NEW YORK (Money Magazine) - As we close out the third consecutive down year for the stock market, conventional wisdom has never been more worthless -- which is why a conventional recovery seems so unlikely.

At least that was the premise the editors and writers of Money magazine started with when we set out to assemble our list of the best investments for 2003. When you read through our picks you'll notice, for example, our list's strong large-cap bias -- a bias that contradicts a long history of small stocks recovering first from bear markets. The way we see it, large companies got us into this mess; they should be able to lead us out.

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Overall we expect 2003 to be a solid year for stocks. The problem right now is that corporate chieftains are too nervous to spend money on personnel or equipment. "Deep pockets but short arms" is how one prominent CEO describes the predicament. "The stock market is the key to the confidence of senior management," echoes Mark Zandi, chief economist at Economy.com. CEOs, Zandi says, won't take big risks until the market rewards them for doing so.

That said, our picks for 2003 are more conservative than our overall optimism might dictate. Going out on a limb seems unwise given the market's extreme unpredictability. So after crunching numbers and interviewing scores of analysts, economists and money managers, we homed in on seven stocks that not only are well positioned for an economic recovery but also offer downside protection if it doesn't materialize. Call it a portfolio for the cautiously optimistic.

The picks are Dell Computer, Gillette, Hewitt Associates, Northern Trust, Northrop Grumman, Philip Morris, and Wyeth. Click on any name to jump straight to Money magazine's analysis.

Recommended prices are as of Dec. 2, the closing date for Money magazine's January issue.

To understand why we're bullish on Dell's prospects for 2003, first consider what the world's leading computer maker just accomplished. In 2002, a year described by tech tracker IDC as "the worst ever" for the IT industry, Dell widened its profit margins and improved revenue per employee.

For 2002 it's on pace to grow profits by 23 percent. If Dell (DELL: Research, Estimates) could do all that in a year when global technology expenditures actually declined (by 2.3 percent, according to IDC), imagine what it might do when the industry is actually growing.

A whole lot, in our opinion. That's why we think Dell is so well positioned. Desktops and servers usually become obsolete or costly to maintain after three to five years. With so much of corporate America's computer hardware purchased in the two years leading up to Y2K, a burst of new IT spending is both inevitable and overdue.

Ned Riley, chief investment officer of State Street Global Advisors, is so optimistic about Dell's prospects for 2003 that he thinks the 24 percent earnings growth that analysts are predicting is too conservative. "Most of today's forecasts reflect three years of accumulated negativity," Riley contends.

Yes, Dell's P/E ratio is high -- at around $29 a share, Dell trades at 29 times next year's estimated earnings -- but we'd argue that Dell's marketing and cost advantages make it one of the safer ways to bet on a tech resurgence.

Rain or shine, Dell continues to steal market share from rivals like Gateway and Sun Microsystems. And consider Dell's cagey move into the printer business.

"If Dell is aggressive in the way it prices printers and cartridges, it's going to put pressure on Hewlett-Packard to respond in kind," says Charles Wolf, a Needham & Co. analyst who counts Dell as his top pick. "And that in turn will weaken HP's ability to compete in PCs and servers."

Another positive is Michael Dell's sudden open-mindedness on the subject of dividends. Despite its $9 billion in cash and liquid investments, Dell has long resisted paying a dividend, using excess cash for stock buybacks instead. But with Congress talking about easing the personal tax on dividends, Michael Dell tells Money that he'll "absolutely consider a dividend" if Congress acts -- something he'd like to see happen. -- back to top

By the end of the 1990s, Gillette had gotten dull. Its 1996 acquisition of battery maker Duracell didn't fulfill synergistic promises. Missteps in its money-minting razor division bloated costs and crippled earnings. But thanks to new CEO Jim Kilts, Gillette is acquiring a sharper edge. "The company is night and day as far as what they were before Jim Kilts," says Bank of America consumer-products analyst Bill Steele.

Kilts took the helm in early 2001 after a three-year tenure as CEO of Nabisco. He has a long and impressive record in the consumer-products world, having headed up Philip Morris' Worldwide Food division (which housed Kraft and General Foods) and served as president of Kraft USA.

At Gillette (G: Research, Estimates), he's introduced the Mach 3 Turbo and a new line of Oral B toothbrushes. He's also launched a plan to cut $350 million in costs by 2006 by shuttering underutilized plants and streamlining global operations.

In 2003 Gillette will roll out promising new products, including the Sensor 3, a high-end disposable razor. Given the staggeringly profitable 43 percent operating margin of the razor and blade business, the successful launch of Sensor 3 could have a sizable impact on Gillette's profits.

While Gillette clearly dominates shaving systems with 70 percent market share, batteries are a different story. Its Duracell business has lost share to Energizer and today delivers 24 percent of Gillette's $8.6 billion in sales but just 11 percent of its $1.7 billion in profits.

Kilts has started to make headway -- he's trimmed overhead costs, cut inventory and ramped up advertising spending to revitalize the brand. So far, so good. Operating margins at Duracell have improved from 11 percent in 2001 to 16 percent in 2002. Market share has grown to 42 percent from 40 percent, and for the first time since 1999, Duracell increased profits.

