Stocks That Still Carry S&P STARS

Sam Stovall, senior investment strategist for Standard & Poor's Corp., offers a bit of trivia that could justify optimism about the stock market. Starting with the fact that the first quarter of 2001 was the sixth worst since 1959, he points out that six months after the five other worst quarters, the S&P 500-stock index advanced an average of 21%.

He isn't ready to predict that the pattern will repeat itself. But he suggests that for long-term investors, it's always smart to take advantage of stock prices that have been beaten down, if the company has solid fundamentals.

On S&P's STARS list (STARS stands for Stock Appreciation Ranking System), there are currently 80 stocks with 5-STAR (strong buy) rankings, compared with 100 in typical times. The greatest number are in the energy, consumer staples, financial, and health-care sectors, Stovall says. He notes four names that advanced into the buy list despite general market conditions: Quanta Services, Health Management Associates, Canadian National Railway, and AmeriPath.

These were among comments Stovall made in a chat presented Apr. 10 by BusinessWeek Online and Standard & Poor's on America Online. He was replying to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from the chat follow. A full transcript is available from BW Online on AOL at keyword: BW Talk.

Q: What a day, Sam, with the Dow back up over 10,000! Is it too optimistic to think the bears have been routed so soon?

A: Yes, it could be a little too early to discount another leg down in the market. Because we have yet to see first-quarter earnings, we will most likely see several disappointments, and I never really expected this recovery to be V-shaped. We'll have to wait and see.

Q: So how has the recent unpleasantness affected S&P's STARS rankings? A lot fewer 5-STAR strong buys?

A: Currently, there are about 80 stocks on our 5-STAR list, and the number is usually closer to 100. In addition, the 5-STAR stocks fell 12.6% year-to-date through Mar. 31, as compared with a 12.1% decline for the S&P 500. In 2000, however, I'm happy to report, our 5-STAR stocks advanced more than 8%, vs. a 10% decline for the S&P 500.

Q: What sectors have the most buy listings?

A: S&P currently has an overweight recommendation on the consumer staples, energy, and utility sectors. Those sectors with the greatest number of 5-STAR stocks include energy with 16; consumer staples and financials, each with 13; and finally, health care, with 12. The reason that the utility sector doesn't have a double-digit number of 5-STAR stocks is its less than 5% weighting within the S&P 500.

Q: What do you think of EMC (EMC

)?

A: We have EMC ranked 4-STARS. In S&P's Stock Appreciation Ranking System, we forecast the price appreciation potential for more than 1,000 stocks for the coming six-month period. Companies ranked 5-STAR are given best buy rank. They are expected to outperform the market and its peers. Those ranked 3-STARS are holds, while those ranked 1-STAR are sells and are expected to underperform the market and their peers. A 4-STAR rank [accumulate] means we like it, but we're not willing to bet our bonus on it. A 2-STARS rank means avoid.

EMC reported earnings of $0.79 a share in 2000 and is likely to post earnings of $0.95 in 2001 and $1.28 in 2002.

Q: Do you feel JDS Uniphase (JDSU

) has a chance to come back, and how many STARS do you give it?

A:JDSU currently is ranked 3-STARS. This, and many other tech leaders, are likely to come back -- it just might be later than sooner.

Q: Moving into the energy sector, how about El Paso Energy (EPG

)?

A: EPG is ranked 5-STAR -- and has been a 5-STAR stock for several quarters. The company is a very strong natural-gas transportation company and is expected to post a 37% increase in earnings this year to $3.34 a share. We are positive on the company and its industry and sector.

Q: Over into fun and games, how about Disney (DIS

)?

A: Disney is ranked 4-STARS (accumulate). Our analyst upgraded the shares on Mar. 28 from hold because he likes the recent cost-cutting efforts and believes that they'll buffer advertising weakness...

Q: And back to energy, how about Exxon Mobil (XOM

)?

A: XOM is also a 5-STAR stock. The international integrated industry has fallen 3.9% this year, which is much better than the near-15% decline for the S&P Super 1500 (which consists of our Large-Cap 500, Mid-Cap 400, and Small-Cap 600 indexes). Our outlook is optimistic for this company, industry, and sector.

Q: It's hard to figure the long-term effects of purchase accounting on Tyco International (TYC

) -- any comment?

