Best Investments 2003 WAS THE BOUNCE-BACK YEAR WE'VE BEEN WAITING FOR. WHAT WILL 2004 HOLD? MORE OF THE SAME. HERE'S HOW TO PLAY IT
(MONEY Magazine) – When the writers and editors of MONEY set out to find the best stocks for the upcoming year, we recalled a market that caught us by surprise in 2003. Remember SARS? Or how spooked you felt before the invasion of Iraq? How about the predictions that corporate scandals would haunt the market for years? We always knew the market would rebound, but in the early days of 2003 a bull market seemed unlikely. By early December, though, we were on much firmer ground. Corporate profits were up, and the economy was starting to create jobs. The S&P 500-stock index, up 21%, was heading for its first gain since 1999.
With that in mind, we sought stocks that would thrive in an improved climate but were still a good value. That quest led us to some potentially controversial choices: a company completing a big merger, one betting on a new technology, a troubled drug stock and a scandal-tinged fund firm. We also picked a media titan and a little-known energy play. Without further delay, here are our best stocks for 2004.
Anthem (ATH) CEO: LARRY GLASSCOCK SECTOR: HEALTH CARE
Acquisitions are supposed to increase shareholder value. But sometimes their merits aren't initially clear or convincing to investors. Consider the reaction to Anthem's $17 billion purchase of WellPoint Health Networks: The acquirer's stock fell 10% because investors feared that the deal was a ploy to disguise slowing growth and that it signaled a pending price war.
We see it differently. Anthem operates Blue Cross/Blue Shield health-care plans in nine states. When the acquisition is finalized, Anthem will have 26 million Blues members in 13 states and $36 billion in revenue--making it the largest managed-care firm in the country. This heft will allow it to better attract national employers while cutting costs by eliminating redundancies. Anthem CEO Larry Glasscock estimates that the company, to be called WellPoint, will save almost $500 million by 2006 and will notch 15% annual earnings growth over the next several years.
Even without the deal, Anthem had strong momentum. Earnings rose 21% in the first nine months of 2003, as cost controls boosted profit margins to 4.6% from 3.6% in 2002. Plus, enrollment growth has been healthy; a new program designed to let members access Blues health-care providers in all 50 states has already helped Anthem sign up 30 new accounts for 2004--almost as many as it did in all of 2003.
The managed-care business moves in cycles, and typically, after enjoying several years of strong growth, companies start slashing prices to win market share, hurting earnings. CFO Michael Smith says the business is now less likely to engage in destructive price wars, and we agree. For one thing, today's industry is far more concentrated than it was in past down cycles. And more market power means better pricing. Plus, after heavy investment in information technology, managed-care companies are better equipped to predict and manage medical costs--which should help maintain margins. "There is so little incentive for a company in our business to gain market share by pricing below costs that you're just not going to see it happen," Smith tells MONEY. Yet this fear has made Anthem cheap: Its shares trade at 12 times 2004 projected earnings vs. 15 for giant UnitedHealth Group.
Avaya (AV) CEO: DONALD PETERSON SECTOR: TECHNOLOGY
After the spectacular crashes of Internet and telecom stocks, you may have sworn off such issues forever. So an old-school telephone-equipment company with an exciting Internet product is probably the last thing you want to hear about. But check this out: Along with its traditional telephone-switching gear, Avaya, which was spun off from Lucent in 2000, peddles systems that transmit phone conversations over data networks using voice-over-Internet-protocol (VOIP) technology. Such systems slash corporate phone bills, and demand for them is expanding exponentially.
Many companies, such as Cisco Systems and Nortel, are trying to capitalize on this trend, but Avaya has a couple of significant advantages. For one thing, as the largest supplier of corporate telephone switchboards, it already has established relationships with many big customers. And its leading product is an upgrade package that adds VOIP wizardry to ordinary telephone systems. Rival VOIP offerings require corporations to replace everything from the main switchboard down to the phones, which is much more expensive.
