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Jubak's Journal
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| | Jubak's Journal
8 great blue chips youve never heard of
A name you know is no guarantee of safety and above-average returns. In fact, only a handful of relative unknowns got past my rigorous screening.
By Jim Jubak
What do we really want from a blue-chip stock? Safety and above-average return.
Thats not what youre getting if you own the same old blue-chip names that fill most investors portfolios, but it is what you can find if you go off the beaten track to buy blue chips.
Ive found eight great blue chips that youve probably never heard of that meet all those tests and more.
Familiarity does not guarantee big returns
Look at the list of the 20 stocks most widely held by individual investors and youll notice a lot of familiar names. Time Warner (TWX, news, msgs) tops the list, according to Merrill Lynch. Its followed by four spin-offs from the old AT&T -- AT&T Wireless Services (AWE, news, msgs), Agere Systems (AGR.B, news, msgs), Avaya (AV, news, msgs) and Lucent Technologies (LU, news, msgs). Youll also find two of the old Baby Bells, SBC Communications (SBC, news, msgs) and Verizon Communications (VZ, news, msgs) in the group, as well as a few old standbys, International Business Machines (IBM, news, msgs), Home Depot (HD, news, msgs) and Oracle (ORCL, news, msgs).
All in all, the list is a tribute to investors tendency to equate familiarity and size with safety and solid investment returns. When we go looking for blue chips, we tend to look for big companies with names we recognize, figuring that theyre too big to fail and are such fixtures on the economic landscape that they must be solid investments that will outperform the average stock. Of course, because these stocks are so familiar, theyre likely to dominate mature markets and sport huge market capitalizations making that outperformance unlikely.
For example, SBC and Verizon, the embodiment of safe blue chips to many investors, are stuck with falling returns on invested capital in the mature phone business. The stocks are down 45% and 29%, respectively, over the last five years. General Electric (GE, news, msgs), which has a market capitalization approaching $300 billion, has returned just 12% over the last five years. Its shedding and acquiring businesses almost daily in an effort to find enough growth to make a difference to the companys $131 billion in sales. Home Depot, also up 12% in the last five years, faces a similar problem in what looks like a saturated retail market.
Contrast that with these unknown blue chips.
14 years of double-digit growth
Lets look at Donaldson Co. (DCI, news, msgs). Not exactly a household name, but its numbers shout blue chip.
In fiscal 2003, the Minneapolis company, which makes filtration systems and parts, reported its 14th consecutive year of double-digit earnings growth. (And thats using conservative generally accepted accounting principles, or GAAP, earnings growth.) The company earned a 21% return on equity during the trailing 12 months. (Compare that with the 16% return on equity of this sites parent company, Microsoft (MSFT, news, msgs), or to the 9% for the companies in the Standard and Poors 500 stock index ($INX).) Donaldson grew earnings per share by 13% annually over the last five years, and Wall Street is projecting 12% annual growth over the next five years. And, as youd like from blue-chip management, Donaldson brass has a track record of being conservative about its projections. Management projected flat gross profit margins in fiscal 2003, for example, and then delivered a 100 basis point improvement in margins. (100 basis points equal one percentage point.)
That doesnt mean that this company doesnt aggressively go after business, however. Donaldsons new patented PowerCore air-filtration system for truck and heavy equipment engines will cannibalize sales of the companys existing line of filters, for example. The patents on this new product, however, will let Donaldson lock in the aftermarket filter-replacement business for PowerCore customers for the next 17 years at higher margins than Donaldsons current products pull down.
Over the last three years, Donaldsons shares have shown an annualized return of 16%. Its been 12.8% a year over the last five years and 16% over the last 10 years. The annualized 10-year return for the S&P 500 index is 7%.
Just as importantly for conservative blue chip investors, Donaldsons shares havent registered a 10% annual loss in any of the last 10 years. The worst losses came in 2002, when the stock fell 6.5%, and in 1998, when shares declined 7%. The S&P 500 fell 23% in 2002, for comparison.
A dominant position in key markets (80% of heavy duty trucks use Donaldson mufflers, Merrill Lynch estimates), superb returns on capital, above-average returns to investors and a record of very modest losses in falling markets -- now thats what I call a blue chip.
And Ill be adding it to Jubaks Picks with this column.
Yes, there are others like Donaldson
Are there a lot of stocks out there like Donaldson? No. Just 26 stocks passed the screen that I used to identify Donaldson. And just eight of those passed my more extensive due diligence.
But given the rigor of my test, I was pleasantly surprised to find any stocks earning a passing grade.
To make the first cut:
- A stocks market capitalization had to exceed $193 million.
- Annualized earnings per share had to be above 10% on average for the last three years. In addition, the company had to show positive earnings growth per share in each of the last four years.
- Annual returns from the stock had to be in the top half of all stocks for each year stretching back to 1998. And in the very tough year of 2002 the stock couldnt show a loss of more than 13%. That would put the shares in the top quarter of all stock performance that year.
- Finally, the stock had to be in the top-performing quartile in total return for all U.S. stocks over the last five years.
In my due diligence, I looked for the stocks of companies with the potential to sustain the outperformance of the past for the next five years. If the record of the past five years was built on conditions, such as rapidly falling interest rates, that seemed unlikely to be repeated over the next five years, I took the stock out of the running.
