Company Focus
Recent articles:
• Bargains bloom in the tech sector, 3/30/2005
• 4 cancer-drug companies with room to grow, 3/23/2005
• Extravagant CEO pay is back, 3/16/2005
More...
| | Company Focus
12 stocks to buy in an inflation scare
When others panic over the specter of inflation and sell cyclical stocks, the smart money will look for buys. Here are some names to watch.
By Michael Brush
The bad news: Inflation is back.
The good news for stock investors: It doesnt matter. Not yet, anyway.
To be sure, signs of too much inflation during a recovery can be bad. It can foreshadow aggressive interest-rate hikes as the Federal Reserve tries to choke off price increases.
That can kill a recovery in its tracks, making stocks the worst place to be.
But its still way too early to have these fears. So in the months ahead, whenever investors get struck by inflation paranoia and sell cyclical stocks -- the ones most geared to economic growth -- itll be a smart move to buy them.
The best places to look? Among technology, industrial and basic-materials stocks. This means companies like Nokia (NOK, news, msgs), Hewlett-Packard (HPQ, news, msgs), Caterpillar (CAT, news, msgs) and Deere (DE, news, msgs), or steel companies like Commercial Metals (CMC, news, msgs) and Quanex (NX, news, msgs).
To understand why this makes sense, it pays to check in with James Paulsen, an economist who makes broad market calls as chief investment officer at Wells Capital Management.
Paulsens got a knack for staying above the fray and making the right calls at crucial moments. Since you may not have heard of Paulsen -- a low-key type -- heres a brief look at some examples of his calls in my columns. - Near the peak of the stock market euphoria in late 1999, Paulsen advised investors to sell growth stocks and buy bonds. Over the next three years, stocks got crushed and bonds paid off well.
- In late August 2002, just two months away from the cycles post-bubble low in October, Paulsen said it was time to buy cyclical stocks. One of the biggest 12-month moves in market history followed.
- In January 2003, when many experts figured the dollar had hit its lows, Paulsen correctly predicted it had much more to go.
Why does he maintain its too early to freak out about inflation? There are three reasons.
1. Economic policy still supports economic growth: First of all, real interest rates are still very low -- which means money looks cheap to companies. So they'll continue to borrow more, invest it, and make the economy grow. Sure, the Fed has raised short-term rates to 2.75% and long-term rates -- as measured by the 10-year bond -- are at 4.4%. But the money businesses have to pay back lenders is losing value at a rate of 3.4% per year -- the inflation rate. This makes real interest rates -- or the amount of interest charged minus the rate of inflation -- low by historical standards.
Next, huge federal spending, which has resulted in deficits of about $400 billion, continues to spur growth. Plus, the weak dollar supports growth because it makes our goods so cheap to foreigners. "To expect the economy to decelerate youve got to have some real policy tightening, and it is hard to see it," says Paulsen.
Related news and commentary on MSN Money
2. Stocks still look cheap: Even though the stock market is up 50% since the lows of late 2002, stock valuations are virtually unchanged. Profits have risen sharply as well, so companies in the S&P 500 ($INX) still trade for an average of about 16 times forward-looking earnings estimates, roughly what they have sold for over the past three years. Stocks also still look cheap relative to bonds.
3. A little inflation is a good thing: While inflation is almost always bad for bondholders, to a degree its actually good for stocks. It means companies can boost revenue growth by raising prices. "If rates go up and stay up, then the market might be in trouble," says Paulsen. "But not on the way up." As a rule of thumb, yields on the 10-year bond have to go up to around 6% and stay there to really hurt growth; they were recently around 4.4%.
Buying when the worrywarts bail
Even though there's a strong case for being at peace with inflation, investors will fret about it anyway in the coming months whenever news shows that prices went up more than expected.
What are the best stocks to buy during these panic attacks? The same stocks some investors will sell out of fear -- cyclical companies whose sales are tied the most to economic growth.
Heres a brief look at 12 companies to buy on the next inflation panic.
