NEW YORK (CNN/Money) – The tag line to "Love Story", which depending on your appetite for tearjerkers is either the most romantic or most schmaltzy movie of all time, is "Love means never having to say you're sorry."
But investors have a different idea of romance: How about "love means never having to live through two years of revenue declines" or "love means never having to restate your earnings because of accounting irregularities."
Investors had their affair with high-flying tech stocks, and now they need stocks they can count on. For the patient investor, quality does win out in the end. But how do you find these gems?
Searching for stability
More: Love and Money
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"The best way to build enduring wealth is owning great companies for a long time," says Bob Millen, co-manager of the Jensen fund, a large cap growth fund whose returns rank in the top percent of its category for the past five years, according to Morningstar.
Millen and his team of managers run screens to look for companies with dependable earnings growth over the past 10 years and sustainable competitive advantages. They then look closely at the balance sheet, cash flow statements and valuations and eliminate stocks that look too expensive or have questionable accounting practices.
* Based on 2003 estimates and prices as of 2/7 | Source: Baseline |
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With that in mind, we ran a screen of our own. We first looked for companies that had strong earnings and sales growth over the past five years (including the past 12 months), and similarly strong outlooks for the next few years. From there, we eliminated companies with high debt-loads, deteriorating profit margins and earnings that were riddled with write-offs. We also looked for companies that pay a dividend and have been increasing the size of it. Only 37 companies made the cut.
We then did some "smell tests." We wanted to avoid companies that have a cloudy near-term profit outlook, concerns about accounting, or other risks. We finally settled on five stocks that are worth sending roses to (or investing your money in): Wal-Mart Stores, Johnson & Johnson, State Street, Cardinal Health, and Paychex.
Wal-Mart
What's not to love about Wal-Mart (WMT: Research, Estimates)? The world's largest retailer and Dow component has posted an average earnings gain of 15 percent a year over the past five years and analysts expect earnings to increase by about 14 percent over the next few years.
And although the current economic storm has slowed Wal-Mart's sales growth somewhat and hurt its stock, the company has held up much better than its competitors. Target reported declining same-store sales in November, December and January while Wal-Mart's same-store sales increased slightly. Bankrupt Kmart is desperately trying to survive.
Wal-Mart is known for having incredibly efficient supply chain management so inventory problems rarely surface. The stock, at about 23 times this fiscal year's earnings estimates, is cheaper than normal. And if the company is still able to eke out 2.3 percent same-store sales when times are rough, just imagine how it will do once the economy does pick up.
Johnson & Johnson
If you had to buy just one drug stock, Ted Parrish, co-manager of the Henssler Equity fund, says Johnson & Johnson (JNJ: Research, Estimates) is the one. He likens it more to a healthcare mutual fund because the company is a dominant force in consumer healthcare products, pharmaceuticals, biotech and medical equipment.
Johnson & Johnson is the model of consistency in a business where there is constant pressure to keep introducing new products. And with $7.2 billion in cash and just $2.1 billion in long-term debt, there seems to be no reason why the company won't be able to keep innovating.
Earnings have increased at about a 14 percent clip over the past five years and analysts are predicting that the company will be able to continue growing at this rate for the foreseeable future. Because of this consistency, the stock is pricier than many other pharmaceuticals, at 20 times 2003 earnings estimates.
And even though the company is a conglomerate, its accounting is fairly clean, with write-offs accounting for just 3 percent of earnings over the past three years. "You can pack Johnson and Johnson away in a trunk for a few years and not worry about it," says Parrish.
State Street
In a year when many large banks and brokerages were burned by bad loans to Enron, WorldCom and Latin America and the Wall Street conflict of interest controversy, State Street (STT: Research, Estimates) emerged unscathed.
That's because the majority of State Street's revenues come not from lending, trading or investment banking but from fees for doing the accounting and record-keeping for mutual fund and pension firms as well as holding clients' securities, a business known as custody services.
The stock is a top five holding in the Jensen fund. Millen says that the fact that State Street is the custody services leader gives it economies of scale and a huge competitive advantage. For this reason, it has been able to increase its earnings even during the bear market, with profits increasing 6 percent over the past 4 quarters and 14 percent over the past five years.
And Millen says that with more and more mutual fund and pension companies choosing to outsource their back-end operations, this bodes well for State Street. An eventual pick-up in the market would boost earnings growth as well since part of State Street's fees are based on the total amount of assets it holds for its customers. Analysts are expecting State Street's earnings to increase at a 15 percent clip over the next few years. The stock trades at just a slight premium to its growth rate, at 16 times 2003 earnings estimates.
Cardinal Health
Fifteen consecutive years of at least 20 percent annual earnings growth is, to put it mildly, extremely impressive. And it's more impressive that analysts think Cardinal Health (CAH: Research, Estimates) should continue to post gains of about 20 percent for the next few years.
The company is one of the largest drug wholesalers, which means that it buys and distributes prescription drugs to hospitals. And companies like Cardinal Health stand to benefit immensely if President Bush's call for increased Medicare spending is approved by Congress since it would likely lead to higher sales of prescription drugs.
But Parrish, who owns Cardinal Health, says that even without healthcare reform, the company is in great shape going forward. He says the company's tight focus on keeping costs down has enabled it to grow faster than rivals AmerisourceBergen and McKesson.
What's more, the stock is now trading at about 18 times 2003 earnings estimates, a rare discount to its long-term growth rate, making it an attractive buy right now according to Parrish.
Paychex
No debt. No write-offs. And a dominant position in a growing market is why Millen owns Paychex (PAYX: Research, Estimates) in his fund. The company is the leading provider of outsourced payroll services to small and mid-sized businesses.
Earnings have increased at a rate of 25 percent over the past five years. But Millen says that what's most impressive is that the company was able to post an earnings increase, albeit a mere 4 percent, during the past four quarters – a time of rising unemployment and low interest rates.
Why are low interest rates a concern? Millen says that in addition to fees from customers, Paychex also holds the money from their clients' payrolls and are able to generate interest on the float before the payroll is actually cashed. So with the Federal funds rate currently at 1.25 percent, interest rates don't have much more room to fall.
"Interest rates are not going to say this low forever. When the economy turns, Paychex will have a huge jump in earnings," Millen says. What's more, an improving economy should also lead to job growth, which also plays into Paychex's favor. The stock is not cheap, at 32 times 2003 earnings estimates but Millen says he would be adding to the stock at these levels since growth is likely to accelerate.
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