Analysts predict that 2004 could be a boom year for VOIP. Sales of Internet-enabled switchboards are expected to rise 51% to $2.7 billion, and to reach $6 billion by 2008, reports research firm IDC. Avaya's sales, which include traditional systems and services, are expected to reach $4.5 billion in 2004, while analysts predict it will earn $188 million. Although Avaya's stock is up 400% in the past year to a recent $13, its P/E of 29, based on estimated 2004 profits, is a relatively cheap--vs. Cisco (37) and Nortel (40)--and direct bet on VOIP. "VOIP is a big, big business, and Avaya is positioned nicely," says Robert Turner, chairman of Turner Investment Partners, which recently began buying Avaya.
Bristol-Myers Squibb (BMY) CEO: PETER DOLAN SECTOR: PHARMACEUTICALS
Few patients heal as fast as Bristol-Myers Squibb. A year ago, the pharmaceutical giant's condition looked critical. Its drugs were aging, bad accounting had caused it to overstate sales, and a large investment in Erbitux, the ImClone scandal drug, looked worthless. These days, though, Bristol-Myers is well on its way to recovery, but the stock is priced as if it's still ailing.
The good news: A new drug, Abilify, is quickly becoming the treatment of choice for schizophrenia. Erbitux, which treats cancer, seems likely to gain FDA approval soon. And while the Securities and Exchange Commission is still investigating, the company has cleaned up its books and hired a new chief financial officer, largely putting accounting issues behind it.
The company is also well on its way to replacing the $6 billion in sales that analysts expect it to lose to generic competition. Liu-Er Chen of the Evergreen Health Care fund, which holds Bristol-Myers shares, predicts that Abilify and Erbitux alone could soon produce $4 billion a year in sales. Also due out in the next few years are a new treatment for diabetes, another cancer drug and a rheumatoid-arthritis pain reliever.
Even so, Bristol-Myers shares, at a recent $27, trade at just 16 times projected 2004 profits. That's less than most other drug stocks and less than the S&P 500. Whats more, the dividend of 4.2% is the largest in the pharmaceutical sector. "We're confident that the focus at Bristol is back to medicine and new drugs, and not damage control," says Judson Brooks of Harris Associates, which owns the stock.
Janus Capital (JNS) CEO: MARK WHISTON SECTOR: FINANCIALS
First, Janus saw its red-hot growth funds implode when the market crashed. Then it was among the first companies caught up in the burgeoning mutual fund scandals. No surprise, then, that the stock has taken a beating, losing more than half its value since it started trading in June 2000. But that's why we like it, even with the taint of scandal.
Janus is a different company than it was in the late '90s. For one thing, it has a new management team, led by former Fidelity exec Mark Whiston, who replaced Janus founder Tom Bailey as CEO in January 2003. Second, the fund complex is no longer overly reliant on large-cap growth funds. Thanks mainly to acquisitions, it now features funds with a wide variety of styles, including value, small- and mid-cap, fixed-income and quantitative investing.
As for Janus' involvement in the mutual fund scandals, the company says it has taken measures to purge any questionable activity, has promised to make necessary restitution to fund shareholders and is fully cooperating with New York State attorney general Eliot Spitzer and the SEC. While some rogue employees permitted the Canary Capital hedge fund to trade Janus funds, the firm itself has not yet been charged with any wrongdoing. "The steps we're taking will help ensure that this will never happen again," chief financial officer Loren Starr assured MONEY.
So far, most investors have stuck with the firm. Assets under management stand at where they were, around $150 billion, before the imbroglio surfaced. "A year from now a lot of this will be ancient history," says Franklin Morton, an analyst with Ariel Capital, which owns 10% of Janus. "Meanwhile, the quality of the company will have drastically improved."
Despite the scandals, the fund business is still fantastically profitable. In what should be its worst moments, Janus achieved 30% operating margins in the third quarter of 2003, down from 40% during the peak of its popularity, when assets under management topped $300 billion. Yet its shares, at a recent $14, trade at 15 times estimated 2004 profits vs. 20 times for untainted peer T. Rowe Price.