Wall Street is slowly starting to take notice. At a recent $30, Gillette is up 11 percent from its low of $27. Expected to grow earnings 15 percent in 2002, the stock trades at 28 times the previous four quarters' earnings versus a five-year average of 34. Gillette, says Sanford Bernstein's Jim Gingrich, "is in the third inning of a turnaround. I think there's more to come." -- back to top

You know times are strange when a data processing and outsourcing company becomes one of the hottest initial public offerings of 2002. Maybe it's because Hewitt has an established franchise.

The Lincolnshire, Ill., company was incorporated in 1940 and, according to Dale Gifford (who has spent 30 years with the company, the past 10 as CEO), has had double-digit earnings growth for 38 of the past 40 years. But with so many companies struggling to manage pension liabilities and skyrocketing health insurance costs, Hewitt is the right company at the right time.

Two-thirds of Hewitt's (HEW: Research, Estimates) $1.72 billion in revenue comes from its outsourcing business, which handles record keeping, paperwork and endless questions from employees about their health benefits or 401(k) plan. The other third of the business is a human-resources consulting practice that, among other things, helps companies crunch numbers for their pension plans.

We particularly like the fact that Hewitt's outsourcing unit signs three- to five-year contracts, giving it a steady, predictable revenue stream. Investors "should take the opportunity to own a company like this," says William Blair portfolio manager Harvey Bundy.

According to a recent forecast by Gartner, the U.S. market for the outsourcing of human-resources administration is projected to grow 20 percent a year this year and next, and to reach $60 billion by 2004. Analyst Brace Brooks of T. Rowe Price, Hewitt's largest shareholder, says the company's heavy investment in top-drawer technology and its prestigious brand name will help it capture additional market share.

This promising opportunity and industry consolidation -- Hewitt bought its leading U.K. competitor in 2002 -- are why CEO Gifford decided to move ahead with IPO plans regardless of market conditions. "It was disconcerting to see the market take a pounding every day during the road show," he says, "but it was also clear that going public would enhance our long-term success."

Since its June IPO, Hewitt has notched impressive earnings (reporting 16 percent for the fiscal year that ended Sept. 30). Prospects are similarly sizzling, with Wall Street predicting 19 percent yearly profit expansion over the next five years. Moreover, its clientele is made up of Fortune 500 companies like Johnson & Johnson and GE, and no single client accounts for more than 10 percent of sales.

Despite the tumultuous market, Hewitt's potential hasn't gone entirely unrecognized; since its debut, shares have risen from $19 to a recent $33 and trade at 27 times estimated 2003 earnings. But William Blair's Bundy argues that the stock still looks cheap compared with outsourcing rivals ADP and Paychex. Brian Gerber of Brazos Funds, which owns about 1 million shares, says that given the company's growth rate, the stock could hit $43 this year. -- back to top

We scoured the beleaguered financial sector for companies that would attract investors once the market's pall clears. After weighing the risks and rewards of buying shares of Citigroup, Merrill Lynch, even J.P. Morgan Chase, we settled on a financial stock that isn't tainted by SEC investigations, doesn't have incalculable exposure to lawsuits and is not the target of pesky state attorneys general. Our choice? Chicago's Northern Trust.

Here's why: Even with the stock market rout, there are still a lot of rich people around -- 2.5 million Americans have more than $1 million in investable assets, in fact. What's more, that segment of the population is expected to grow nine times faster than the population at large.

All asset managers want a piece of rich folks' assets, but Northern Trust (NTRS: Research, Estimates) has a 113-year head start. In a business where hand-holding is important, this venerable institution already has a branch near many of America's wealthiest neighborhoods. "We create an environment where people feel they have someone who listens to them," says Northern Trust CEO William Osborn.

Yes, the market slump has taken a toll on the bank's business, with revenue off 5 percent. But to offset declining sales, Northern Trust has cut expenses by closing underperforming offices and capping executive pay. At the same time, the bank has been prospecting for new business and planning for a market rebound. Osborn intends to open 17 new offices (with a recent focus on Atlanta) by 2005, bringing the total to 100.

Because of Northern Trust's sterling reputation, the stock has long commanded a premium to the market. But the shares were off 33.5 percent in 2002. The culprits: declining earnings (profits are expected to fall 4 percent in 2002 but rise 7 percent in 2003) and write-offs for soured loans and venture-capital investments.

At $40, the stock is far below the $89 it reached in late 2000. It's now trading in line with the market's P/E multiple of 18 times 2003 earnings-well below its five-year average of 28. Plus, Northern pays a 1.7 percent yield. Jeff Van Harte, manager of the Transamerica Premier Equity fund, which owns the shares, is betting that the stock will regain its premium valuation. -- back to top

Fueled by the threat of terrorism and the prospect of a war with Iraq, the U.S. defense budget is set to grow 15 percent next year to a whopping $379 billion. That's good news for Northrop Grumman, the nation's third-largest defense contractor.

