(MONEY Magazine) – When we sat down in November to begin our hunt for the best investments for 2002, we "lacked visibility" (to use Wall Street's current favorite phrase) about where the market was headed. Specifically, we had no firm conviction about which sectors were most likely to perform well over the next 12 months. Given the uncertainty following Sept. 11, the war on terrorism, the first recession in 10 years and the market malaise, we felt the only way to approach our task was to scour every corner of the market, stock by stock, for the most promising opportunities.

After weeks of crunching numbers and interviewing scores of analysts, money managers and executives, a theme emerged: The majority of our eight stock picks are battered large-caps, many either turnaround plays or mergers set to pay off.

Technology and health care, dominant in our thinking last year, are nowhere to be found. That's not because we no longer believe in these industries, but because the stocks' valuations remain too high even after steep declines. This year's decision-making hinged on details like strong management, solid financials and the prospects for total return beyond the market's expectations. Instead of concentrated bets on a few industries, our picks this year are diverse, ranging from consumer staples and retailing to metals and energy.

Broadly, they represent a bet on an economic recovery, which we expect later this year (see Michael Sivy's forecast on page 57). But because the rebound is unlikely to happen until the second half, and because the stock market is already anticipating a strong rebound, we've tempered our optimism by paying close attention to valuations and, where possible, dividends. As a group, our eight picks are all reasonably priced compared with the market and are forecast to grow faster than the S&P 500 over the next few years. In addition to our eight stock picks, we've also determined the five best bond funds.

Why no equity funds? Not because there aren't any good ones, certainly, but because we recently identified our favorite funds, the MONEY 100, in a special fall issue (if you missed it, check our website at www.money.com for the full listing) and because next month's issue will include a guide to the best funds for the year ahead, plus a ranking of more than 3,500 funds. On to the best stocks and bonds of 2002.

--A.F.

ACCENTURE Newly public, these consultants have grown even in a tough climate.

Since installing the first computer ever designed for business use (at General Electric in 1953), Andersen Consulting--recently rechristened Accenture--has been helping to solve the technology problems of some of the world's largest corporations. In July, after 40 years as a private partnership (including 12 years of 26% average annual profit growth), Accenture sold 12% of itself to the public for $14.50 a share.

The information technology industry is crowded with topnotch organizations like market leaders IBM and EDS, but Accenture is known for its lucrative, longstanding relationships. Its top 10 clients have been with Accenture for an average of 20 years, racking up $125 million apiece in annual billings. Many other consultancies are lucky to get a million or two in revenue from their best customers. "We don't just put together a recommendation, we implement and sometimes run it," explains Harry You, Accenture's chief financial officer.

Accenture is much more than its info tech business, however. It consults on topics ranging from strategic planning and supply-chain management to recruiting employees and outsourcing services. This doesn't make the firm immune to an economic slump, but it does soften the blow of a meltdown in any single industry. Also, notes Bonnie Digrius, an independent consulting analyst, "The more services you can offer to one company, the better the chance of locking them up."

Thanks to its broad offerings and wide customer base, Accenture bucked the economic turmoil in 2001 that hampered many of its peers. In its fiscal 2001 (which ended in August), Accenture brought in $11.4 billion in revenue and notched more than $1 billion in profits (before one-time charges relating to its conversion from a partnership to a corporation). More impressively, Accenture booked $1 billion in new contracts in September, only the third time it has accomplished such a one-month feat. Lisa Rapuano, who runs Legg Mason Special Investment Trust, which owns 2.7 million shares, says, "The ideal investment can create value at a rate in excess of the market over long periods of time. Those opportunities are rare, yet Accenture is one of them." Ra#puano cites good operating profit margins (13%) with strong potential for improvement (Accenture is promising to boost margins by one-half to a full percentage point a year over the next three years, while increasing the bottom line an average of 15%), gobs of free cash flow (a predicted $700 million in 2002 and $900 million in 2003) and returns on capital in excess of 50%. At a recent $21.43, Accenture trades at about 25 times the 87[cents] a share it is estimated to make in 2002. --P.G.

ALCOA The no.1 aluminum maker is a closet growth company.

