"Safe" and "Cheap"

12/03/2004 12:00 am EST

Focus:

Richard Band

Editor, Profitable Investing

"Our twin watchwords are ‘safe’ and ‘cheap’," says Richard Band, editor of the always exceptional Profitable Investing. "By scooping up quality investments at bargain prices, we’ll stay well ahead of the crowd. I’ve got two new stock picks for you that fit the bill perfectly."

"We want to own companies that carry plenty of cash and a minimum of debt. Both of my ‘safe and cheap’ picks are giant corporations with rock-solid franchises. Yet both are trading at remarkably modest valuations, in a market that isn’t exactly teeming with bargains.

"You know the Gap (GPS NYSE), a world-class franchise. It is one of the nation’s largest and most shrewdly managed clothing chains, with 3,000 stores and $16 billion in annual sales. What sets this business apart from others in the rag trade is the breadth of its product line. GPS caters to men, women, and children through three successful storefronts, each aimed at a different price point (Banana Republic, Gap, and Old Navy). GPS has also jealously guarded its balance sheet. The market value of the company’s stock exceeds long-term debt by a 7:1 margin, well above the 4:1 ratio I consider healthy for a retailer. In fact, GPS could, if necessary, retire all its debt instantly with $2 billion of cash left over. A cheap stock? Yes! Gap is currently quoted at only 13 times next year’s estimated earnings—a steal for a company that should be able to grow its earnings 15% annually over the next five years. (Most companies with this potential trade at 20 times or higher.) Although GPS pays only a nominal dividend, the low p/e leaves the door open for rapid increases in coming years. Meanwhile, on October 7, Gap announced a $500 million stock-buyback program (its first in four years), which will make each surviving share more valuable.

"The dominant wireline phone company in Germany, Deutsche Telekom (DT NYSE) also operates wireless networks in eight countries (including the United States) through T-Mobile and provides Internet access in Germany, France, Spain, and elsewhere in Europe through T-Online. Like other European telcos, DT stumbled badly earlier in the decade by taking on too much debt. But new management has righted the ship, selling off non-core assets, slashing costs, and shedding debt. DT passed a milestone toward full privatization in October when the German government trimmed its stake to 36%. Now I look for the a resumption of the dividend (omitted during the worldwide telecom bust). My guess is that DT’s yield will reach 4% by 2006. At less than 11 times next year’s estimated net, DT sells for almost a 30% discount toVerizon. Yet analysts expect Deutsche Telekom to grow faster than Verizon over the next five years. Does that make sense? Only to folks who can’t read price tags.

"Lock these blue chips away and watch your wealth zoom 50% or more in the next 24–36 months. Buy GPS at $21 or less and DT at $20 or less. I project a gain of at least 50% with both stocks by 2007. Note that Germany imposes a 21.1% withholding tax on dividends paid to US residents. Since you can’t recover the tax inside a retirement account, it’s wisest to hold DT in a taxable account."

Related Articles on