Blue chips on sale
With share prices falling and investors again worried about oil, lots of top stocks look downright cheap.
NEW YORK (MONEY Magazine) - The problem with buying opportunities is that they usually show up just at the moment when most of us are hesitant to put money into stocks. And this looks like one of those moments.
Just as stock prices seem reasonable, there's a widespread feeling that we're heading for another blah year like 2005, if not a bear market.
I'm not nearly so pessimistic: The outlook for stocks still looks basically solid, in my view, and any pullback is a chance to pick up high-quality shares on the cheap. Many blue chips are trading near their yearly lows. Yet if the economy keeps expanding, the S&P 500 stands to gain as much as 10 percent this year, based on mainstream earnings estimates.
Many big, depressed growth stocks could offer even larger gains of as much as 20 percent.
Moreover, it is important to remember that there is more to investing than just betting on the next 12 months. The real payoff comes from holding quality companies for a decade or more. And your gains will be greatly magnified if you get in when prices are clearly cheap.
There are valid reasons that many forecasters are worried about the near-term market outlook, aside from recent bad earnings reports and the latest jump in oil prices. The recovery that began in late 2002 has gone on longer than the average bull market.
In addition, interest rates look ominous: Bond yields are very low, considering how much the Federal Reserve has raised short-term rates since June 2004. Pessimists point out that when long-term rates are below short-term rates -- the so-called inverted yield curve -- a recession often follows.
But none of these facts necessarily mean that share prices have peaked. Recoveries can last a lot longer than the averages. If you look at the size of share-price gains, this bull market is at least 10 percent behind the norm. Concerns about interest rates seem equally overstated.
It's true that yields on 10-year bonds are about the same as those on two-year issues. But what that really signals is that bond buyers expect today's high inflation to ease -- they accept low long-term yields because they're not too worried about inflation eating into their returns. Economic slowdowns curtail inflation, but so do many positive trends. If oil prices ease and productivity gains continue strong, recent high inflation could moderate while growth continues. That scenario is quite bullish for blue chips.
Seventeen stocks in the Sivy 70 are trading within 10 percent of their 2005 lows. Some have been down for a while, but several appear not to have anything fundamentally wrong with them.
Here's a look at three stocks that offer the potential for a turnaround in the near term and 13 percent-or-better annual returns in the long run, yet that are selling at bargain prices of less than 18 times current earnings:
Fortune Brands (Research) (FO) is an exceptionally successful collection of top consumer brands, including Jim Beam bourbon, Titleist golf balls and Moen faucets. Earnings have grown at a 15 percent annual rate over the past five years, and the stock has nearly tripled.
Since mid-2005, however, the share price has sagged, partly because of the costs of a corporate restructuring designed to bulk up stronger businesses and shed less dynamic ones.
In July, Fortune Brands bought 20 spirit and wine brands -- among them Sauza tequila and Courvoisier cognac -- from Pernod Ricard for $5 billion. Then the company spun off its ACCO office-products division, including Swingline staplers.
As a result, the stock should enjoy faster earnings growth. That, in turn, could boost the price/earnings ratio from 14.6 to 16 or so. The stock could easily rise 15 percent or more in the next year or two.
General Electric (Research) (GE), in CEO Jack Welch's day, was a stock market darling. But since Jeff Immelt took over the conglomerate in 2001, GE has been suffering from slower growth and a stagnant share price.
Immelt has responded with the traditional GE strategy of selective excellence, putting resources behind the strong businesses at the expense of the weak ones. The company is ramping up in aerospace and broadcasting, while its consumer-finance arm is shedding insurance divisions.
At $35 a share and a P/E of 18, the stock isn't wildly undervalued. But it's still a good price to buy into what may be the country's best-run company.
Wal-Mart (Research) (WMT) has become the No. 1 target for every advocacy group unhappy about employment conditions for working Americans. And there is now real pressure for the company to improve employee benefits -- Maryland recently mandated minimum levels of corporate health-care spending.
The political climate has helped send Wal-Mart shares down 15 percent in the past year. The company's rapid expansion has always depended on cheap labor, but it should be able to adapt to higher benefits costs by adjusting the product mix to be more profitable and expanding internationally.
Wal-Mart's current 15.2 P/E understates the company's true potential. Warren Buffett, who bought 19 million Wal-Mart shares last year at prices around today's, knows that it wouldn't take much good news to bump up the P/E and the share price by 20 percent or more.
Read editor-at-large Michael Sivy every Tuesday at money.com/sivy. E-mail him at email@example.com.