Lucky 13

02/04/2005 12:00 am EST

Focus:

Kelley Wright

Managing Editor, Investment Quality Trends

I've been a fan of Investment Quality Trends for over two decades, and I'm very pleased to welcome them to our coverage in the Digest. Here, editor Kelley Wright, discusses his strategy and offers his annual "Lucky 13" list of the market's most undervalued blue chip stocks.

"IQ Trends is based on the twin pillars of quality and value. Today, only 4% of the stocks on our Select Blue Chip list are at their historic level of 'undervalue'. After scouring our vast archives we find this is the smallest number of undervalued stocks at any time in our history. From our perspective then, our investment universe is deteriorating in the two areas we are most concerned with - quality and value.

"In somewhat of a confirmation, the traditional measures of value on the Dow such as p/e, dividend yield, book value, pay out and debt are being stretched thin as well. If I was a physician I would be reporting that the patient is dead. Lastly, directors serving on the myriad boards of corporate America are selling like crazy. While I wouldn't give a tinker's diddle for any one of their individual market forecasts, I do take notice whenthey unload their stock. As a contrarian, deteriorating quality, disappearing value, excessive bullishness and complacency topped off with energetic insider selling at minimum gives us cause to pause.

"Traditionally we avoid specific forecasts and will continue that policy with this issue. Our mindset is one where we focus on the market of stocks as opposed to the stock market. Accordingly we focus on buying companies that meet our criteria and hold them until we sell when they reach historically 'overvalued' levels. For all practical purposes our portfolio is always fully invested. Whether that makes us Bulls, Bears or Fools we will leave for others to argue.

"Five years ago we initiated a feature in the first issue of the year that we call our 'Lucky 13' portfolio. The feature has been popular and quite successful. While not every stock in the portfolio has been a winner, there were enough winners in the group to produce five consecutive years of double-digit returns. The returns for the portfolio beginning in 2000 were 31.20%, 15.20%, 10.90%, 30.20% and 13.21% respectively. An average annual return of just over 20.0% for this five year period is obviously something we are proud of, particularly since the first three years were an ugly bear market.

"Now we step up to the plate with a new portfolio for 2005. Our focus this year, as always, is to select stocks that exhibit the highest quality, offer value, and have attractive dividend yields. Hopefully these selections will safely provide all the above.

Automatic Data Processing (ADP NYSE) - One of three holdovers from 2004, ADP is rated A+, has raised its dividend at least 10% per year for the last twelve years, has zero debt and with a low payout ratio has room to raise the dividend further.

Arthur J. Gallagher (AJG NYSE) - Another A+ with low debt and an attractive yield.

Atmos Energy (ATO NYSE) - A voracious acquisition spree has turned this once sleepy little utility into a monster. The $1.4 billion acquisition of the TXU distribution system has pushed the debt level higher than we like, but it is good debt and the acquisition is already paying off.

Bank of America (BAC NYSE) - The second holdover from 2004, and why not? A- rated with a rising dividend, and perhaps the best run bank in America.

Bristol-Myers Squibb (BMY NYSE) - Big pharma has been the whipping boy for good and bad reasons. We think BMY's bad is behind them and their 30 year chart shows almost no downside. For boot, you get an A rating and a fat 4.6% yield.

Bob Evans Farms (BOBE NASDAQ) - A- rated with almost no debt and a management that is diversifying smartly through some excellent acquisitions.

Citigroup (C NYSE) - This stock is almost 55% below their historic level of undervalue, no doubt due in part to a closet full of who knows what surprises. Nonetheless, an A+ rating and a "G" designation, not to mention major dividend increases the last two years provide plenty of upside potential.

Claire's Stores (CLE NYSE) - A very well managed company that understands its niche in the retail space. A recent bump in the road offers opportunity to investors. A- rated and another "G," CLE is below undervalue, has zero debt, and a very low payout.

Home Depot (HD NYSE) - Arguably sports some of the longest lines in America. A+ rated and while not a huge dividend, offers good growth.

Altria Group (MO NYSE) - Signs are pointing to this being the year that litigation or the threat thereof finally comes to an end. The break up value is close to $80 a share, which is what management intends to do when the last lawsuit is over. In the meantime you get an A+, with almost a 5.0% yield and the best record of raising dividends.

Pinnacle West Capital (PNW NYSE) - The wind seems to be at the back of this Arizona utility. With regulators seemingly back in control of their faculties, the A rating, low downside and excellent yield of almost 4.50% are attractive indeed.

SBC Communications (SBC NYSE) - The last of the holdovers from 2004, the Cingular acquisition with Bell South is performing better than anticipated. With a 5.0% yield the downside looks minimal.

Teleflex (TFX NYSE) - This diversified industrial is positioned in some timely spaces and has earned kudos from the Street for shedding undesirable assets. A+ rated, low debt and a low payout provides good reason to consider TFX."

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