Commodity producers are by nature cyclical, and Alcoa, the world's largest aluminum manufacturer, is no different. It makes more money when aluminum prices are high. But over the past decade (thanks, in part, to former longtime chairman and current Treasury Secretary Paul O'Neill), Alcoa has smoothed the impact of price swings--by relentlessly cutting costs while buying market share--to become the sector's premier growth stock. Over the past 10 years Alcoa has increased earnings 31% annually, while the average S&P 500 stock gained only 11% a year. "It's simply one of the best-managed companies in America, if not the world," says Susan Byrne, manager of Gabelli Westwood Equity, who's owned Alcoa for the past five years. "I don't own a lot of cyclical companies, nor would any of the others warrant being held throughout that period." Over the past five years, Alcoa returned 154%, compared with the S&P 500's 64%. Yet the stock currently trades at a 2002 P/E ratio of 19 vs. 23 for the average S&P 500 stock.

Even a mild recovery in the economy in 2002 should lift aluminum prices, which fell through most of 2001. That will boost Alcoa's profits. Byrne targets earnings growth of more than 55% next year to $2.75 a share. Chief executive Alain Belda agrees. "If the recovery comes, which it probably should, we'll have some big earnings surprises," he says. But he's quick to emphasize that he's not relying on the economy, or anything else he can't control, to hit expectations. In 2001, he began a $1 billion cost-cutting program to be completed by 2003, hard on the heels of a just-completed $1.1 billion plan.

Founded in 1888, Alcoa began transforming itself into a growth machine in the mid-1990s by aggressively buying competitors in Europe and the U.S. In 2000, it bought Reynolds Metals, then the world's third biggest aluminum producer, and aerospace-metals supplier Cordant Technologies. Today, Alcoa produces 20% of the world's aluminum. Belda says the company is looking to Asia for more acquisitions. Late in 2001, it agreed to buy 8% of China's largest aluminum maker. Long term, the demand for aluminum from the technology, automotive, consumer packaging and construction industries remains strong, and Alcoa's dominant position means it is better placed than any other company to capture a large percentage of that business. --J.N.

CENDANT The once-disgraced franchising giant is back on track.

Consumer-services franchisor Cendant--the company behind Avis rental cars, Ramada hotels, Coldwell Banker real estate and other big brands--was among the hottest properties on Wall Street throughout the mid-1990s. But the Street's love affair with Cendant and its high-profile CEO Henry Silverman ended in 1998, when the company admitted that a recently acquired subsidiary had been cooking the books for years. Cendant agreed to pay a $2.8 billion settlement and Silverman retrenched, vowing to restore the luster to both his firm and his reputation.

Today, Cendant is back, but its stock lags--and therein lies an investment opportunity. After two years of cleaning house, which included unloading 18 nonstrategic units, Silverman has resumed doing what he loves best: empire building. This year, Cendant bought the 82% of Avis it didn't already own for $937 million, snapped up online travel booker Cheap Tickets and purchased reservations system Galileo International. The result: Revenue for 2001 is expected to reach $8.8 billion, compared with $5 billion in 1998, while earnings should hit $1.02 per share vs. 85[cents] in 1998. "We're a very different company from two years ago," says Silverman.

But investors remain wary, particularly after the attacks of Sept. 11, which hit the travel industry hard. Those fears may be overblown. First, travel accounts for only half of Cendant's cash flow; real estate and financial services make up the rest. Second, the company's franchising arrangements allow it to collect fees even in dry times. "They don't own planes, they don't own hotels, so they don't incur the costs of empty planes or empty beds," says Jake Fuller, an analyst at Thomas Weisel Partners.

As the travel industry recovers, Silverman figures that cash flow will increase to $2 billion from $1.4 billion in 2001 (before subtracting the $1.5 billion Cendant will pay to complete its settlement). "Our management is very well compensated to create wealth for our shareholders; that's really job No. 1," he says. But at a recent $16.60, the stock is 23% below its 52-week high and trades at just 13.5 times next year's estimated earnings, which are expected to rise 21%. Oakmark fund manager Bill Nygren likes that trade-off. "I would view this as an investment less risky than average that has a much better than average return potential," he says. --S.D.S.

CHEVRONTEXACO A new oil giant cuts costs and improves its balance sheet.

