Top Ten for the Second Half

06/25/2004 12:00 am EST


Sam Stovall

Chief Investment Strategist, CFRA Research

"Despite rising rates, stocks will be higher on December 31," says Standard & Poor's The Outlook in its special mid-year forecast issue. Here, Sam Stovall and the S&P analysts provide an overview of the market outlook and their top ten mid-year picks.

"Since 1970, the Fed has reversed course and begun raising rates nine times. On three occasions, the central bank boosted rates only once; six times it orchestrated a series of interest-rate increases. We expect a string of upward moves that will bring the fed funds rate from its 46-year low of 1% to 2% by the end of this year and to 3.5% at yearend 2005. Despite our view that higher short-term rates will likely cause some people to dump stocks, we think strength in the economy will bring them back. We project GDP growth of 4.8% this year, the best gain since 1984. And we see operating earnings on the S&P 500 at $65.79, an all-time high, and 20% above 2003 earnings. We see the S&P 500 at 1270 by mid-2005. Meanwhile, our analysts believe that the stocks appraised here look particularly attractive:

Analog Devices (ADI NYSE)

"We project that this semiconductor maker’s sales will grow 38% in fiscal 2004 (ending October) and 30% in fiscal 2005. Its high-performance analog and digital signal processors convert sound, video, heat, and other real-world signals into digital formats. The products are used in industrial applications, communications equipment, computers, and consumer electronics. Thanks to a diversified customer base, average selling prices for the company’s chips have been relatively steady. ADI initiated a dividend in 2003 and raised it in May, for a modest yield of 0.5%. The company has plenty of cash, and we think a further hike in the payout is possible. We estimate earnings of $1.64 a share for fiscal 2004 and $2.30 for fiscal 2005. Our target is $70.

Avon Products (AVP NYSE)

"We forecast that 2004 sales will increase about 11% for this global marketer of beauty products. Revenues should be helped by solid volume gains in the core direct selling business, fueled by the growing ranks of sales representatives and new products. Our outlook is for modest weakness in the US dollar and Latin American currencies, and we expect Avon to benefit somewhat from foreign exchange translations. Our 2004 earnings estimate is $1.70 per share versus the split-adjusted $1.39 in 2003, excluding charges and one-time items. Our 12-month target is $55, derived from discounted cash flow and relative valuation analyses.

ExxonMobil (XOM NYSE)

"As the world’s largest publicly traded oil company, with a large refining operation on the Gulf Coast, ExxonMobil should be well positioned to benefit from improved energy demand as economies rebound and from strong US gasoline markets, in our opinion. Also, its diversified businesses should provide a hedge against commodity price and geopolitical risks. We estimate operating earnings of $3.42 a share for 2004 and $2.99 for 2005, given our projection of lower oil prices. The company has a relatively high degree of earnings stability and a strong balance sheet, in our view, and the shares have outperformed the S&P 500 index over the past 20 years. Based on discounted cash flow and relative valuation analyses, we have a target of $52. We advise purchase for potentially superior total return.


"This company provides technology systems and services, primarily to financial firms. Fiserv’s unit that offers financial institution transaction and account processing services contributed 65% of the company’s operating revenues in the first quarter. We project that operating revenues will increase 13% to 15% annually over the next three years, and we also see improvement in the operating margin. Our earnings forecasts are $1.96 a share for 2004 and $2.20 for 2005 vs. the $1.61 a share reported in 2003. The stock trades at notable discounts to both the p/e and p/e-to-growth ratios of peers. Our 12-month target price is $45, and we advise purchase for potentially superior capital appreciation.


