4 Quality, Low-Risk Stocks

09/20/2011 11:30 am EST

Focus: STOCKS

James Stack

President, Stack Financial Management

In this tough environment, InvesTech Research’s Jim Stack has a list of stocks he likes, but he also weighs in on the recent boom in IPOs and why these are not the IPOs of the last decade in this exclusive interview with MoneyShow.com

Jim, you’re an analyst and a money manager, and you have lots of clients who are concerned about safety. I think safety first is one of your core principals. The people look at a market like this where all of these wonderful companies and wonderful stocks just get incinerated in less than a day.

Yeah, it’s scary out there.

First of all, what do you tell your clients? And how do you go about finding stocks that have, let’s say, a smaller chance of that happening?

Well, the thing that we have to keep in mind is that, if it’s ever really comfortable going into the market, it’s probably closer to a market top than a bottom. Some of the best profits in the stock market are historically made when it is the most nervous out there.

We certainly have had a market that’s had this perpetual wall of worry from the bottom in 2009. Every step of the way, you’ve seen headlines of a possible double-dip recession.

The thing to keep in mind is that there are higher-risk sectors and lower-risk sectors. Those that tend to perform the best going into a new bull market, like the financials and the consumer discretionary stocks, they tend to become the higher-risk sectors, because they often lose the most if you hold them too long or if you rollover into a bear market without selling them.

So, in planning a safety-first strategy in an economic recovery that is now in its third year, you steer toward the more defensive sectors. They may appear a little bit more boring, but very often they can provide the best returns. They definitely provide the safer returns in a maturing bull market.

Those would be ones like health care, where there are some great valuations out there in stocks like Medtronic (MDT) and Abbott Labs (ABT). We own both of those in our managed accounts.

Again, if you step over and look at some of the other mature-bull-market sectors. Oil is dropping back near $80 a barrel. You can pick up Marathon Oil (MRO) for single-digit P/E ratios, and it’s got a fantastic cash flow.

Conoco Phillips (COP)—again, you’ve got great dividend yields. Conoco just raised their dividend to 4% in a 0%-interest-rate climate, and you’re buying the company for about a seven P/E.

It doesn’t have the sizzle that some people might want in trying to swing for that home run. But when you’re trying to manage risk and looking at an economic recovery where you might be nervous, you don’t have to go after those big-hit stocks to make excellent returns.

Now obviously the stocks that get the most coverage are Apple (AAPL), which is a very strong stock…

And the social media stocks. Oh yeah.

Social media. I was just going to ask you about that. I know you were a big veteran skeptic in the 1990s of the all the dot-com stocks.

Oh yeah.

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So is this déjà vu all over again, as Yogi Berra says, or is there something different about these companies?

I don’t think we’re seeing the speculative bubble in social media stocks that we saw in technology or the Internet stocks in the late 1990s. I wouldn’t call it a bubble, but there certainly is a very high frothy degree of optimism and expectations.

These companies that are going public are being priced to perfection, and if there’s any bump in the road, the biggest bump in the road with a lot of these social media, is that they don’t have it locked up on competition. There are so many companies that can come out and if they find a different niche, all of a sudden their growth-rate expectations drop…and the stock price will drop sharply with it.

So you have to recognize if you’re going to go into those kind of stocks, you’re going to be carrying a pretty good risk with them too.

Now, it’s very interesting to me that a lot of those stocks have been bought on private markets. To some degree, does the private market now do what the IPO used to do, where people got in and made their money on the pop and now even the people getting in on the IPO are a little late?

Yeah, yeah. The problem with IPOs today is they’re not valued the same way that they were 20 years ago. It used to be 20 or 30 years ago, if a company went public, it was because that was their way of raising capital so that they could expand and increase, basically build a fledgling company into a rapidly growing company and benefit all of the shareholders.

A lot of the IPOs that are going today are basically just selling off shares of the people who started the company. They’re cashing out.

Exit strategies. Exit strategies for venture capitalists.

And they’re not floating a large number of shares of the company. It’s just a very small number, so that they can create a very high IPO price that they can sell out as their lock-up period ends, they can continue selling and cashing out.

Interesting.

The IPO market is not as attractive as it was many years ago.

Very quickly, you mentioned a whole bunch of stocks before. Do you own those stocks personally or professionally?

Every stock that I talk about, we hold in our managed accounts. In fact, I can’t talk about a stock that we have under consideration until after we have added it in our managed accounts.

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