(MONEY Magazine) – REMEMBER THOSE OLD NAUTIcal words of wisdom? Red sky at night, sailors' delight. Red sky at morning, sailors take warning. Well, it's nearly morning in 1996, and here's our warning. Forget about smooth sailing with a following wind. It won't happen next year. Instead, it's time to toss your cyclical stocks overboard--those in sectors like airlines, autos and steel, which don't cope well when the economy slows--and load up on dependable defensive issues that offer safe dividends, predictable earnings or both.

You can spot the safe-dividend types by their fat payouts (exceeding the 2.4% yield on Standard & Poor's 500 index), which act as a cushion when prices decline. Companies in this group tend to be out-of-favor but financially solid blue chips that have regularly raised their dividends for at least 10 years. Exxon, for example, gets yawns on Wall Street, but the world's largest energy company has reliably boosted its dividend every year for the past 12 years.

Predictable earners, on the other hand, come in two versions: companies that continue to churn out steady double-digit earnings growth when the economy sputters, and niche players. The steady earners are leaders in their industries and boast entrenched franchises, typically selling products people can't do without. If you suffer from heart disease, for example, the chances are good that sooner or later you'll be walking around with a pacemaker or defibrillator in your chest from Medtronic, which makes more of these implants than any other company in the world.

The niche-market players, in contrast, are small and medium-size companies with less established histories. But each has carved out a spot in a growing market that is largely immune to an economic downshift. Ecolab, for instance, supplies cleaning materials to hotels, fast-food outlets and restaurant chains. No matter what happens to the GDP, someone's got to wash those dishes and mop those floors.

We polled more than three dozen stock analysts to find nine safe stocks for '96 in these three categories. All come strongly recommended by at least three analysts who believe they will handily outperform the market in the year ahead. A warning, however: Outperforming next year's market may not necessarily be an enriching experience. If MONEY's worst-case forecast comes to pass--which would mean a 15% skid in the Dow--our picks might beat the market by rising a scant 5% or even declining slightly. But if the market is flat, the scenario we think is most probable, our picks figure to provide returns ranging from 13% to 28%. Here they are, listed within their category in descending order of potential returns. All nine trade on the New York Stock Exchange.


J.P. Morgan (ticker symbol: JPM; recently traded at $77.75; 3.9% yield). A 130-year-old bank with $168 billion in assets, Morgan boasts decades-long relationships with the world's premier companies. Alas, these are the very companies that have stopped raising capital through bank loans in favor of issuing stocks and bonds. So Morgan exploited legal loopholes to enter the securities underwriting business. This foray into investment banking swelled expenses, and in early 1995 the bank laid off 4% of its work force.

However, Charles Peabody, an analyst at UBS Securities, believes that Morgan's diversified strategy has paid off. "No other bank offers the depth and breadth of their products," he adds. Meanwhile, Tony Spare, head of the San Francisco investment advisory firm Spare Kaplan Bischel & Associates, points out that investors can sit back and collect a juicy dividend while they wait for a turnaround. Peabody believes that Morgan shares, recently trading at 1.6 times book value, will rise 16% to $90 within 12 months. That would put the stock at 1.8 times book value, the average valuation for big investment banks. Adding in that 3.9% dividend brings Morgan's total projected gain to 20%.

Bristol-Myers Squibb (BMY; $80.50; 3.7% yield). One of the world's largest drug and consumer-products makers, $13.7 billion Bristol is finishing its most profitable year ever. But the New York City company's future is clouded by two uncertainties. How will it fare in the pending silicone implant lawsuit? And how will the company deal with the expiration of the U.S. patent on its blockbuster cardiovascular drug Capoten, which currently generates 11% of revenues? Patent protection ends in February, leaving Bristol open to competition from generic drugmakers.

