Stand-Up Stocks in a Stumbling Market


This is a time to be very picky with stocks, but some opportunities are out there. So says Rich Moroney, editor of the Dow Theory Forecasts newsletter (along with The Low-Priced Stock Survey). He advises investors to look for companies where both sales and earnings are growing or outfits likely to rebound -- and, in both cases, with reasonable valuations.

According to Moroney's analysis, the signals are still bullish. But for that reading to continue, the Dow Jones industrial average must push above the 10,365 high set last March, he says. Meantime, he describes the market's aimless performance as "sloppy price action."

Among the stock opportunities Moroney spots are Scientific-Atlanta, Electronic Data Systems, Vishay Intertechnology, Cigna, and Excel Energy. With many other stocks, he's concerned about high valuations. On the Best Buy list of his Low-Priced Stock Survey, he now includes Young Innovations, Scicor, Flagstar Bancorp, and a recent addition, Rockford, a maker of car speakers.

These were among the points Moroney made in a chat presented May 30 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Following are edited excerpts from this chat. A complete transcript is available on AOL at keyword: BW Talk.

Q: Rich, the Dow has been in a series of sinking spells. Should our spirits be sinking, too -- or will the market revive them before too long?

A: Certainly, it's been hard not to be discouraged by the market's sloppy price action.... Our advice is to look for opportunities on a stock-by-stock basis. We're telling subscribers to be opportunistic in looking for stocks. Things are still in the bullish camp. That does not mean we could not be in for more sloppy trading, but averages will probably be higher over the next 12 months.

Q: Where do you see opportunities now? Can you give us a few stocks on your Focus List?

A: We see opportunities in a variety of different sectors.... One attractive pick is Scientific-Atlanta (SFA). The stock has been under pressure in recent trading, due to concerns regarding its customer base, and while I acknowledge that there's some near-term earnings risk, there are some promising next-generation products that SFA is bringing to market. With the stock at $19...I think the risk/reward trade-off with SFA is very attractive.

Another stock we like quite a bit is Cigna (CI). Cigna has historically been an underperformer in the managed-care sector. The company is still not showing very good membership growth relative to its peers, but the company has done a good job of getting costs under control, and pricing trends seem likely to remain favorable in the managed-care area. With the stock at 12-times forward earnings, I think Cigna represents a real value.

Q: What are your feelings about Lockheed Martin (LMT)?

A: Lockheed Martin is one of the better holdings in the defense sector. The company has a well-regarded management team, and its outlook for share growth appears bright. My only concern would be the stock's valuation. Lockheed Martin now sells at 25 times expected 2002 earnings. That seems like a steep price to pay, so I would be looking to buy the stock on weakness -- perhaps on a dip into the 55-50 range.

Q: What do you think of Berkshire Hathaway (BRK)?

A: Berkshire Hathaway is a tough company to get your hands around. You have to admire the job Warren [Buffett] has done investing shareholders' money, and the outlook for the insurance industry appears relatively favorable. One concern I would have would be the company's future after Mr. Buffett retires. To be honest, I don't have a buy/hold/sell opinion on Berkshire Hathaway, as I've not invested enough time to fully investigate the company.

Q: Will accounting scandals keep the Dow (and my stocks) depressed for long?

A: Concerns regarding accounting and corporate governance have certainly played a big role in the market's malaise this year. I don't see a quick end to this problem. It will probably take a couple of quarters of improving corporate earnings before investors begin to look for opportunities in stocks rather than see only risk in the stock market. However, I think you can take advantage of the industrywide selling that has affected certain sectors by finding companies that have been hit by the selling, yet are actually in good shape.

One company I like that has been bid up with the energy stocks is Excel Energy (XEL). Because of concerns regarding its independent power subsidiary (NRG), Excel has pulled back sharply this year. However, I think people are missing the point that Excel is largely a regulated utility that generates the vast majority of its earnings and sales from plain-vanilla electricity and gas distribution. The stock is now yielding 8.6% and selling at 10-times earnings. While I don't think you can view the dividend as a sure thing, the current price seems to already discount a cut. Moreover, I'm not convinced that the outlook for electricity is as bleak as Wall Street now seems to think. With improvement in the economy, I think investors may be surprised at how quickly electricity prices rebound, which could make Excel's NRG subsidiary an upside kicker.

Q: How about a little on Dow theory? Can you use it to explain the market's downward drift?