Prudent speculation in tech stocks
With the Nasdaq down 8.3% in 2005 and scraping its lows for the year -- in part because of inflation fears -- tech stocks are being shunned. But thats often a good time to buy these stocks.
John Buckingham -- who runs the Al Frank Fund (VALUX) and who recently launched a newsletter focusing on tech called the Prudent Speculator TechValue Report -- cautions that you should own at least 25 tech names as part of a bigger portfolio. But here are four from his list to start you off.
First, consider two large-cap names, Nokia and Hewlett-Packard. Nokia stumbled hard last year, falling to $8 from $23 when growth came up short. Now it trades for around 14 times current earnings, if you subtract the $3 a share the company holds in cash. The stock also offers a 2% dividend yield. Buckingham thinks Nokia may get back in the game as it rolls out new lines of handsets. And as a wireless-infrastructure supplier, Nokia should benefit from growth in 3G, a wireless format now being deployed in the U.S.
Buying Hewlett-Packard is a bet that new management will be able to turn around this huge global vendor of printers, PCs, servers, storage devices and consulting services. While you wait, you collect a 1.6% dividend yield on a stock trading at just 12.5 times the coming year's earnings. Analysts expect the company to grow earnings at 11% a year.
Buckingham also likes AsiaInfo Holdings (ASIA, news, msgs), a profitable Chinese telecommunications-software and networking company. The company holds about $3.25 a share in cash, and its stock price is just $5.20. AsiaInfo may get a boost from the build-out of wireless networks and robust growth in China's business sector, says Mark Mowrey, an analyst who works with Buckingham.
Given that the chip sector is so out of favor, it's no surprise that chip-equipment maker Mattson Technology (MTSN, news, msgs) shows up on Buckinghams buy list. At $8, the stock trades for just 1.6 times sales. Mattson also has $1.79 a share in cash.
Better-than-average industrials
With lots of fixed overhead costs, manufacturing companies typically see some of the best profit growth when the economy picks up. U.S. manufacturers also get help from the cheap dollar, which makes their goods look less expensive abroad. Even though the dollar has gained some strength in recent weeks, the weak-dollar benefits aren't gone because long-term contracts are still in place.
Both Caterpillar and Deere are obvious plays on this theme. And Morningstar equity research director Pat Dorsey likes a smaller company called MSC Industrial Direct (MSM, news, msgs).
MSC's business, selling supplies like valves, electrical components and safety goggles to manufacturers, may seem boring. But the companys growth wont be. MSC is looking to become the Amazon.com (AMZN, news, msgs) of its niche -- by selling through the Internet and catalogues as opposed to brick and mortar stores.
"Once you get the warehouse and distribution system built, as the demand comes in the return on capital is phenomenal," says Dorsey. Despite Morningstar's normally parsimonious bent, analyst Matthew Warren thinks MSC should be worth $43 right now -- even though it recently traded for $32.
Basic materials
Given that steel is a fundamental building block, its no surprise to see Wall Street analysts raise their estimates for these companies as growth picks up. An impressive 14 of the 18 steel companies in the Thomson Financial database saw analysts' 2005 estimates leap anywhere from 15% to 67% in the past three months.
But because steel pricing is linked directly to economic expansion, fears that excessive inflation would curb growth hit these stocks hard. The dips, however, ought to be good for profitable trades, if not more, since long-term trends look solid.
"We are going to have increased global demand for the next 10 years," says Scott Burns, who follows steel stocks for Morningstar. He chalks it up to solid global economic growth, particularly in industrializing countries like China and India.
Four steel stocks rank among the best for earnings-estimate revisions and also get the highest rating by Value Line, an investment research group with a solid long-term record. They are: Cleveland-Cliffs (CLF, news, msgs), Commercial Metals, Quanex, Allegheny Technologies (ATI, news, msgs) and Nucor (NUE, news, msgs). Id suggest buying these on sell-offs sparked by inflation worries.
Just remember that as commodity plays, steel stocks can be riskier than most stocks. "2004 was the greatest year steel ever had, and 2003 was close to the worst year. So it is a pretty volatile group," says Burns. "I wouldnt recommend putting your retirement money in there."
|
