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07/30/2004 12:00 am EST

Focus:

Price Headley

Founder and Chief Analyst, BigTrends.com

"Despite the choppiness so far this year, the next six months are providing a tremendous amount of bullish potential," says Price Headley. "And for that matter, 2005 looks pretty solid too." In a special mid-year report, Headley offers some of his current favorite stocks.

"We may hit a market very bottom sooner than most people realize. The recent ho-hum mentality isn’t necessarily a symptom of weaknessit’s just a sign of lack of interest. Although the worst of the Fed’s rising-rate-induced sell off is already behind us, the official announcement of each incremental rate hike isn’t exactly going give the bulls a reason to celebrate. But, once investors get comfortable with the idea of well-paced interest rate increases, the bull trend can resume. Remember, the Fed raises interest rates to control a growing economy not to shrink it. Rising rates are the method to keep the economy’s growth (and the markets) healthy and long-lasting. Meanwhile, corrections are just a natural part of the cycle, and isn’t a reason to get shaken out of long-term positions. In fact, the mild inflation and the ‘optimal’ GDP growth are suggesting that the coming months and years should be very profitable. The bottom lime is that the stock market has a lot of good things going for it right now. Let’s look at some stocks and industries that are well poised to take advantage if this continued economic expansion:

"Remember how the capital goods companies just start to enter their prime in the latter stages of the bull market? Boeing (BA NYSE) is an example of this. At this point in time last year, the market was only three months into its recovery, and there still wasn’t any conclusive evidence that the economy was improving. There’s no way that any airlines or air couriers would be thinking about buying things as expensive as a jet plane back then. But what’s changed since then? The economy is growing, which in turn means that air shipping, business travel, and vacationing are all becoming brisk. This will be (and already is) reflected in their respective stocks. In fact, the transportation stocks and air couriers are in the top 10% of price performers over the last three months. So what’s that got to do with airplane manufacturers? If the couriers and airlines want to expand, they need planes to do it. Plus, they have to maintain them, buy replacement parts, etc. Boeing conveniently does all of those things. One of the few industries that have outpaced both the broad transportation stocks and the couriers has actually been aerospace. Of course, Boeing just happens to be the biggest company in this group, and is arguably the best. With a p/e of 22.8, Boeing is priced as much like a value stock as it is a growth stock. Earnings are growing at an annual rate of 46%, and as long as the economy remains robust (and we think it will), earnings will be solid.

"Natus Medical (BABY NASDAQ) is a small company, but one with a lot of potential. The company manufactures highly specialized equipment to detect and monitor common disorders in newborns. Most of their focus is on the detection and treatment of hearing disorders in newborns. Although the company is still losing money on a year-over-year basis, we still like the direction that profits are headed. In fact, it’s the lack of earnings that makes this stock so compelling right now. It’s one of those companies that nobody seems to be interested in since there are no earnings. However, a closer look reveals that Natus has been steadily improving profits over the last three years. A company spokesperson recently announced that profits are expected for both the third and fourth quarter of 2004. If that comes to fruition, BABY will have positive annual earnings for the first time in years. That type of event is finally what gets the attention of other investors, so you could really start to see the buyers pour in then. The company also expects to see the same revenue and profit growth rates in 2005, so the rally has the right foundation to make this stock a long-term holding. Although shares have made a strong move to as high as 6.60 recently, it should be noted that this is not likely to be a stock that moves in straight lines. There’s enough trading volume to be liquid, but prepare for some volatility. That’s the necessary evil in finding one of these hidden gems that nobody else has discovered yet. The other compelling reason to own shares of BABY is simply that there is very little analyst coverage of the company. This leaves the door wide open for Wall Street to jump on the bandwagon as they search for new companies to buy. Each upgrade, or even just the initiation of analyst coverage, puts the company out in the eyes of the public. But, since there is an inherent ‘buy’ bias in all analyst coverage, the momentum and return to profitability for Natus could result in a long string of positive analyst opinions.

"Chevron-Texaco (CVX NYSE) is just a logical way off capitalizing on the continuing energy crunch. As long as the global economy stays healthy, the demands for energy sourcesand oil specificallywill remain equally healthy. Some could argue that the reason oil stocks have been so strong in recent months is that the oil supply was threatened, thus raising the price of oil. While that is true, the cost of acquiring and re-selling oil also went up. In other words, higher gas prices didn’t mean wider profits margins for the oil industry. The reason that oil and energy stocks have done so well is their return back to profitability. That, however, was prompted entirely by increased consumer demand. As the economy has grown, there are more cars and trucks on the road, more deliveries being made, and more demands on power plants than there has been in years. And with the momentum behind the global economic expansion, we’re not going to see a slack in demand anytime soon. Evidence? Despite gas prices being at all-time highs a couple of months ago, auto-fuel consumption was also near all-time highs. In other words, we were still paying the higher prices. It makes you wonder what kind of consumption we’ll see when gas prices fall again it could be huge. In any case, the cost of acquiring or re-selling oil isn’t a direct reason to own or not own an oil company. Look at profitability to make that decision. As far as Chevron-Texaco goes, profits aren’t a problem. The company has turned in increased earnings in four of their last six quarters, and is projecting record earnings for 2004. In terms of investor favor, we like the fact that Chevron-Texaco is overshadowed by industry-giant Exxon-Mobil. Being the biggest company in a sector means that the market will look to buy and sell that name first following any economic or geopolitical development. We’d like to avoid some of that unnecessary gyration though. While all eyes and interest are on the best-known name, stocks like CVX can quietly make their progress, at least partially free of all that volatility. But even if being in the limelight wasn’t an issue, Chevron-Texaco is a better fundamental choice. They’re both great companies, but CVX shares seem to be the better bargain right now. Chevron’s p/e is 12.4 right now, while Exxon-Mobil is trading at an earnings multiple of 14.8.

"Although it’s a large-cap stock, you may have never even heard of Illinois Tool Works (ITW NYSE). It’s one of those companies that isn’t involved in cutting-edge technologies or in a high-profile industry. As such, it doesn’t get a lot of media attention. In fact, you may think that Illinois Tool Works is downright boring they make plastic and metal fasteners. But there’s nothing boring about the company’s earnings growth of 43.7%. This is an industrial/capital goods position taken to the extreme. While Boeing is technically a capital goods company, what they do is still relatively narrow in focus. ITW, on the other hand, has a pretty wide range of customers as well as products. This gives Illinois Tool Works a virtually endless market to tap into. However, the reason for the company’s recent success is founded in the expanding economy. Rivets, fasteners, and packaging are basically a commodity. But when the entire economy expands, companies like this are called upon to help other companies meet their new demand. Everyone from soft-drink makers to steel producers uses a product that Illinois Tool makes. When Illinois Tool Works’ customers are busier, you can bet that ITW shareholders will be the ultimate beneficiaries. The company is expecting to post its third consecutive year of annual profit increases in 2004. The current p/e is right at 26.00, which is in line with its competitors. But with earnings growing at 43.7%and revenue expected to grow between 10% and 15% through the end of 2005, ITW is one of the stronger stocks in industry. But why ITW shares? Well, in terms of fundamentals, it’s in the top quartile among its comparable peers. We also like the high degree of institutional ownership of this company. Approximately 78% of all outstanding shares are held by mutual funds, pension funds, and the like. Insiders hold another 13% of shares. Throw in the fact that the company initiated a stock buyback program in the second quarter of 2004, and what you have is a positive endorsement from those who are ‘in the know’."

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