Pick Your Stocks, Very Carefully


The stock market is "probably in the midst of a bottoming-out period," and if corporate earnings improve as expected, things should be better by October. That's the view expressed by Marcia Vickers, associate editor of BusinessWeek covering markets and investments, in summing up the magazine's Midyear Investment Guide in the July 1, 2002, issue.

It's a time for careful stock-picking, Vickers says, describing the theme of the outlook. She suggests looking for beaten-down companies with long-term growth potential, a price-earnings ratio below the industry average, solid management -- and "no hints of accounting monkey business."

Among the stocks she mentions are Health Management Associates and Baxter International in health care; Gap, American Eagle Outfitters, and Talbots in retailing; and Merrill Lynch and Prudential Financial in financial services.

Vickers made these points in a chat presented June 25 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Marcia, stocks sank again today. What's the BW outlook for the rest of the year?

A: Well, it doesn't look great for the summer. There are really no catalysts driving the market right now. So what you see is a lot of these so-called "suckers' rallies," where stocks will go up and then investors are selling into these rallies, bringing stocks right back down again. Really, we won't to see anything sustainable until fall.

Q: We've always been told the market looks ahead six months. Is the market telling us to get out of the way?

A: No, actually, the market is probably in the midst of a bottoming-out period. You've been seeing Nasdaq stocks and S&P stocks reverting to their post-September 11 lows. So during the summer, we may see more of this. In fact, it could be a good time to buy some really good companies that are beaten down by the market. In the fall, we'll start to see some more positive earnings numbers, and that will start to drive stocks upward, hopefully.

Q: You already answered this in part -- what are we to do? Hold what we have, buy more, what? HELP!

A: You might want to look at, for instance, companies that are substantially off their 52-week highs that have solid long-term growth potential and strong or improving industries. And their p-e ratios should be below their industry's average. And they should have solid management and obviously no hints of accounting monkey business.

Companies like this can be found in a variety of sectors. Right now, for instance, health care may present an opportunity, if you stick to some of the managed-care and insurance companies. A couple that we suggest investigating in our most recent issue are Health Management Associates (HMA) and Baxter International (BAX). Both are trading at reasonable p-e's and relatively low prices.

Retailers might also be a buy right now, if you look at beaten-down companies like Gap (GPS), American Eagle Outfitters (AEOS), and Talbots (TLB). Plus, financial-services companies, especially midsize banks and even perhaps some big brokers like Merrill Lynch (MER) and Prudential Financial (PRU).

Q: Experts talk of a market bottom, but how does one know when it's reached?

A: It's always simple: You know when a market bottom has been reached when you look at it in a rearview mirror a year down the road. Seriously, it's difficult, if not impossible, to really know if the market is bottoming. But some technical indicators can help.

For instance, if a "double bottom" has occurred in a 52-week period, sometimes that's a sign that the market is going to start on a comeback trail (see BW Online, 6/25/02, "What's Turning Barton Biggs into a Bull"). And if history is any guide, we recently pointed out that the S&P 500 has now fallen in 11 of the past 13 weeks. Five out of the past six times that has happened, the market climbed over 11% in the next six months.

Q: How low do you think the market will go this year?

A: I actually think we're in the midst of a bottoming-out period now. That will likely continue throughout the summer. The only thing that's going to start to drive the market upward again is earnings. Second-quarter profits have already started to turn up. But we won't see real evidence of profit growth until the third and fourth quarters.

One reason for this, of course, is that the year-over-year comparisons are starting to get much easier. But don't forget we're in the midst of an improving economy, and ultimately companies will start to benefit from that and post stronger profit comparisons toward yearend. We actually think mid-October, when the positive profit numbers really start to come in, will be a turning point for the market.

Q: Marcia, in your intro to the Midyear Guide, there's a list of things investors should do ("Do Your Homework"). Share some of the points with us if you will.

A: Yes, there are several things investors need to be aware of in this murky market. First and foremost, stay away from companies with any hint of accounting weirdness.

Second, try at all costs to avoid so-called value traps. It may sound appealing that you can pick up a Tyco (TYC) or a WorldCom (WCOM) way, way off their highs, but some of the most respected pros have been burned recently buying such stocks.