Here are the eight stocks that were left standing:
| Lesser-known blue-chip stocks | | Company | Industry | Recent price | 52-week high | 52-week low | StockScouter rating | | Affiliated Computer Services (ACS, news, msgs) | Computer services | $48.75 | $56.56 | $32.70 | 7 | | Applebee's International (APPB, news, msgs) | Restaurants | 33.59 | 33.47 | 19.03 | 5 | | Chico's FAS (CHS, news, msgs) | Apparel retailer | 32.72 | 33.94 | 15.60 | 10 | | Donaldson (DCI, news, msgs) | Filtration systems | 56.41 | 57.9 | 29.91 | 9 | | Expeditors International (EXPD, news, msgs) | Freight services | 35.92 | 39.28 | 27.63 | 5 | | Kinder Morgan Energy Partners (KMP, news, msgs) | Oil & gas pipelines | 43.45 | 43.86 | 30.23 | 6 | | Main Street Banks (MSBK, news, msgs) | Commercial banking | 25.11 | 26.1 | 15.95 | 7 | | SCP Pool (POOL, news, msgs) | Swimming pool supplies distribution | 29.41 | 30.22 | 16.10 | 8 |
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Frankly Id never even heard of half the names on this list. So, I was pleased by what I found when I dug deeper into unfamiliar territory. SCP Pool (POOL, news, msgs), based in Covington, La., a New Orleans suburb, is the largest distributor of pool supplies and equipment in the United States. Return on equity over the last 12 months has been better than 26%. Main Street Banks (MSBK, news, msgs), thanks to a recent acquisition, has become the dominant community bank in Atlanta with an arc of branches that spans the fast-growing counties north of the city.
Look to buy after a pullback
Most of these stocks arent cheap, and Id certainly like to buy any of them after a pullback. But remember that these stocks dont tumble a lot even in the worst of markets, so a 10% correction in price for one of these equities is a big deal.
Id advise looking for a decent entry price for building a long-term position. That way, an investor has a chance to get to know the company before a large amount of money is at risk. Over time, that will turn one of these unknown blue chips into a company thats familiar to you.
Remember that with stocks like these, its the long haul that counts. None of the stocks on this list has a particularly large market capitalization. These companies have plenty of room to grow, and so does the valuation of their stocks. Affiliated Computer Services (ACS, news, msgs), with a market capitalization of $6.5 billion, and Kinder Morgan Energy Partners (KMP, news, msgs), at $5.9 billion, have the two highest market caps. Main Street Banks market cap is $415 million, while SCP Pools is $1.1 billion.
And heres a result of my work on this screen that might provide food for thought to any investor who believes that big is best. Only one stock, Bed Bath & Beyond (BBBY, news, msgs), with a market capitalization greater than $10 billion made the first cut in this screen. But Bed Bath & Beyond, which has certainly been a great retail stock, is facing questions about the future direction of its margins that took it out of the running in the due diligence stage.
Something to think about if your portfolio is stuffed only with the General Electrics (GE, news, msgs), Exxon-Mobils (XOM, news, msgs), Microsofts and Wal-Marts (WMT, news, msgs) of the market. With stocks like the eight on this list, I dont think an investor is giving up anything in safety in order to secure higher potential returns. Theyre blue chips -- even if youve never heard of them, and the rewards from owning them may be higher simply because relatively few investors are familiar with these names.
Changes to Jubak's Picks
Buy Donaldson
Donaldson (DCI, news, msgs) has everything an investor would want in a blue-chip stock, even though most investors have never heard of the filtration industry leader. Donaldson has been a model of blue-chip consistency, scoring double-digit earnings per share gains for the last 14 years in a row. And the stock has delivered the combination of safety (worst loss during the last five years was the 7% decline in 1998) and above-average total return (an annual average of 30% for the last five years) that investors look for but seldom find in a blue-chip investment.
Growth at Donaldson will come from the companys continued expansion from air filtration products into liquid filtration (now only about 1% of total company revenue but 25% of the engine filtration markets), the extension of the new, higher-margin PowerCore product line into new markets, and new emissions regulations that will increase Donaldsons revenue per vehicle in the heavy-duty muffler business from todays $75 a unit to something over $200 by 2007. As of Oct. 14, Im adding Donaldson to Jubaks Picks with a July 2004 target price of $67. (Full disclosure: I will be adding shares of Donaldson to my personal portfolio three days after this column is posted.)
New developments on past columns
8 stocks to watch in a wandering market
Wall Street certainly wasnt disappointed with PepsiCos (PEP, news, msgs) third-quarter earnings report on Oct. 7. Earnings per share climbed 17% from the same quarter in 2002 to 62 cents a share. That matched Wall Street consensus projections for the company. For the full year, PepsiCos management raised its earnings projections to $2.21 as share, a penny above the Wall Street consensus. But the story on the revenue side was even better. Revenue in the second quarter had grown by a disappointing 6% from the same quarter in 2002. So, the pickup in the third quarter to 8.4% growth came as a decided relief. Revenue climbed to $6.83 billion for the quarter, about 3% above Wall Street projections. As of Oct. 14, Im raising my target price to $54 a share by January 2004. (Full disclosure: I own shares of PepsiCo.)
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 equity mentioned in this column: Pepsico. He does not own short positions in any stock mentioned in this column.
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