David Saks at Gruntal & Co. says that the company can afford the more than $2 billion he estimates the implant lawsuit could cost. The company has already set aside $1 billion, and it has $3 billion in cash, very little debt and $12 billion in borrowing power. Barbara Ryan, an analyst at Alex. Brown in Baltimore, reckons that even without Capoten, Bristol can expand profits 8% in 1996 and 9% in 1997, vs. 11% in 1995, through the growth of new products, acquisitions and cost cutting. "But the share price reflects expectations that earnings will grow only 6% next year," she says. On the strength of its earnings growth, plus an expansion in the company's P/E ratio from 14 to 15, Ryan sees Bristol shares hitting $90 within 12 months for a total return of more than 15%.

Exxon (XON; $77.88; 3.8% yield). By continuously slashing expenses, this $112 billion oil giant has managed to prosper through 15 years of lean energy prices. The company operates in 100 countries, so that it is somewhat sheltered from misfires in any one country's economy, and its three main businesses--oil exploration, refining and chemical manufacturing--tend to run in different cycles, smoothing earnings overall. Example: Exxon's chemical division now generates 34% of profits, vs. 10% in 1990. Conversely, oil exploration today accounts for 50% of earnings, vs. 81% five years ago.

Joe Culp, an oil analyst at A.G. Edwards, says many investors wrongly view Exxon as always either in the middle of a boom or a bust, depending on oil prices. But the company has ample cash flow, which gives it the flexibility to invest in areas that could pay off big over time, including energy-rich Russia. "By making smart investments in its core businesses, Exxon has put itself in position to post above-average earnings, cash flow and dividend growth," says Thomas Lewis, an analyst at Duff & Phelps. He expects earnings to expand 12% annually in the next five years. On the strength of that growth, Lewis reckons Exxon shares will climb to $85 within 12 months, for a 13% total return.


Medtronic (MDT; $51; 0.4% yield). With $2.1 billion in sales, Medtronic is the world's largest manufacturer of cardiac pacemakers and other medical devices. What keeps the Minneapolis firm a step ahead of its rivals, says analyst Archie Smith of Piper Jaffray, is the combination of a strong management team, heavy spending on research and the ability to get new products to market in lightning speed. Smith thinks the company can expand earnings 20% annually for the rest of the century, as the baby boomers get older and their tickers get weaker.

Though the price of shares has already doubled this year, Charlene Lu, an analyst at Prudential Securities, says: "The stock still has significant growth potential." Example: Medtronic has a 50% share of the $580 million market for implantable defibrillators, devices that normalize a rapidly beating heart. Analysts believe the size of that market could nearly double in four years. Smith sees Medtronic shares climbing in line with earnings to $65 within 12 months, for a 28% total return.

American International Group (AIG; $85.25; 0.4% yield). Life insurance is relatively unknown in developing nations. But AIG, a $22 billion giant in casualty, property and life insurance, is changing that. Though its headquarters are in New York City, AIG was founded in Shanghai in 1919 and operates in 130 countries worldwide. Since 1992, it has been the only foreign insurer licensed in China, and last year it opened offices in India, Russia and Vietnam. Says Gloria Vogel of Ladenburg Thalman: "In these undeveloped insurance markets AIG has a great deal of pricing flexibility. That allows for nice profit margins."

Alice Schroeder, an analyst at Oppenheimer, attributes the company's success abroad in part to its skill at polishing its image with foreign governments. Example: AIG has pooled its own and other investors' money in a limited partnership that finances the construction of bridges, roads and other infrastructure projects in China and other Asian countries. Says Schroeder: "It's a profitable venture but also a way for AIG to show it is a good corporate citizen that has a long-term commitment to the country."

Vogel believes AIG's overseas business will expand 20% annually over the next three years--a third faster than AIG's domestic businesses. Marring the company's otherwise bright outlook are concerns that AIG's 70-year-old chairman and CEO, Maurice Greenberg, has not groomed a successor. However, he is in apparently good health, and Vogel expects AIG's price to climb to $100 within 12 months for a 18% total return.

Walgreen (WAG; $31.25; 1.4% yield). The nation's largest pharmacy chain, $10 billion Walgreen is also starting to cash in on graying baby boomers. "The typical American uses twice as many prescriptions at 65 as at 25," notes David Magee, an analyst at Robinson Humphrey Co. In 1995 Walgreen filled 170 million prescriptions, or 8% of the total market, generating 43% of the company's revenues in the process. David Presson, an analyst at Edward D. Jones & Co., expects the prescription business to continue to expand at a 20% annual clip for the rest of the century.

