The best stocks for 2009 (pg. 3)

As patent worries subside, J&J should improve growth in 2010 and beyond. Analysts estimate that earnings per share will climb by nearly 9% in 2010, by 10% in 2011, and by 8% in 2012, according to CapitalIQ. While investors wait for the company to work through a slow 2009, they get a decent 3% dividend yield and a 46-consecutive-year track record of dividend increases.

J&J is trading near its 52-week low at $55, and at a price/earnings ratio of 12. That may seem steep when so many stocks are trading at P/Es of eight or lower. But it's the lowest for J&J since 1979 - the company has averaged a P/E of 22 over the past three decades - and far below its consumer-staples peers. And even with stocks, comfort is worth paying for.

For decades, Americans' health coverage has been fraying, and every new President vows to tackle the problem. The incoming Obama administration has made similar promises. Will it be able to deliver? As the largest pharmacy benefits manager (PBM), Medco Health Solutions (MHS, Fortune 500) is poised to benefit from potential reforms. But this well-managed enterprise should thrive even if the government fails to overhaul health care, because the company already addresses the overarching problems of high costs and low quality.

Medco helps customers, including Blue Cross/Blue Shield, HMOs, employers, and government agencies, keep prescription costs down. It attacks the quality-of-care issue by collecting data on how well drugs perform so that patients can be put on more effective medicines faster, which saves money wasted on drugs that don't work. CEO David Snow argues that dramatic cost cutting, with Medco's help, will extend coverage to more Americans.

Snow has been actively communicating with policymakers who are creating a reform plan, and his company has already been tapped as part of the government's efforts to shrink costs. Medco has been managing the government's Medicare Part D prescription drug program, which went into effect in 2006. The federal program subsidizes prescription drug costs for Medicare beneficiaries.

Increased use of generic drugs should also give Medco a lift. "Generics benefit prescription benefit managers because the margins on generics tend to be better," says Les Funtleyder, author of Healthcare Investing and an analyst at Miller Tabak. "The companies that make blockbuster drugs can demand a higher price because their drug is the only choice for a PBM, but generic drugmakers must compete against several companies, so PBMs have more say over pricing." In just a few years we will see some of the biggest blockbusters come off patent, including Pfizer's Lipitor, the cholesterol treatment that is the top-selling name-brand drug on the market (see next entry). Bristol-Myers's heart-attack-prevention drug Plavix and Eli Lilly's bipolar-disorder treatment Zyprexa also lose their patent protection in the next three years. "Even if health-care reform doesn't generate increased use of generics, these expirations will," says Funtleyder.

Medco has been doing well even without those external factors. The company keeps its corporate customers happy; it has a retention rate of 98% for 2008. Earnings per share jumped in the third quarter by 49%, and the company gave a full-year 2009 earnings estimate of $2.45 to $2.55 per share, up 15% to 21% over its 2008 guidance. Moreover, the company trades at a P/E ratio of 15, the same as rival Express Scripts, despite Medco's dominance in the category.

Executives say they want to increase Medco's cash, an attainable goal if the company generates its estimated $2 billion in free cash flow in 2009. Medco's cash balances have been growing all year to about $441 million, and the company expects to double that balance by the end of 2009. "There's not a lot of liquidity out in the marketplace," CFO Rich Rubino said recently, "so we make our own."

It's no secret why Pfizer's shares have dropped 40% in the past two years. The pharmaceutical giant's top seller, cholesterol medicine Lipitor, loses patent protection in 2011. Drugs representing more than a third of Pfizer's revenues will cede their exclusivity in the next five years. CEO Jeffrey Kindler has so far failed to deliver replacements, and investors have punished him for it: Pfizer (PFE, Fortune 500) shares trade just above their five-year low of $14, or six times the company's next 12-month earnings. That's a 25% discount to its peers, according to Steven Lichtman, an analyst at Banc of America Securities.

Pfizer's stock is undeniably cheap - but it's also undervalued, given the company's healthy assets and recent turnaround efforts. "The price reflects the known issues - the generic threat to Lipitor," says Lichtman, who thinks the shares are worth $20. "But it doesn't take the opportunities into account." What many investors don't know (or disbelieve) is that Pfizer, which used to chase the ever elusive next blockbuster drug, has changed its ways. Kindler drastically restructured last year, breaking the company into smaller, more concentrated units. In a note to investors, Deutsche Bank analyst Barbara Ryan applauded management for turning Pfizer "into an operationally leaner, nimble, and customer-centric business."

Pfizer is now aiming for numerous little hits rather than a few mega-successes. And the company has the pipeline to do it, in Lichtman's view. Pfizer is developing 114 drugs, 25 of which are in the final stage before being submitted for approval. (By contrast, rival Merck has nine in the latter category.) Pfizer is working on a treatment for rheumatoid arthritis that Lichtman thinks could yield as much as $4 billion a year. That drug embodies Pfizer's shift from emphasizing obesity and heart disease to other fields, including pain, Alzheimer's, and cancer. Such markets are not only lucrative but also expensive for generics to enter - a vital shield against the next wave of cheap drugs.

The company's most immediate salve may be its wallet: Pfizer has $26 billion in cash, which is more than Merck, Eli Lilly, and Bristol Myers-Squibb combined. Kindler could snap up a biotech company, many of which are available at low prices; Deutsche Bank's Ryan points to Gilead and Amgen as possible candidates. Until then, investors can tide themselves over with the company's 8% dividend (again, the best in its class). CFO Frank D'Amelio recently assured investors that the payout is safe. That's a good reason to buy in - and wait for Kindler's plans to pay off.

Six months ago, Potash Corp. of Saskatchewan (POT) - the world's largest fertilizer company - peaked at $240 a share. Today it's $56, only three times projected earnings per share for 2009.

Yes, slumping grain markets and credit-crunched farmers have sent fertilizer prices tumbling. And yes, it's possible - likely even - that analysts will trim 2009 earnings estimates further. But a P/E of three means there's margin for error. Next year's earnings could straggle in 50% below expectations, and Potash Corp. would still be reasonably priced. The current price assumes the company will earn less than $5 a share in 2009, Citigroup analyst Brian Yu recently noted. The analyst consensus for 2009: $16.

The long-term case for higher grain prices - and thus stronger fertilizer demand - remains intact despite the global recession and withering commodities markets. Government mandates mean biofuel production will continue to rise. Ethanol will consume 33% of this year's U.S. corn crop vs. 23% of last year's. Global population growth and an expanding Third World middle class are expected to lead to a 10% rise in food-related grain demand by 2017. "The food crisis, which was headline news in June of this year, has not gone away - it's just been overshadowed," says Potash CEO Bill Doyle.

Potash Corp. is well positioned compared with its competition. Prices for fertilizers based on nitrate and phosphate have plummeted, while those for potash (its specialty) are at record levels. One reason: It's brutally expensive to enter the business, as potash mines cost $2 billion to $4 billion to build. Potash Corp. should also benefit from its 32% stake in SQM, a Chilean miner and the top producer of lithium and iodine. Those are key ingredients in the lithium-ion batteries expected to power the next generation of hybrid cars. SQM stands to be a big winner. That means Potash Corp. should profit from multiple long-term trends.

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