A: Well, purchase accounting has to do with the accounting for acquisitions by TYC. TYC is a 5-STAR stock that has been known for making multiple acquisitions over the past several years -- and that was on its way to becoming a well-respected conglomerate.

In the past, a few have questioned Tyco's accounting techniques, yet the company -- and the Securities & Exchange Commission -- have shown that itsaccounting activities have been in order. We have liked the TYC shares for many quarters, and believe that it will continue to outperform in the coming 6 to 12 months.

Q: Do you have a crystal ball handy? What will happen after the final court decision on Microsoft (MSFT

)?

A: Actually, Microsoft has held up exceedingly well through all of this carnage in the market. That's mainly because investors believe that the biggest problem with the lawsuit is the uncertainty of the outcome, not necessarily whether the company will benefit if it remains intact or is forced to divide itself. We currently rank MSFT shares 3-STARS and think that it's best to hold on, and wait for the final decision, which could take many years to be fully resolved.

Q: How about biotech? What do you think is happening with Amgen (AMGN

)?

A: The biotech stocks have been hit pretty hard this year, down more than 22%. That's vs. the market's near 15% decline. AMGN is currently ranked 4-STARS...Our analyst believes that Amgen's shares are attractive due to discounted cash flows and upcoming approvals.

Q: What do you see happening with Cisco Systems (CSCO

)?

A: Here's another one that our analysts believe you should hold onto. Fiscal 2001 earnings (July) are estimated at $0.51 a share, falling to $0.46 a share in fiscal 2002. We lowered our estimates for Cisco recently, based on comments by Nortel Networks (NT

) and on signs of increased pricing pressures in the networking equipment industry. Maybe we're being overly pessimistic, but we believe that a cautious stance is warranted.

Q: Would you consider now the time to start nibbling on stocks?

A: I always think it's a good idea for long-term investors to take advantage of stock prices that have gone through severe corrections -- particularly if these stocks have solid fundamentals.

One bit of trivia to make investors more optimistic about the future is that the first quarter of 2001 was the sixth-worst for the S&P 500 since 1959. Six months after the five worst quarters since 1959, the S&P 500 has advanced an average of 21%. There's no guarantee that this will happen again, but it certainly makes a bottom-fisher feel a little bit better.

Q: What's your opinion on American Electric Power (AEP

)?

A: We have AEP ranked 3-STARS...If you're looking for a buy-ranked utility, we have two: Constellation Energy (CEG

) and TXU Corp. (TXU

) are both ranked 5-STARS.

Q: How about the financial sector generally, Sam?

A: In general, we have a neutral ranking on the financial-services sector. Even though we're in a declining interest rate environment, the financial stocks typically keep pace with the market, rather than outperform it 6 and 12 months after the Fed has started to lower interest rates.

However, we do have a few 5-STAR recommendations -- in particular, Ambac Financial Group (ABK

), AmeriCredit Corp. (ACF

), IndyMac Bancorp (NDE

), and Allstate Corp (ALL

). All of these are ranked "buy" and have strong 13-week relative strength.

Q: I need help on Oracle (ORCL

). Will it rebound to higher levels or go lower?

A: Oracle is ranked 4-STARS...The reason why we're favorable on the shares is that the company has shown improved profitability -- ROE of around 40% and a 15% to 20% long-term growth rate. This industry leader continues to be attractive.

Q: Here's the inevitable question on Lucent (LU

) -- your thoughts?

A: Our thought is that if you have the shares, definitely hold on to them. The company strongly denies Chapter 11 bankruptcy rumors, and we believe that its new $6.5 billion credit line provides financial flexibility to execute a turnaround. However, we will wait for the upcoming second-quarter balance sheet to assess the future.

Q: Sam, how about reviewing some of the 5-STAR stocks you haven't mentioned yet?

A: Let me take this time to mention some recent upgrades to 5-STAR status: Quanta Services (PWR

), was raised to 5-STARS from 3-STARS. We believe that PWR's shares were oversold. Health Management Associates (HMA

) went to 5-STARS from 4-STARS, due to rising demand and strong industry fundamentals. Another was Canadian National Railway (CNI

), due to higher coal demand and wide margins. And finally, AmeriPath (PATH

), because the shares are attractively valued on a p-e to growth basis.