A year ago, Chevron and Texaco were second-tier oil companies. Their market caps, both around $50 billion, paled next to $100 billion-plus monsters like ExxonMobil and Royal Dutch Petroleum. But following the October merger, ChevronTexaco is playing with the big boys. "If you're undersized in this industry, it gives you a competitive disadvantage," says Rick White of Neuberger Berman Guardian, who counts ChevronTexaco among his top 10 holdings. The company is now the fourth largest oil firm in terms of production and reserves, a top three producer in every market in which it competes, and No. 1 in the high-growth areas of California and the Caspian Sea.

ChevronTexaco remains on track to realize its own targets of nearly $1.2 billion in cost savings from the merger by June, and $1.8 billion by early 2003--but the final tally could be even higher. "It's in their interest to low-ball those numbers," says Kevin McCloskey, a portfolio manager at Federated funds, which owns 2.6 million shares. "By the end, the total could be 10% to 15% higher." Any surprise savings would translate into big money on the bottom line. An additional 10% savings, for instance, could translate to a 17[cents] increase in earnings per share, a big boost in a period when industrywide profits are getting smacked by weak oil prices.

As a result of the merger, ChevronTexaco also boasts one of the best balance sheets in its industry. With more than $2 billion in cash and less than $13 billion in long-term debt, its 37% return on capital dwarfs the other big oil players by around 15 percentage points. The firm also pays a hefty and growing dividend of 3.3%, higher than ExxonMobil and Royal Dutch. "We expect our balance sheet to be even stronger going forward," says CEO David O'Reilly. "We plan to maintain the same dividend policy under any [oil] pricing scenario."

Yet the company hasn't garnered the respect it deserves from Wall Street. With a trailing P/E of 9.7, ChevronTexaco is cheaper than BP (11), ExxonMobil (14.6) and Royal Dutch (12.6). But all that should change over the next year, says Charlie Ober of T. Rowe Price New Era fund, as the company shows the market that "it can perform, achieve the cost savings from the merger and increase its production growth." --A.C.

FOOT LOCKER The former Woolworth's secret: do one thing well.

Foot Locker stores suffered during the 1990s, first under the umbrella of the troubled Woolworth's empire, then as a part of Woolworth's successor, Venator Group--a scattered collection of retail operations that included a number of Burger King franchises. Now, at last, the $4.5 billion Foot Locker is on its own and doing fine as the largest, most influential retailer in the athletic footwear and apparel industry.

With earnings and margins deteriorating drastically at Venator in the late 1990s, the company needed a major overhaul to survive. The answer: streamline. It sold off nonathletic chains like San Francisco Music Box and closed inefficient Foot Locker stores. At remaining Foot Lockers, management focused on profitability by tweaking the merchandise mix, remodeling store interiors and pumping up advertising and promotional deals.

The gambit worked. Earnings shot up 71% in the past 12 months, after averaging a 28% annual loss during the past five years. Operating margins, which hovered around 1% in late 1998, were 8.5% this year and should increase by another percentage point in 2002. The company is also cleaning up its balance sheet, reducing long-term debt from 35% in 1998 to 28% this year. Finally, to signal its transformation, the company changed its name to Foot Locker on Nov. 2.

With an 18% (and growing) share of the athletic retail market--nearly twice that of its nearest competitor--Foot Locker uses its weight to negotiate advantageous deals with manufacturers like Nike and Reebok. It gets the hottest products earlier and cheaper than its peers. "They are the gorilla," says analyst Lee Backus of Buckingham Research Group. "And they use the benefits of their size." Foot Locker is also more adept than its rivals at pushing clothes and accessories by bundling them with popular footwear items. The firm already has 3,600 stores but plans to open another 1,000 in the years ahead.

Still, Foot Locker trades like distressed merchandise at the old five-and-dime. At $16.15, the stock sells at a 38% discount to the market. "Historically, the company has sold at a 10% discount to the market," says Jim Margard of Rainier funds, which owns 1% of the retailer. "If they earn 98[cents] a share in 2001 and another 15% the next year, that could mean an appreciation of 50%." --A.C.

J.P. MORGAN CHASE It's a good value in a beaten-down sector.

In September 2000, Chase Manhattan and J.P. Morgan, two of America's five biggest banks, combined to create a global giant that now has nearly $800 billion in assets, second only to Citigroup. The goal: merge Morgan's investment banking expertise with Chase's consumer and commercial lending muscle to become a one-stop financial services powerhouse with everything from asset management to credit cards. Unfortunately, no sooner was the deal announced than the economy swooned and capital markets dried up. That's particularly bad news for a company that gets 60% of its earnings from investment banking. J.P. Morgan Chase's earnings fell 52% over the past 12 months and its stock is down 36%.

