like the PEG ratio, which compares P/E with earnings growth. I prefer to add the dividend to the growth rate so that growth-and-income stocks can be fairly compared with pure growth stocks.

Ideally, the ratio should be less than 1.5. That means a stock with 10 percent earnings growth and a 2 percent yield should have a P/E no higher than 18. Obviously, a 15 or 16 P/E would be better.

A more aggressive stock - 15 percent earnings growth plus a 1 percent yield - should have a P/E no higher than 24.

No one knows what the rest of 2007 will hold. The outlook appears quite positive. But there could always be some kind of shock that sends the economy into a slump and causes a market downturn.

But the long-term fundamentals look very positive for investors who are trying to build portfolios for a decade or longer.

It really is a long-distance run. You should have plenty of opportunities over the next year or two to add to your holdings and build a well-diversified portfolio that can carry you through to retirement. And the companies on the Sivy 70 list are your best place to start.


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