NEW YORK (Money Magazine) -
We all know a neighbor who got into General Electric during the 1970s bear market, or the colleague who bought Berkshire Hathaway after the crash of 1987 and held it for years, making bucket loads of cash.
We also know of great investors like Warren Buffett, John Templeton and Fayez Sarofim who became rich on blue chips that they picked up dirt cheap and stuck with for decades. We've often wondered when we'd get the chance to do the same.
Well, this just might be it.
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The basic truth of stock market investing remains this: You don't get rich by buying at the top of a bull market. But you also don't get rich by trying to catch the absolute bottom of a bear market.
After the start of the war in Iraq, the stock market had its best week since 1982. The following Monday, the Dow fell 300 points. The next day the Dow rose again. What such volatility tells us is that it's futile to base buying decisions on the overall level of the market.
Wall Street legend Bernard Baruch put it as well as anyone ever has. After a lifetime of trying to figure out how to time the stock market, he concluded that "nobody buys at the low and sells at the high -- except liars."
While many topnotch stocks have fallen sharply recently, only a few of them will qualify as truly great long-term buys. Here are five guidelines to help you find them.
Look for a pedigree. Sure, that hot new biotech might stand a better chance of growing 20 percent than Pfizer does, but will it really be around in 15 years? While a company's pedigree has always been important, it's particularly so in the aftermath of corporate scandals.
Wary investors are most likely to reward those companies "with a long tradition of doing well by shareholders," says Jeremy Siegel, author of "Stocks for the Long Run." All the companies we've picked have been operating for decades.
Pfizer was founded in 1849. Nokia's roots go back to a wood pulp mill founded in 1865. Even Microsoft, the youngest of our companies, has been around for 28 years.
Pick the best companies. If you want to make money over 10 or 15 years, you want to be in the strongest sectors of the economy. That's why we picked five key sectors -- health care, software, media, banking and telecommunications -- that have growth rates significantly higher than those of the economy as a whole.
Next, by picking the top player in each of these five sectors, we've given ourselves a chance of beating the sector's average performance substantially.
The pharmaceutical sector, for instance, might struggle to improve earnings by 10 percent annually over the next decade. Yet Pfizer, with its history of excellence in marketing and research, should do much better than the other players in the sector.
Get a dividend. Think of a dividend as a safety net. Investors holding a dividend-paying stock still receive some return even when the share price slides -- making them less inclined to sell. That's why solid dividend payers are less volatile than other stocks, notes Sheldon Lieberman of Hotchkis & Wiley's Large-Cap Value fund. "Dividends offer downside protection."
Stick with global giants. Although investors tended to look for strong domestic players in the 1990s, the coming decade will likely favor companies that have a strong overseas reach. The dollar has come down from its record-high levels, boosting the profits of companies that make a good part of their earnings overseas.
The economies of Asia are expected to continue to develop and grow, opening up the prospect of tremendous profits for international brand names that have established a niche in these markets.
Buy at the right price. Finally, even if a company has all the right characteristics, it makes sense to pick it up only at the right valuation. We'd love to recommend names like Wal-Mart and Berkshire Hathaway for this story. The only problem is, we don't think their price is right. All five stocks we've picked for this story are trading at least 30 percent below their five-year peaks; some are down by as much as 70 percent. That makes it likely that when they power back, the rewards will be great.
Five promising stocks
After scouring the stock tables with these criteria in mind, we found five promising buys.
Citigroup. The nation's largest bank had a rough year in 2002, hit by scandals surrounding its onetime star analyst Jack Grubman, and losses related to its exposure to financial markets in volatile countries like Argentina.
The result: The stock has fallen 34 percent from its five-year peak and now trades at 11 times this year's expected earnings. Yet Citigroup (C: Research, Estimates) "has maintained profitability through the downturn better than its peers," says Larry Puglia, manager of the T. Rowe Price Blue Chip Growth fund.
Although profits dipped in 2002, they are expected to bounce back by 23 percent in 2003. Wide geographic sweep is one reason. Citi operates just about everywhere on earth. A good mix of products is another key strength.
(Click here for Citi's Q1 earnings, released Monday morning.)
Its combination of consumer banking and underwriting buffers it from economic slowdowns that hit many other financial services giants much harder.
CEO Sanford Weill has reacted aggressively to questions of integrity by bringing in respected outsiders, such as former Sanford Bernstein boss Sallie Krawcheck, to rebuild Citigroup's standing. The company has been aggressively buying back stock and pays a 2.2 percent dividend.
Disney. The events of Sept. 11 hit Disney particularly hard by cutting the number of visitors who came to its theme parks in Florida and California. In addition, the slowing economy has meant lower advertising profits at the company's ABC network.
That combination of bad news has knocked the stock down more than 60 percent from its five-year high. But Disney's assets are global and deep, ranging from theme parks in Japan to the money-spinning ESPN cable channel.
Plus, the Mouse can boast a versatile film studio division that puts out blockbuster movies as diverse as the animated "Lilo & Stitch" and the musical "Chicago."
That diversity of strengths is why Disney should recover strongly in the near future. The company's earnings are expected to be up 32 percent in the next fiscal year. The stock yields 1.2 percent, the highest among the domestic media conglomerates.
Microsoft. Why has Microsoft's share price fallen 60 percent from its five-year high? Over the past five years, the company has expanded both sales and profits by 15 percent annually on the back of its ever-popular Windows software, but some investors fear that Microsoft's (MSFT: Research, Estimates) newer ventures, such as the Xbox game console, are not turning out to be very profitable.
However, with the stock now trading at a price-to-earnings ratio of 24, Microsoft might not need the spectacular growth rates of the past to justify itself as a good investment.
Windows continues to be a fabulous cash machine and should power the company to a double-digit growth rate for the next few years. A bonus: Ending years of recalcitrance, Microsoft recently cut its investors their first-ever dividend checks. With nearly $40 billion still in Microsoft's kitty, that dividend is likely to grow.
Nokia. If there's one segment of the telecommunications sector you want to be part of, it's the mobile-phone business. Cell-phone usage is still growing in the developed world and is just starting to penetrate emerging countries like India.
Nokia (NOK: Research, Estimates) phones are sold everywhere that people use cell phones. The Finnish company gets 84 percent of its revenue outside the U.S., in countries ranging from China to Brazil to the United Arab Emirates.
The company is a model of efficiency. Its operating margins on its handsets are in the 20 percent range, well above industry averages. It has expanded its market share for cell phones for five years in a row and now boasts a commanding 38 percent share.
That could grow even more. A new line of cell phones, the 3300, incorporates MP3 playback, allowing users to download music to their cell phones.
It's expected to be a big hit. The company, trading at a P/E of 18, has nearly $10 billion in cash and pays a yield of 2 percent.
Pfizer. The lineup at Pfizer includes 10 "blockbuster" drugs that each roped in more than $1 billion in revenue last year by treating conditions ranging from impotence to heart disease. They've made Pfizer the dominant player in the pharmaceutical sector -- a position the company seeks to bolster further through its acquisition of Pharmacia.
The merger beefs up Pfizer's strength in the arthritis and cancer treatment arenas, and should provide tremendous cost-cutting opportunities.
It does, however, make Pfizer (PFE: Research, Estimates) a much bigger company -- and leads many investors to wonder how a company of this size can keep up the blistering growth Pfizer has achieved in the past few years. The answer: At a price-to-earnings ratio of just 18, even a long-term earnings growth rate of 10 percent should make Pfizer a solid bet.