Royal Blue Chips

07/16/2004 12:00 am EST

Focus:

Sam Stovall

Chief Investment Strategist, CFRA Research

"To find stocks that offer the potential of superior long-term total return, we advise investors to seek companies that not only have strong likelihood of a rising stock price, but that also pay a dividend," says Sam Stovall in S&P's The Outlook.

"Companies that pay dividends and boost them consistently while retaining sufficient cash flow to expand their businesses have traditionally made solid long-term investments. Because of compounding, dividends have delivered 41% of the total return of the S&P 500 since 1926. To be considered a ‘royal blue chip’, a stock must have the characteristics:

  • An increase in the dividend in each of the past ten years.
  • A ten-year average annual total return (appreciation plus dividends) of more than 11.3%, besting the S&P 500 index during the same period.
  • An estimated earnings gain of at least 10% for 2004.
  • An S&P quality ranking of at least A-, indicating above-average earnings and dividend growth and stability over the past ten years.
  • An S&P investment ranking of four or five STARS, indicating that our analysts expect the stocks to outperform the S&P 500 index in total return, with shares rising in price on an absolute basis.

"Here are three of the stocks that qualify among the royal blue chips:

"Franklin Resources (BEN NYSE), a diversified money manager, has a broad line of products and strong track record that should continue to attract investors in the coming years. As investors continue to shift their assets into Franklin’s global and equity funds, which are higher-margin products, and away from fixed-income and money market funds, per-share earnings are likely to enjoy a nice boost, in our opinion. We forecast earnings of $2.95 per share in fiscal 2004 (ending September) and $3.31 in fiscal 2005, helped by an expected increase in assets under management, prudent expense growth, and a shift toward higher-margin funds. The shares, which trade at 15 times our fiscal 2005 estimate, have underperformed their peer group thus far in 2004, but we believe Franklin has strong potential for capital appreciation in the next 12 months. Our target is $72, or 22 times our fiscal 2005 estimate. We believe the shares deserve to trade at a premium to their peers, given our view of BEN's consistent net inflows, strong fund performance, and considerable operating leverage. We advise purchase.

"General Growth Properties (GGP NYSE), a real estate investment trust, operates large regional malls and shopping centers, a strategy that we believe will bring the company continued success. Its portfolio totals about 150 million square feet of retail space and includes about 16,000 stores. We believe that the improving economy and healthy retail sales bode well for the company’s financial results. After climbing 30% in 2003, total revenues are likely to rise about 20% in 2004, in our view, mostly because of higher rents. We expect demand for space to continue to be strong, enabling GGP to command double-digit rent increases when expiring leases are renewed. We see funds from operations of $2.70 per share for 2004 and $2.95 for 2005 versus $2.31 in 2003. Our earnings estimates are $1.47 per share for 2004 and $1.65 for 2005. We expect the dividend, currently yielding about 4.1%, to continue to rise in tandem with GGP’s earnings growth. Our 12-month target is $32. We caution that the shares may experience heightened volatility because of concerns about rising interest rates, but we are optimistic about the company’s prospects. In our opinion, the stock is attractive for accumulation.

"Pitney Bowes (PBI NYSE), a provider of mailing equipment and services, has what we think is an enviable recurring revenue stream, which accounted for 77% of sales in 2003. Pitney Bowes has been able to augment its growth through acquisitions. Since mid-2001, the company has made five major acquisitions, providing a solid foothold in selected markets with high-growth prospects, in our opinion. Its acquisition have increased its share of document management outsourcing in Europe; strengthened its share of mail and enterprise systems markets internationally; provided entry into the mail-sorting services market; and enhanced its exposure to government logistics contracts. Pitney Bowes continues to enjoy significant free cash flow, which has enabled it to fund growth and to repurchase stock. In the first quarter alone, Pitney Bowes bought back 2.3 million shares. The stock is selling at 18 times our 2004 earnings estimate of $2.51 a share, below its historical average p/e. We have a 12-month price of $48, based on our discounted cash flow model. We think the potential for capital appreciation, coupled with an above-market 2.8% yield, makes the shares appropriate for accumulation."

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