"This producer of industrial, specialty, and agricultural chemicals recently announced a $15 per ton price hike for soda ash, effective July 1. With the industry operating near 100% capacity and another producer closing a plant acquired last year, we see a good chance of an additional price increase. We believe profits for industrial chemicals will rebound sharply in 2004 as demand continues to strengthen. The We expect earnings to rise to $2.80 per share in 2004 from the $1.12, including special charges of $0.78, reported for 2003. Based on our 2004 estimates, the stock trades at p/e and cash flow multiples well below those accorded the shares of peers, though we note that FMC’s largest business consists of low-growth cyclical commodity chemicals. Our 12-month target price is $54, based on relative p/e analysis.

Guitar Center (GTRC NASDAQ)

"With 130 locations, this is the leading US retailer of musical instruments. Guitar Center also operates American Music, with 19 stores that sell band and orchestral instruments and accessories. American Music primarily rents and sells to the school market. The company’s third segment is Musician’s Friend, an e-commerce and catalog website business. We believe Guitar Center should benefit from growth in a fragmented industry; the top five retailers hold about 26% of the market. In our view, the school band and orchestra market also holds opportunity for consolidation. The shares trade at 21 times our 2004 earnings estimate of $2.15 a share, while we are forecasting 22% annual growth over the next three years. Our 12-month target price of $55 is based on discounted free cash flow and P/E-to-growth analyses.

Hartford Financial Services Group (HIG NYSE)

"We see a number of encouraging growth trends under way at this multi-line insurance and variable annuity company, most notably the 55% rise in retail financial product sales in the first quarter. A rebound in operating earnings that we expected in 2004 was skewed by 2003 first-quarter after-tax charges of $1.7 billion that led to a 2003 operating loss of $0.93 a share. The charges were incurred to cover a $2.6 billion increase in asbestos reserves. Our 2004 earnings estimate is $6.30 per share, at the low end of the company’s guidance. The shares trade at a slightly lower p/e than the peer group, based on 2004 earnings estimates. Our target price of $74 assumes a modest rise in the p/e to about 13, still a discount to peers.

Landstar System (LSTR NASDAQ)

"This provider of trucking services uses independent drivers and brokers who contract with other trucking companies. Industry capacity remains tight, but Landstar has been able to meet rising demand. Based on the company’s recent guidance, we raised our earnings estimates $0.05 each to $1.90 for 2004 and $2.40 for 2005. Our 12-month target price of $56 values the stock at 23 times our 2005 estimate, in line with the company’s historical p/e multiple and slightly below those of peers. Given what we consider Landstar’s superior operating model, strong growth prospects, low debt, and high returns on assets and equity, we believe the shares are worth purchasing for potentially superior long-term capital appreciation.

Qualcomm (QCOM NASDAQ)

"We view this wireless technology company as the best in its class, with one of the most attractive business models in the telecommunications industry. Qualcomm has unique intellectual property, in our view, from the design of code division multiple access (CDMA) for the mobile wireless industry. The strength of its patents has enabled the company to receive lucrative licensing fees. In addition, Qualcomm is the leading "fabless" semiconductor company, meaning that it designs its CDMA chipsets and then outsources the manufacturing. It has $6.6 billion in cash and equivalents and no long-term debt. We estimate earnings of $2 per share for fiscal 2004 (ending September) and $2.45 for fiscal 2005. The shares trade near peer p/e levels, based on 2004 estimates. Our 12-month target price is $80, and we advise purchase.

Zimmer Holdings (ZMH NYSE)

"As a result of its 2003 acquisition of Centerpulse AG of Switzerland, Zimmer is the largest pure play in the global orthopedics industry. We think Centerpulse provided the company with a strategically important foothold in the spinal surgery market. We believe Zimmer can increase earnings per share about 23% annually over the next three years because of expected market share gains in orthopedic implants, favorable unit pricing trends, and synergies from the Centerpulse acquisition. For 2004, we look for operating earnings of $2.25 a share. For 2005, we project $2.80. Our 12-month target price of $107 assumes a 2005 P/E-to-growth ratio of 1.7, at the high end of our medical device universe, and a p/e of 38 times our 2005 per-share earnings forecast."

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