Walgreen's size gives it a strong advantage in this area, since managed-care insurers prefer to deal with huge pharmacies with computerized operations. By the year 2000, an estimated 80% of all prescriptions will be filled for customers enrolled in managed-care plans, up from 55% today. (Currently, managed-care patients account for 60% of Walgreen's prescription business.) Gary Vineberg at Merrill Lynch predicts the chain's profit power will propel shares to $35 over the next year, for a 13% total return.


Equifax (EFX; $39; 1.7% yield). Junk mail offering you a pre-approved credit card may be irritating to you, but it's money in the bank for $1.6 billion Equifax, the nation's biggest provider of consumer credit reports. "To generate those pre-approval offers, card issuers rely on credit data from agencies like Equifax," says Jennifer Scutti, an analyst at Prudential Securities. "And as installment credit catches on in Europe and Latin America, the need for credit-reporting databases will be overwhelming." Scutti expects Equifax's foreign business, which generated 12.5% of 1995 operating revenues, to grow 20% annually over the next three years.

Analysts also give Equifax high marks for expanding in recent years into profitable niches like check authorization for community banks and paperwork processing for hospitals. Robert V. Bolen of J.C. Bradford in Nashville figures that earnings can climb an average of 19% a year over the next three years. Scutti adds that as investors realize Equifax is not just a credit rating bureau, the stock's P/E could jump from 17 to 20. That would propel the share price to $48 within 12 months, for a 25% total return.

Ecolab (ECL; $29; 1.6% yield). You may never have heard of Ecolab, the $1.3 billion specialty-chemical manufacturer, but if you've walked through a glistening Hyatt or Hilton hotel lobby, you've seen the effect of its products. Based in St. Paul, the company supplies a wide variety of cleaning products to hotels and restaurant chains, and-ah-"cleans up in a crowded field," says Dain Bosworth analyst Maureen Pettirossi. A service-oriented sales forces shows customers how to use Ecolab cleaners more efficiently, and the company will modify products to fit special needs. For example, McDonald's often hires inexperienced teenagers, so Ecolab developed premeasured floor and grill cleaners that make mopping up foolproof.

Ecolab polishes up profits by following customers like McDonald's overseas. Pettirossi expects foreign business, which provided 20% of 1995 revenues, to expand at a 10% annual rate over the next three years. Add all this up, and Michael Sargent, an analyst at Salomon Bros., sees Ecolab's earnings growing about 15% annually over the next three years and driving the shares to $34 within 12 months for a 19% total return.

Borg-Warner Automotive (BWA; $31.50; 2% yield). A slowing economy is not the best environment for auto sales, but that won't push $1.4 billion Borg-Warner Automotive off the fast track. One reason: The Chicago-based auto-parts manufacturer provides four-wheel-drive transfer cases for the Ford Explorer and other very popular sports utility vehicles. Says Mark Spellman, an analyst at C.J. Lawrence: "Because market share is moving from sporty cars to sports utility vehicles, these trucks aren't vulnerable to a slowdown the way passenger cars are." Borg-Warner also figures to keep profits purring by selling more parts per vehicle, upping the average sales per vehicle from $75 in 1995 to at least $90 in the year 2000. After adjusting for depreciation related to a leveraged buy-out in 1987, Spellman expects Borg-Warner to expand earnings 10% annually over the next five years.

David Schafer, manager of the $170 million Schafer Value Fund, attributes Borg-Warner's success to "having the best-quality products out there" and its heavy spending on R&D, which amounted to $40 million in 1995. He believes share prices are cheap at 7.9 times projected 1996 earnings and sees the P/E ratio swelling to 10 over the next year as more investors notice the company's performance. The combination of earnings and P/E expansion could lift Borg-Warner shares to $36 within a year, for a 16% total return. That kind of potential can keep your portfolio in high gear even if the Dow spends the year stuck in neutral.