Blue chips that can ride out a recession
Solid stocks have been dragged down along with troubled shares. Learn to spot the bargains.
(Money Magazine) -- Really bad stock markets knock down shares of all kinds. That's essentially what has been happening since the start of 2008, as subprime fallout led to recession anxiety. But not every market sector faces the same problems and uncertainties.
Even if we are in a downturn, many companies will come through with their long-term prospects untarnished. Scoop up such stocks while their prices are depressed, and you have a real chance to boost your returns.
The way I see it, the stock market now is actually three markets. First, there are companies that depend on borrowing and lending, including home builders and makers of big-ticket consumer items that typically require financing, as well as bank stocks. Their shares all posted double-digit losses last year.
Yes, the stocks are starting to look like bargains, and the Fed's aggressive interest-rate cutting should eventually spark a recovery. But I'd be worried about buying in too early: The final chapter of the subprime story isn't written yet.
At the other extreme, inflation-sensitive sectors, such as energy and other commodities, have boomed for several years running. But they've had sizable losses so far in 2008, they're still relatively expensive, and they could stay down for a while if demand for raw materials falls in a slowing economy.
Finding the best deals
That still leaves a big swath of stocks whose share prices are down but which are unlikely to suffer lasting damage from the subprime flu or any mild cold the economy catches. The industrial, technology and consumer sectors all fall into this category.
In particular, companies that derive a large percentage of their earnings from outside the U.S. have the best chance of riding out a bad domestic economy. For example, two of the stocks I recommended in last month's column - Hewlett-Packard (HPQ, Fortune 500) and 3M (MMM, Fortune 500) - get at least 60% of their sales abroad.
Spotting true bargains during this downturn is no layup, though. Price/earnings ratios based on anticipated results may be misleading, for instance, because growth may not come through as expected this year. So make sure that a stock also looks cheap compared with its peers based on P/Es using 2007 earnings.
Another smart way to compare stocks is by ratios of price to cash flow (the cash per share a company actually generates each year). The reason: Cash figures tend to be less volatile than earnings.
Three stocks to watch
In doing a little bargain hunting among stocks in the Sivy 70, I found three that have solid prospects, trade at P/Es below 15 based on 2007 earnings and are priced at less than 10 times cash flow. Those multiples count as cheap by anyone's calculations.
DuPont (DD, Fortune 500) announced 27% earnings per share growth (excluding one-time items) in the fourth quarter and recently raised its earnings targets for 2008. How does a company in a cyclical industry such as chemicals buck a U.S. recession? Almost two-thirds of sales come from overseas, where they are growing up to 20% a year in countries such as Brazil, China and India.
The hottest part of DuPont's business has been agricultural products, boosted by rising food prices and demand for ethanol. That division, which accounts for almost a quarter of sales, is growing twice as fast as the rest of the company. As an added bonus, DuPont shares yield a very healthy 3.8%, making them a great choice for retirees.
Fortune Brands (FO, Fortune 500) is a conglomerate with top-name consumer brands, including Jim Beam bourbon and Titleist golf balls. The company also has a home and hardware division, which consists of product lines like Moen faucets. Those businesses have been suffering because of the bad housing market. As a result, the stock has fallen close to a 52-week low of $66, down from a high of $90. That looks like too much punishment for limited housing exposure. Besides, Fortune is restructuring to trim costs, downsizing its home and hardware division and selling its wine business. As a result, the company took a large write-down in the fourth quarter.
But long-term growth has averaged 9% annually and is projected to continue at that rate over the next five years. Add in the stock's solid 2.6% yield, and you have double-digit return potential.
IBM (IBM, Fortune 500) reported terrific fourth-quarter results. Earnings per share were up more than 20% on a 10% rise in sales. A third of the increase in per-share profits was the result of 2007 stock buybacks totaling almost $19 billion. The rest of the profit gain was mostly from IBM's extensive business outside the U.S., which now accounts for almost two-thirds of total sales.
The company is enjoying especially strong growth in Asia and some developing markets. Bookings for service contracts in 2008 are also several billion dollars above expectations, and IBM has raised earnings projections for 2008. As Big Blue goes global, seems like it would deserve a market-beating multiple.
Are you on track for an early retirement? Tell us why at email@example.com. Include your financial details and your family could be profiled in a future column of our Millionaire in the Making series.