A Six-Pack of 5-Stars

05/13/2005 12:00 am EST

Focus:

Sam Stovall

Chief Investment Strategist, CFRA Research

"Sam Stovall from S&P has become the voice of cautious optimism for us," says the Lou Dobbs Money Letter. "In our interview, he shows us that there are always investment opportunities — no matter what the market’s doing — if you’re patient and look hard enough."

Lou Dobbs: OK, Sam, what’s your current view of the economy? Interest rates just went up again, and the Fed is talking about increased inflationary pressure.

Sam Stovall: Our current outlook on the economy, like the market, is that it’s good but not great. We expect to see real GDP advancing by 3.8% this year, following the 4.4% increase last year. Our forecast is that oil prices will moderate toward the low $40 per barrel area by the end of this year.

Dobbs: How about market performance for rest of year?

Stovall: I regard myself as a single-digit bull, which implies that we see about a 7.5% price appreciation in the coming year. Our target for the end of the year is 1300 for the S&P. We also see interest rates continuing to rise, with the Fed funds rate approaching 4% by the end of the year, causing the 10-year note to breach 5%, maybe 5.1%. Historically, that’s about average.

Dobbs: I know you’ve been looking at the difference between cyclical and secular bull markets. Can you give us some insight into this?

Stovall: The difference between cyclical and secular does not mean that you embrace Billy Graham over Ben Graham. Cyclical bull markets simply mean you’ve bounced 20% from the bottom; secular means that not only have you bounced 20% off the bottom, but you then went on to set a new high. Most importantly, there is always a bull market someplace. If you look at sectors or industries, a majority of them are already in secular bull market mode, even though the overall benchmark itself is not. So there are opportunities out there—just be wise where you put your money.

Dobbs: First, though, what’s your bottom line on the way the year is shaping up?

Stovall: I think basically we are going through a retesting phase right now. Investors, in many ways, are like teenagers pulling out the petals of a daisy saying, ‘Inflation is accelerating; inflation is not accelerating.’ So they’re going back and forth worrying about this. My feeling is the market is looking for a positive catalyst, and it has yet to uncover one. I think the $600 billion of cash on the books of companies in the S&P 500 — that could be put to work in the form of dividend increases, share repurchases, R&D expenditures or mergers, and acquisition activity — could end up being a positive catalyst.

Dobbs: Let’s turn to your recommended stocks.

Stovall: We like a healthcare stock, St. Jude Medical (STJ NYSE) The company develops, manufactures and distributes cardiovascular medical devices, and it’s currently ranked 5 stars (strong buy). We think St. Jude is poised to capture additional market share in the growing US implantable cardioverter defibrillator (ICD) market in 2005. The five-year annual revenue growth rate is 15.5%, and going forward, the company should continue to see market share increases in particular areas. It could be aided by expanding Medicare and private-pay reimbursements.

"Automatic Data Processing (ADP NYSE), the largest payroll provider in the US, is ranked 5 stars, our highest buy rating. We still think the economy is improving and that payrolls will continue to rise. We also see the unemployment rate remaining fairly low, and as a result, we see this trend being positive for this payroll services provider.

"Next, we have Citigroup (C NYSE). We do not expect the Fed’s order that prevents Citigroup from undertaking significant expansion to have an impact on the company’s ’05 and ’06 operating results. Over the past several months, Citigroup has repeatedly and clearly outlined an expansion strategy that focuses on targeted acquisitions of niche businesses. It’s also ranked 5 stars.

"Kaydon (KDN NYSE), which manufactures high-margin industrial components, also has a 5-star ranking. This year it’s continued to trade at a discount to our intrinsic value. We project ’05 revenues to increase about 10% as recovering global economies spur greater capital spending, which in turn should boost demand for Kaydon’s proprietary bearings, electronic components, and industrial filters.

"MBNA (KRB NYSE) is the world’s largest independent credit card issuer, and we believe its current valuation does not reflect the company’s better-than-peer average credit quality and its ability, in our view, to create above-peer average loan and spending volumes. It is rated 5 stars and offers a dividend yield of 2.1%.

"We have a 5-star rating on PepsiCo (PEP NYSE). That’s based on our view of strong profit and cash flow growth, and what we view as solid earnings visibility and consistency given the company’s leading positions in several fast-growing food and beverage categories. We believe Pepsi is poised to deliver 11% to 12% annual earnings growth for the longer term. As a bull market continues to age, typically we find that there is a rotation into the more defensive categories, mainly because investors want to be focusing on a more steady earnings stream, higher-quality stocks that are relatively defensive, because demand for the products and services is fairly static. So from an economic cycle standpoint, PepsiCo looks good."

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