Another tip is to maintain a sell discipline. That is, if a stock falls, say, 10%, you might want to bail. Conversely, if a stock rises, say, 20%, you might want to consider taking some profits. In other words, it's not a buy-and-hold market like in the '90s. And also advice like "buy on the dips," which worked during the bull market, can really burn investors in this market.

Q: Is it time for tech yet?

A: Tech is tricky still. You've got major overcapacity.... Tech spending is still way off. It's a risky move to just pile into tech because it seems cheap right now. Quite frankly, some of the companies...still have relatively high valuations. So in order to avoid falling into a "value trap" like I just mentioned, when buying tech you need to be absolutely sure you're buying a company that's going to be strong going forward. A lot of the leaders during the Nasdaq craze are simply not going to be the leaders going forward.

That's not to say there aren't some good buys in tech. Some say, for instance, that some of the chipmakers like Intel (INTC) have been beaten down so severely that they're ready for a comeback. And it's unlikely that Microsoft (MSFT) will go out of business. That said, you have to be very careful when buying tech these days and make sure you stick with the very best.

Q: Do you agree with this comment? "Look for value. Good solid value stocks will perform long-term. Look at the current market as a buying opportunity."

A: I agree partly with that thesis. There's a caveat in that: You have to be extremely selective in terms of the companies you buy right now. There are certainly great companies that have been pummeled.

If you're a value investor, you might be interested in the big brokerages -- for instance, Merrill Lynch (MER), even Citigroup (C) and Morgan Stanley (MWD). Likewise, pharmaceuticals are at 10-year lows. A lot of people may say that's a riskier value play, but it's unlikely that a Pfizer (PFE) or a Merck (MRK) is going away. But great value investors are always some of the most patient investors around. So if you're willing to wait, there are no doubt some good opportunities right now.

Q: When will electric utilities start their move up?

A: Some prominent Wall Street strategists like the big conglomerates -- for example, ConEdison (ED) and American Electric Power (AEP). One reason they like these is because they're extremely conservative companies that happen to pay dividends. I would absolutely stay away from energy traders right now, especially since many are being investigated by the Securities & Exchange Commission. However, some of the boring utilities could be worth a look.

Q: What about non-U.S. stocks available through ADRs on our market? How are prospects there?

A: It's a great time to look at foreign stocks. You've got an improving global economy, and especially with a weakening dollar, a lot of the multinational companies like Sony (SNE) and Gillette (G) and Coca-Cola (KO) are good bets right now.

Of course, investing in an overseas company in the U.S. often entails buying an ADR, an American depositary receipt. Some tips from our recent issue are China Mobile (CHL), which is China's largest cell-phone service provider, and Ryanair (RYAAY), which is a rapidly growing Irish airline.

Q: What about the data-storage market and companies such as EMC

? Is that a good place to invest now? It looks like a growing market.

A: I don't think storage stocks are the wisest choice right now. Just today, S&P cut EMC's credit rating to BBB. And some analysts are saying storage stocks are dead money. Then, of course, you have the contrarians, who are saying that because these stocks have been beaten down so much, it's time to buy.

That said, there are probably some other areas in tech that might have some stronger possibilities going forward. For instance...some of the semiconductor makers -- Intel and Taiwan Semiconductor (TSM) may be two to look at.

Q: What looks best in energy? BusinessWeek points out that the "Enron effect" may make some stocks bargains.

A: Yes, natural-gas companies could be a good buy right now. That's because U.S. demand for natural gas has been growing, thanks to a surge in power-plant construction. A couple that we think are worth investigating are Devon Energy (DVN) and the Canadian company Encana (ECA). Utilities, as I mentioned before, could be another way to play the energy sector. Another couple of names in that area are FPL Group (FPL) and TXU (TXU).

Q: Marcia, the theme of the BW Guide is that it's a time for careful stock-picking. Can you sum up the criteria to use in picking stocks in this scary market?

A: No. 1 is stick to the very best companies, those that are tops in their industry and have strong balance sheets. Seek strong earnings momentum: Earnings should be growing at least as fast as sales -- and faster than their peers. Beware of too much debt. Watch priece-earnings ratios: A company's p-e should be under its industry's average. Make sure a company is well managed. And, obviously, stay away from companies where there's any hint of accounting shenanigans.


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