Having expanded rapidly through a series of acquisitions, Northrop now has a commanding array of products to supply to the nation's armed forces. Its arsenal-which includes Navy destroyers, the Global Hawk unmanned aircraft, the radar for the F-22 fighter and the AWACS surveillance system-roped Northrop $14 billion in sales in 2001.

In 2003 those products could bring in as much as $26 billion in revenue. That's because Northrop (NOC: Research, Estimates) is in the process of acquiring defense contractor TRW-a deal that would make it only a bit smaller than archrival Lockheed Martin. "TRW is the capstone acquisition. It gives us the capabilities that make us an absolute powerhouse," says CEO Kent Kresa.

Some investors have backed off from Northrop while it completes the complicated process of selling off TRW's automotive unit and winning federal approval for the merger. That's one reason the stock is down 29 percent from its 52-week high.

Rob Petrie, an equity analyst at MFS Investment Management, which recently owned 4.5 million Northrop shares, points out that TRW makes Northrop even more formidable by making it a player in satellite defense, an area of military spending likely to grow. Trading at 18.5 times earnings with a 1.7 percent dividend yield, Northrop looks cheap given its growth potential. Throw in the fact that defense would be the sector most likely to benefit from a war in Iraq, and you've got a value stock that doubles as a market hedge. -- back to top

Philip Morris, which will be known as Altria by February, is an impeccably well-run company. It's immensely profitable. It's also a pariah, and that's what makes Big Mo such a great value. Where else can you find a company with an 8 P/E, a 7 percent dividend yield and a business protected by unscalable barriers to entry?

These days, the Philip Morris (MO: Research, Estimates) story is particularly compelling. A shaky economy and rising sin taxes have once loyal customers clamoring for cheaper smokes-a tough break, considering that Philip Morris derives 90 percent of its U.S. cigarette sales from Marlboro, Virginia Slims and other premium brands.

In November, Philip Morris CFO Dinyar Devitre informed Wall Street that he couldn't confirm earlier estimates of 8 percent to 10 percent earnings growth in 2003, and that sent shares tumbling; recently they traded at $38, off 35 percent from the high. Now Wall Street expects Philip Morris to notch 5 percent profit growth in 2003. Factor in a 7 percent dividend yield, and all of a sudden you're looking at a plenty attractive 12 percent return.

Of course there's always the threat of more litigation, but thus far it's had little impact on Philip Morris' ability to consistently grow earnings-14 percent on average for the past three years. Ron Muhlenkamp, manager of the Muhlenkamp fund, explains, "We have so many state attorneys general expecting money from these lawsuits, they're basically debt holders who have an interest in keeping Philip Morris prosperous."

And if that's not enough to convince you, how about this: Susan Byrne, manager of MONEY 100 fund Gabelli Westwood Equity, has made Philip Morris a top 10 holding solely for its stake in Kraft (KFT: Research, Estimates). Philip Morris owns 84 percent of the food giant. So in essence you're getting the country's premier food stock, which sports a 17 P/E, for a humongous discount. -- back to top

Why is Wyeth, formerly American Home Products, the cheapest of the large drugmakers? Its portfolio of drugs and vaccines treats everything from osteoarthritis to depression, faces little threat of patent expiration and is enjoying rapidly expanding sales. The company has struck lucrative partnership deals with biotechs like MedImmune and other pharmas like Johnson & Johnson. Plus, it owns nearly 8 percent of biotech king Amgen.

So why is it so cheap? In July, Wyeth (WYE: Research, Estimates), a leading manufacturer of female hormone replacement pills, was jolted by a study suggesting that women who take hormones to block the symptoms of menopause might run a higher risk of cancer.

At the same time, the company was hit by concerns over its capacity to manufacture enough of its infant vaccine Prevnar to meet a spike in demand. The result: The stock fell 38 percent in 2002 (through Dec. 2) and is trading close to the bottom of its five-year P/E range. That valuation makes Wyeth a likely candidate to become one of this year's big rebound stories.

For starters, the company is moving fast to reassure investors that it is fixing its manufacturing problems. "There's absolutely no reason we can't supply Prevnar reliably to the market," asserts CEO Robert Essner.

Essner points out that 2003 should see an important product launch for the company: FluMist, a nasal flu vaccine that Wyeth developed with MedImmune, could receive approval this year, just in time for the next flu season. [Editors note: On Dec. 17, the Food and Drug Administration advisory panel voted that FluMist was safe and effective for healthy people aged 5 to 49. The endorsement means the FDA likely will approve FluMist for sale because the agency usually follows its panels' advice.]

While sales of Wyeth's hormone replacement therapies are likely to decline, Kris Jenner, manager of T. Rowe Price Health Sciences fund, believes that investors are going to be surprised by the strength of Wyeth's other products in 2003. Sales of Prevnar, for instance, are projected to expand by more than 50 percent in 2003. That's why Wyeth's earnings should grow by 11 percent this year. As a bonus, investors in Wyeth pick up a dividend yield of 2.4 percent. -- back to top