Now at $38.06, its shares trade for just 13 times next year's earnings, which makes it a bargain compared with Merrill Lynch (17 times) and Citigroup (15). That discount indicates the market has concerns about how smoothly the merger is really going, but CEO William Harrison says that combining the companies has made them more competitive than ever. "We're gaining market share in most of our businesses, and our revenue declines are less than most of our competitors," he says. The company also forecasts merger savings of $3.6 billion, most by the end of 2002, up from their original estimate of $2 billion. And with even a mild pickup in the economy, Wall Street sees J.P. Morgan's earnings jumping at least 50%. "The investors I spend a lot of time with say, 'We like your potential, but we want to see the numbers when the market turns,'" says Harrison. "And that's fair enough. That's the real test. And we're extremely well positioned to perform." Meanwhile, the stock pays a handsome 3.6% yield. Among the major banks, says John Snyder, manager of John Hancock Sovereign Investors fund, "This is where I want to be right now." --J.N.

PROCTER & GAMBLE After years of missteps, P&G is turning the tide.

Procter & Gamble has always been a brand powerhouse. Its 11 billion-dollar-plus names, including Tide laundry detergent and Pampers diapers, account for about half of the company's $39 billion in revenues and a greater percentage of profits. But over the past few years, P&G let rivals Colgate-Palmolive and Kimberly-Clark eat into market share while rising costs clipped margins. Thanks to A.G. Lafley, its chief executive of 18 months, P&G is finally fighting back with a renewed focus on what lafley calls "big brands, big countries, big customers." Says Paul Wayne, co-manager of Kayne Anderson Rudnick Large Cap fund: "Lafley understands that losing market share is not acceptable."

P&G recently beat quarterly earnings expectations and increased operating margins to 21% vs. 19.5% in the same period last year, thanks to cost cutting and low raw materials prices. But the real issue for P&G is how to grow when many consumer categories are stagnant. Two recent acquisitions in fast-growing segments will help. The purchase of Iams, a maker of dog and cat food, was a "home run," says consultant Burt Flickinger III of Reach Marketing. Already a player in hair care with Pantene and Head & Shoulders, P&G hopes for similar success with its $5 billion purchase of Clairol.

Lafley thinks fiscal 2003 (which begins in July) will be P&G's year: "We are one more fiscal year to reaching our top-line growth goal [of 4% to 6%], and I think that is when we will get back to bottom-line growth in the double digits." At a recent $77.44, P&G's stock trades at 23 times earnings--on the low end of its historical range and well below rival Colgate. Its 2% dividend yield is an added plus. --A.F.

VIACOM This media conglomerate's time has come.

What do you get when you mix MTV, Survivor, The Godfather trilogy on DVD, 180 radio stations and two top media executives in a single pot? Viacom, one of the world's great cash-flow-generating machines. The $76 billion entertainment conglomerate, which took its current incarnation when Viacom bought CBS in 2000, is finally stepping out of the shadow of better-known rivals Disney and AOL Time Warner (MONEY's parent) to emerge as the best-positioned media company for at least the next year, if not the next few. Count these assets: a major film studio (Paramount), two TV networks (UPN, CBS) and a slew of cable networks (MTV, VH1, Nickelodeon). President and chief operating officer Mel Karmazin says the company gets its edge by being a key player in sectors ignored by its rivals: radio, outdoor advertising and video rental (Viacom has an 82% stake in Blockbuster Video). "We have the better, faster-growing mix of assets," says Karmazin, who runs the show with CEO Sumner Redstone.

Despite all that, Viacom is trading at 15 times 2001's estimated cash flow, making it cheaper than AOL Time Warner. Why the discount? Viacom gets a greater percentage of its revenue from advertising, and when Sept. 11 dealt a further blow to the already sluggish ad market, investors knocked Viacom's stock 40% off its August 2000 levels. An expected advertising recovery in mid-2002 would give Viacom a major fillip. But Karmazin insists that even if advertising doesn't pick up, cost cutting will help add another $500 million to cash flow in 2002. What will Viacom do with all that cash? Buy back stock, for one thing. Since May 2000, says Karmazin, the company has repurchased $2.6 billion of its own shares: "We believe in our stock. We think it's a very attractive price." --A.A.