Patterson-UTI Energy (PTEN) CEO: CLOYCE TALBOTT SECTOR: ENERGY
Our excitement over Patterson-UTI Energy stems from one simple fact: Demand for clean-burning natural gas is rising, yet existing wells aren't productive enough to meet that demand. The rising prices that result from that supply-demand imbalance will spur production and the search for new wells. That in turn means more business for firms like Patterson-UTI, which owns 343 drilling rigs in North America.
Patterson-UTI's roots dig deep into the heart of energy country--its headquarters are in Snyder, Texas (pop. 10,783), not far from where CEO Cloyce Talbott grew up. At 67, Talbott has been in the gas business for more than 45 years and can rattle off reams of data on natural gas pricing and production. Chairman Mark Siegel is the city boy who has brought financial discipline.
That combination has paid off in improved efficiency and earnings growth. Patterson-UTI's top rigs drill more, better and faster than any others in the country. That's partly because the company has its own fleet of trucks that can move rigs quickly to wherever they're needed most and get them working--and earning day rates--faster. How quickly? They can get a rig capable of drilling 10,000 feet moved and ready to go in under seven hours, compared with two days for competitors.
This efficiency means that when demand for natural gas drilling rises, profit margins shoot up. Just look at the first nine months of 2003, which saw production turn up as the economy strengthened: Patterson-UTI achieved a 10% operating margin on $568 million in revenue compared with a measly 1.3% on $387 million in revenue in the first three quarters of 2002. "Small, incremental changes in demand really drive results," says Steve Romick, who has been buying Patterson-UTI shares for his FPA Crescent fund.
Romick believes that this trend will continue as the economy recuperates and gas consumption expands. Because of its strong balance sheet, Patterson-UTI can still buy rigs to ensure that it meets increased market demand as that happens. Romick reckons that the company's shares are worth $50 based on the value of its rigs alone, or 67% more than the stock's recent price of $29.33.
Viacom (VIAB) CEO: SUMNER REDSTONE SECTOR: MEDIA
Viacom president Mel Karmazin is happy to discuss how the improving economy will mean a dramatic rebound in advertising revenue in 2004. He's glad to chat about improving profit margins at their television stations and Viacom's decision to start paying a dividend. But he really, really wants to make sure we know that the SpongeBob SquarePants movie hits theaters in November 2004. That will be Viacom's "pièce de résistance," Karmazin says. "What puts us over the top."
It's gotta be a good thing to have one of the hottest cartoon sensations ever on your side, but Karmazin will forgive us for being a little more excited about all the other positives Viacom has going for it heading into 2004. After a lackluster 2003 in which advertising revenue didn't recover as much as expected, investors should stay tuned for a full-blown Viacom comeback.
With nearly half of its total revenue driven by advertising, Viacom is well positioned to benefit from that ad upturn. Advance TV advertising orders are already up sharply over last year, Karmazin says, and this year's political elections plus the Olympics will further spur demand--and thus pricing. Crown jewel CBS also gets a boost from the Super Bowl in February. Because TV is such a high-fixed-cost business, a remarkable 80% of every additional advertising dollar falls to the bottom line. That's how Viacom can generate earnings growth of 13% to 15% even when sales are trotting at a 5% to 7% pace. The company throws off loads of free cash flow, which it's been using to buy back stock and initiate a regular dividend payment. It also uses the cash for acquisitions--such as last year's purchase of Comedy Central.
Thanks to 2003's weak ad-spending increase, investors have the rare Chance to pick up this blue-chip media company, which sports a sterling balance sheet, on the cheap. At $39.75, Viacom's shares trade at roughly 11 times 2004 operating profits, below other media companies and at the low end of its historical price-to-earnings ratio range. We think the stock is worth at least $50. As the inimitable SpongeBob would say, "Yahoohoo!"