By Gene Marcial As the stock market struggles to find its footing, lots of investors continue to be wary. They still believe that valuations are very high and pose a risk for another selloff -- unless the corporate earnings outlook brightens considerably. "Right now, the profit picture remains murky," asserts R. Stephen Bartholow Jr., managing director at investment management firm Carrett & Co., which manages some $2 billion.
The fact that the Dow Jones industrial average has gained about 2,200 points since its Sept. 21 low -- and has spawned very few profit takers -- "makes me a bit uneasy," he says.
Yet he isn't totally bearish. Despite his misgivings, he describes his current stance as "cautiously optimistic." That's because he concedes that some positive evidence is appearing, such as the growing signs of inventory rebuilding and increasing confidence among consumers (see BW Online, 1/29/02, "Again, Consumers Are Carrying the Load"). And he thinks that's creating some opportunities.
MAJOR RETRACEMENT. The bottom line? "It is not too early," says this money manager, to establish partial positions in companies that should benefit from an eventual economic recovery. He cautions that investors should be prepared over the short term for at least a 50% retracement of the market's advance from the Sept. 21 low.
After such a pullback, he expects the indexes will try to establish a base. The market is bound to see "group rotation" -- or different sectors advancing and falling back until strong leadership is established -- and the indexes will move sideways, says Bartholow. That's precisely the time, he says, when astute stock picking is paramount.
He forecasts that the major market indexes will probably net only single-digit gains for 2002. In this volatile market, "hitting singles and occasionally stealing second base is just fine for now," advises Bartholow.
BASIC INDUSTRY. So Carrett's market strategist recommends nibbling on early-cycle value stocks that have growth potential and trade at low price-earnings multiples. In particular, Bartholow thinks basic industrial companies that benefit from renewed spending and low-cost production, and that maintain a competitive edge globally, should do very well. The biotech, medical-device, and specialty pharmaceutical sectors are also among the early-cycle stocks that should move up, adds Bartholow.
Among his top stock picks:
Shaw Group (SGR), a large supplier of industrial piping systems, mainly to the electric power, refining, and chemical industries. Alcoa (AA), the world's largest producer of primary and finished aluminum products. And Abbott Laboratories (ABT), a leader in diagnostics and major maker of drugs, nutritional supplements, and hospital and laboratory products.
Shaw's shares have been on the ropes since last year, falling from 62 in early April, 2001, to 18.50 on Jan. 23, 2002, before edging up to 20.85 on Jan. 29. A provider of comprehensive design and engineering services, Shaw is being shunned by Enron-sensitive investors because of its power projects. But the company has never had any contracts with now-bankrupt Enron.
PROFITABLE BIDS. Shaw supplies equipment and builds power plants for electric utilities. While many of its competitors have had contracts canceled as utilities curb spending on new projects, Shaw hasn't seen any such cancellations, says portfolio manager Peggy Preston, who specializes in utilities at Carrett. "So far, Shaw has dodged the major bullet," says Preston, mainly because of the way it crafts its bids for major contracts. Unlike many of its competitors, says the analyst, Shaw makes sure the bid will result in profits, instead of taking on risks that could undermine the bottom line just to make sure it wins a contract.
Preston says Shaw has plenty of projects already under way, and it has $3.5 billion in signed letters of intent for new projects. She expects the company to earn $2.70 to $2.75 a share in fiscal 2003 (ending in August), up from $2.10 to $2.20 in fiscal 2002. In 2001, it earned $1.46. The stock is trading at just 7.4 times estimated fiscal 2002 earnings. Bartholow figures the share price could run up to 35 in 12 months -- or 13 times 2002 earnings.
Alcoa, a low-cost producer of aluminum, could see weak results over the next two quarters, figures Bartholow. But as the economy rebounds, he thinks earnings for 2002 will climb to $2.60 a share from an estimated $1.71 in 2001. That makes Alcoa another low p-e, early-cycle play, trading at just 7.6 times estimated 2002 earnings. With a projected earnings growth rate of about 15% annually in the years ahead, Bartholow figures the stock deserves a p-e of 17, the equivalent of 45 a share, over the next 12 months.
"SOLID GROWER." Abbott covers all the bases in health care, with its well diversified focus on specialty drugs, biotech, and medical supplies, notes Bartholow. It's also a leader in diagnostics, where it has a high market share, he adds. He says Abbott is a "solid 13% to 15% grower," and expects it to earn $2.55 a share in 2002, up from an estimated $2.25 in 2001. Based on 25 times estimated 2002 earnings, the stock should climb from its current 57.60 price and hit 64 to 65 a share in 12 months, says Bartholow.
His attempt to find the right stocks for this specific market climate underscores the old maxim: Even in uncertain times, some stocks are bound to be winners. The secret is knowing which ones. Marcial is BusinessWeek's Inside Wall Street columnist