Jubak's Journal Recent articles: • 10 energy stocks -- and when to buy them, 12/14/2004 • Vicious cycle: Rising oil prices, falling dollar, 12/10/2004 • 5 more ways to play a weak dollar, 12/8/2004 More... | Jubak's Journal 5 stocks for cautious times The rally could dissipate after the new year starts, which means investors ought to look for top-dog companies in growing sectors. By Jim Jubak At this stage in the rally, its not time to get adventurous. In fact, its time to get downright conservative. Since this current stock market rally started at the Aug. 12 low, the Dow Jones Industrial Average is up 8%, the Standard & Poors 500 index is up 12% and the Nasdaq Composite is up 23%. Looking backward, some investors have started to get giddy. The talk on Wall Street is that the recent surge of mergers and acquisitions is a sign that the stock market is set to rise. Certainly CEOs are behaving that way. For example, Oracle Already this year, global mergers and acquisition total $1.7 trillion, according to Thomson Financial, well above the $1.3 trillion recorded in 2003. Who can blame investors for believing that they should still be aggressively buying stocks if CEOs are willing to pay sizeable premiums to acquire companies even after this rally? You must remember this But now certainly isnt the time to forget that this is a seasonal rally fueled by year-end cash flows into retirement accounts and professional portfolio managers trying just about any trick to finish ahead of their benchmark indexes.
Nothing has really changed to make 2005 look like a great year for stocks. Earnings for the stocks in the S&P 500 are expected to grow just 8.1% in the first quarter, down from 17% in the third quarter. Stocks dont command higher price-to-earnings multiples, nor higher prices, when earnings growth is slowing and interest rates are rising. Oil prices are falling and the dollar has staged a mini-rally, but those certainly arent trends to bet on for 2005. Finally, CEOs have a history of overpaying for acquisitions: They buy when their stocks have climbed even if the stock of the company to be acquired has already soared. Why should the CEO worry? Its not like these deals use real money when they're paid for in stock, right? Looking into 2005, Im worried that earnings growth will get tougher for companies to find. That makes me want to sell the aggressive, high-multiple stocks that have done so well in this year-end rally and put the money into the shares of companies with guaranteed earnings growth that comes from being top dog in a big and growing sector. I made three picks of stocks like this during my Wednesday appearance on CNBCs "Morning Call." Much more than cola Domestically, Frito-Lay continues to gobble up market share at the expense of regional competitors, and internationally the company is using its combined beverage/snack distribution and marketing clout to expand into new markets. Many of those markets were closed to PepsiCo as long as the battle was head to head with Coca-Cola's About 65% of PepsiCos sales come from North America, but thats likely to change as PepsiCo continues its strong international growth. Standard & Poors estimates international operating profits will grow 15% in 2005. Add PepsiCos domestic growth in the Frito-Lay division, international growth (especially in China and India) and a product development juggernaut that introduced 200 new products in 2003, double-digit annual earnings growth for the next five years is as close to guaranteed as youll find in the stock market. Our StockScouter rated PepsiCo a 6 out of a possible 10 on Dec. 15. Diversification in one stock With that kind of reliability, plus $13 billion in cash and just $3.4 billion debt, the company has earned an AAA credit rating that puts its cost of cash near that of the U.S. Treasury. With the company able to borrow so cheaply, it can easily acquire growth businesses and then increase the profitability of those companies by lowering their capital costs. Of course, you do have to run these acquired businesses so well that they throw off piles of cash. Here J&J has built an amazing track record completing 30 acquisitions in the last five years and keeping the return on invested capital at an annual average 22% during that period. The proposed acquisition of Guidant The Tiffany network CBS hasnt won that demographic since 1980, so long ago that younger members of the 18-49 age group werent even born yet. Networks always pack the sweeps period with special programming but not CBS this time around. The network had six of the top 10 shows in this demographic and all were continuing series. Even better for the profit news, CBS program schedule is especially strong at 10 p.m., the important lead-in to local news shows that put money in affiliates' pockets. The affiliates then pass on that audience to CBS late-night programming, which has suffered for years from weak lead-in audiences. StockScouter doesn't rate Viacom. My two exclusive picks just for CNBC.com on MSN readers are based on two other guarantees: that the dollar will continue to fall and the defense budget will continue to climb. Betting on Buffett Buffett has also made a big bet on the dollar's decline, owning foreign-currency forward contracts with a notional value of $20 billion at the end of September. So think of what you get by buying Berkshire now. You get a stake in a cash flow machine. Free cash flow for the September quarter topped $5 billion. You get a big option on a drop in stock prices because Buffett will buy if they fall. And you get an option on the dollar's decline. Not a bad package for 2005. StockScouter doesn't rate Berkshire. In the military now But thats not the best news. Because the company is in the business of logistical support for the U.S. military, it can count on seeing its order backlog grow as long as the military budget keeps growing. And that trend seems firmly in place for 2005 if the recent funding request from the Pentagon for operations in Iraq is any indication. The request for $80 billion to $85 billion surprised lawmakers and even some members of the Bush administration who had been expecting a request for $70 billion to $75 billion. The funded contract backlog at Engineered Support is $588 million, a record for the company and equal to two quarters of revenue. It's not a bad insurance policy as the company heads into 2005. Oh, and the company reserved the right to further increase its guidance as the year unfolds. Our StockScouter rated Engineered Support a 10 on Dec. 15. Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Berkshire Hathaway, Engineered Support Systems and PepsiCo. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||
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