4 bargains that can beat the credit crunch
The shares of companies with little debt should soon command premium prices. Buy before that happens.
(Money Magazine) -- Cash is suddenly king again. And as you'll see, that presents you with a bargain-hunting opportunity.
The business climate changed radically and quickly this summer as the economy slowed and the subprime mortgage crisis hit the banking industry.
Lenders took big, unexpected losses on low-quality loans. Many of them worried that they might be even more overextended than they knew.
As a result, banks and Wall Street firms have become reluctant to lend money. Recently mergers and acquisitions have been derailed because companies couldn't get financing on acceptable terms.
Money will probably remain tight for the next couple of years, even after the Fed's recent interest-rate cut. Companies that were heavy borrowers could have trouble finding the capital they need to grow.
By contrast, businesses with plenty of cash or pristine balance sheets that make them attractive borrowers will be able to expand, acquire weaker players and take advantage of other opportunities.
Investors haven't yet fully recognized the competitive advantage of creditworthiness. But they will soon enough, and financially strong companies should then be accorded higher price-to-earnings ratios.
To identify stocks that should benefit from this revaluation, I started by looking at companies in the Sivy 70 that have very little debt. I narrowed my search to those that stock analysts have rated highly over the past couple of years but whose shares are currently depressed trading at or below the market's average P/E.
I ended up with four stocks, from four different industries, that are real bargains.
Here's a closer look at them, starting with the cheapest.
Staples is the leading retail chain for office supplies, and it has been a phenomenal success. Earnings per share have increased at a 20% compound annual rate over the past five years.
Because of the slower economy, business is suffering right now. But over the long term, Staples has a lot of opportunities.
And with so little debt, it won't have any trouble funding the opening of stores domestically or overseas.
Growth is projected to average 15% annually over the next five years.
Johnson & Johnson
Johnson & Johnson is among the most diversified of the pharmaceutical giants and has a superb balance sheet, with very little debt and a lot of cash. J&J does have some of the same worries other big drug companies do, particularly the lack of new products to replace blockbuster drugs that are losing patent protection.
Nonetheless, the breadth of J&J's product lines, including its over-the-counter health and beauty businesses, limits that risk.
Moreover, in an industry where new product development is horrendously expensive, J&J can afford to support robust research.
Today the stock yields 2.6%, well above the 1.8% offered by the S&P 500.
Illinois Tool Works
Illinois Tool Works is a specialty industrial company that makes a wide range of fasteners, adhesives and mechanical components. The stock has been a strong performer over the past five years, and I believe it can continue to reward investors.
Along with possible acquisitions, that should magnify future earnings gains, especially if manufacturing, which has slowed recently, rebounds.
Microsoft generates a torrent of excess cash from its operating system and other software for PCs. Despite fierce competition and a hostile antitrust climate in Europe, the company has tenaciously maintained its dominance.
The next version of Microsoft Office is scheduled for release in 2009. In the meantime, Microsoft (MSFT, Fortune 500) is enjoying rapid sales growth from its video games, which now account for 12% of revenue, and should get a further boost from the launch of Halo 3.
The company remains an 800-pound gorilla with no debt and more than $20 billion in cash. Plus, it generates $11 billion a year beyond what's needed to maintain its businesses and is planning acquisitions, perhaps including a stake in Facebook.