A: Sure. Under the Dow theory, you want to see both averages confirming each other in moving to important highs. Both the industrials and transports staged big increases off their September lows to early January. Then, both averages retreated to lows reached in late January and early February, before rebounding again above the highs reached in early January. In short, the averages charted out a pattern of higher highs. Since peaking in March at 10,635 on the industrials and 3,049 on the transports, both averages have been under fairly steady selling pressure.

What we need to see now is a rebound above the March highs for the Dow theory to remain in the bullish camp. If we see a move to those highs that fail to surpass them, then fall down below levels reached in the current correction, the Dow theory will return to the bearish camp. Still, the cardinal rule of Dow theory is to let the averages tell the story. So we intend to allow market averages to play out before changing our posture.

Q: Which tech stocks look hot?

A: I think we need to be looking past the former leaders of the Nasdaq and look for opportunities in tech stocks that are not so widely followed. I mentioned Scientific-Atlanta as an interesting value play in the tech area. We also have two technology-service companies on our Focus List, Electronic Data Systems (EDS) and SunGard Data Systems (SDS). Both companies have good earnings and sales momentum, and I think the demand for technology outsourcing remains bright.

Another stock we like as a play in the semiconductor area is Vishay Intertechnology (VSH). This is not a typical Dow Theory Forecast recommendation. The company does not have near-term earnings or sales momentum, and the stock feels fairly expensive based on 2002 earnings estimates. What I like about Vishay, besides their management, is that I think they're in position to pass Wall Street's expectations. Vishay has done a good job of using the downturn to expand from its stronghold in passive components into active components like semiconductors.

Q: What do you believe is the current bottom for the Dow and Nasdaq?

A: I really don't have a good sense of where the Nasdaq might bottom. The obvious number to point to is 1,387, where the index bottomed in September. While I would be surprised by a near-term move to that level, I certainly wouldn't rule it out. For the Dow, a move below 9,800, where the average found support in early May, would be discouraging. A move through 9,618, the January low, would be further confirmation of a downward trend. I would be surprised if the Dow were to break that 9,600 level.

Q: Wearing your Low-Priced Stock Survey hat, what names look good now?

A: Our Low-Priced Stock Survey has posted some outstanding results over the last three years. So far this year, the survey's Best Buy list is up 12%. We continue to see opportunities in reasonably valued growth stocks, such as Young Innovations (YDNT), Scicor (SCRI), and Flagstar Bancorp (FBC). We recently added Rockford (ROFO), a maker of car speakers, to our Best Buy list. All four of these stocks sport modest valuations despite strong earnings momentum and favorable year-ahead growth outlooks.

Q: What's your near- and long-term outlook on REITs?

A: Provided you're selective, I think having some exposure to REITs is a decent idea. While the stocks do tend to trade as a group, over the long term performance can vary dramatically, based on management's ability to invest in the right properties. Duke Realty (DRE) is notable. The stock yields about 6.6%. Duke Realty has a nice portfolio that's diversified across different property types and geographic markets.

Q: Based on the long-term history of GE, do you think that it's a wise investment to continue to average?

A: For the first time in some while, GE is beginning to represent a good value. I would continue to average into the stock if you're a long-term investor. The big question with GE is its ability to sustain its growth in 2003, when its power-systems unit is likely to face a sharp earnings decline. Still, at these prices, I think much of those risks are discounted, and buying the stock as part of a dollar-cost-averaging program would seem fine.

Q: What is your view on the growth of Krispy Kreme Doughnuts (KKD)?

A: Krispy Kreme seems like a stock that's priced for perfection. The shares have attracted a cult following that seems to rival the cult following that its doughnuts have attracted. At current prices, the stock sells at 40 times the highest Wall Street estimate for the year ending January, 2004. While I would expect Krispy Kreme to continue growing at a double-digit rate, I don't think it can grow fast enough to justify that type of valuation. Historically, investing in fad restaurant stocks has been a losing proposition.

Q: Rich, can you leave us with some criteria you suggest using in being "selective" with stocks, as you recommend investors be for now?

A: I would look for companies that have done a good job of growing both sales and earnings. Companies have had a tough time maintaining sales momentum in this environment, and many have resorted to boosting reported profits through methods that are hard to sustain. Alternatively, you may want to consider looking for companies such as American Express (AXP), where results seem likely to rebound. For such rebound plays, it is crucial to have a good understanding of the company's strategies, management, and staying power. Also consider whether the company is generating cash flow comparable to the earnings it's reporting.


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