What investors should do now
Be extremely picky. For your core holdings, stay away from bank stocks entirely. Yes, there's a chance that beaten-down bank stocks will rebound now that the federal government wants to help them get bad loans off their books. But we think there's just too much uncertainty about what the final bailout bill coming out of Congress will look like.
For similar reasons, we're loath to recommend any nonfinancial company whose business depends on access to bank credit or capital markets. Cash really is king today, and those companies that are cash-rich are going to be in a strong position to pick off some of their overleveraged rivals. Berkshire Hathaway's recent acquisition of cash-strapped gas and electricity supplier Constellation Energy is a case in point.
For a list of cash-rich companies with good prospects, we used Baseline's stock-screening tool to search for companies with low debt (debt-to-capital ratios of 10% or less) as well as modest valuations (price/earnings ratios of 14 or less) and solid earnings forecasts (earnings-per-share growth of 10% or better for both 2008 and 2009).
We required that they be dividend-paying companies, because those generally outperform the market and have done so significantly over the past three months, when the average dividend-paying stock had a total return of -3.9%, vs. -7.9% for companies not paying dividends. Among stocks with market capitalizations of $1 billion or more, 12 stocks passed the screen and three in particular stand out as good buys.
The first is tech behemoth Microsoft (MSFT (MSFT, Fortune 500)), which happens to be a current favorite of fund manager Forester. Despite some recent stumbles, Forester sees plenty of upside for the software giant. "My gosh, at 13 times earnings, whatever problems they have seem to be fully priced into the stock," he says. Another reason to buy now: On Sept. 23, Microsoft announced a five-year, $40 billion stock-buyback program and raised its quarterly dividend.
We also like a pair of stocks from the oil patch. Diamond Offshore Drilling (DO (DO)) and Noble Corp. (NE (NE)) are both offshore drillers - expensive contractors that a Shell or Chevron will hire to drill for oil and gas in deep water.
Their stocks are down 20% and 16%, respectively, this year, reflecting the market's perhaps dubious assumption that oil prices will collapse along with the global economy. The two stocks barely budged on Sept. 22, a day when oil prices rose over $16 a barrel, to $120 - the biggest one-day jump ever. They're both reasonably priced, with P/Es of 14 for Diamond and nine for Noble. And 2009 earnings at the companies are expected to grow 23% and 26%, respectively. Those are the kind of value plays that look attractive in any market.