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Time to Go for Growth Stocks

As the economy starts to recover, the best course for investors is to look at growth stocks, according to Sam Stovall, senior investment strategist for Standard & Poor's. And in S&P's STARS list (Stock Appreciation Ranking System), at least 50% of the 5-STAR (buy) names are either small- or mid-caps.

Among the newer arrivals in the buy categories are PolyCom, a network-solutions company in the tech sector, Commerce Bank, FTI Consulting, and trucking firm Landstar System. Larger stocks in the 5-STAR list include Exxon Mobil, IBM, Sun Microsystems.

Stovall says S&P still recommends Tyco despite the concern of some investors that it might face accounting problems such as those that most notably have hit Enron. S&P analyst Mike Jaffe believes that Tyco, having successfully undergone SEC scrutiny of previous accounting questions, will do so again, Stovall reports. [Editor's Note: A week after this chat was held, Jaffe on Feb. 5 downgraded his rating on Tyco to 3 STARS, or hold.]

These comments came in a chat with Stovall presented Jan. 29 by BusinessWeek Online and Standard & Poor's on America Online. Edited excerpts from this chat follow. A complete transcript is available from BusinessWeek Online on AOL, keyword: BW Talk.

Q: People seem to be worried about more Enrons, and thus: What do we do with Tyco (TYC) -- buy, sell, hold?

A: Understandably, investors are a bit nervous. In early 2000, when the dot-coms and the Nasdaq imploded, many high-profile analysts with investment-banking connections urged investors to keep buying. Last year, many of these same analysts had predicted earnings advances when, in fact, earnings for the S&P 500 likely fell nearly 30%. Now, corporate management and their accountants don't even appear to be trustworthy.

Despite this, our analyst Mike Jaffe has reiterated his 5-STAR buy recommendations on the Tyco shares. To Mike, the recent concern about the company's accounting practices reminds him of the accusations in late 1999 that led to an SEC inquiry. The SEC validated Tyco's practices, and we believe the marketplace will do so this time as well. We regard the recent sell-off as an excellent entry point.

Q: I bought IBM (IBM) at an adjusted price of $27. Should I finally sell some?

A: Not in our opinion. IBM is ranked 5-STARS, because we believe that the technology sector is likely to turn around this year, and IBM will be one of its leaders. We also approve of the appointment of Sam Palmisano as CEO.

Q: Your opinion on AOL (AOL), please -- I bought it at $79.

A: We have a 4-STAR (accumulate) ranking on the AOL shares. We see earnings of $1.06 this year, a shade lower than the $1.11 for 2001 (for more on AOL Time Warner's prospects, see BW Online Special Report, "AOL Time Warner--One Year Later").

Q: Can you can refresh our memories on how the S&P STARS list works?

A: S&P's team of analysts has buy, hold, and sell rankings on nearly 1,100 stocks. These rankings are called STARS (Stock Appreciation Ranking System). Like a movie or restaurant review, a 5-STAR is best, while a 1-STAR is the worst. From its inception in late 1986 through the end of 2001, while the S&P 500 gained an average of 10.9% per year, our 5-STAR list rose an average of 18.4% per year, while our 1-STAR list fell an average of 1.3% per year.

Our investment time frame for these recommendations is typically 6 to 12 months and is analyst-driven, focusing on typical fundamentals such as earnings-growth prospects and quality of management.

Q: So where does one find a list of the 5-STAR stocks?

A: Subscribers to BusinessWeek Online can get lists of our 5- through 1-STAR stocks, as well as monitor STARS changes on a daily basis. In addition, I believe a screening capability is available that allows investors to look for STARS companies with other attributes, such as low p-e's or high relative strength.

Q: I'm down on AT&T (T). I've had some since the divestiture. Is it time to get rid of all the AT&T?

A: The AT&T shares are currently ranked 4-STARS, or accumulate. We upgraded the shares to accumulate from hold back in late December. We see the remaining AT&T businesses trading at less than six times our 2002 estimated earnings.

Q: Microsoft (MSFT) -- buy, sell, or hold?

A: Microsoft shares also carry a 4-STAR (accumulate) ranking.... The company remains a market leader, and we see strong opportunities for server products and the Microsoft consumer divisions.

Q: What do you think of Wal-Mart (WMT) as a core holding?

A: Wal-Mart is a good core holding. The shares are ranked 4-STARS, or accumulate, and the company is likely to benefit from the Kmart (KM) store closings over time. Wal-Mart might see some sales erosion near term as shoppers flock to Kmart in order to cherry-pick sale items. Yet we remain favorable on Wal-Mart because we see improving consumer spending in the second half of this year. Wal-Mart is also adding 300 stores in the U.S. and 120 overseas.

Q: This probably echoes the concern of many investors today -- which other companies have the accounting problems of Enron?

A: Certainly that's a question that a lot of investors are attempting to figure out, and that's why Williams Cos. (WMB) shares were pounded today. And also why American Express (AXP) shares were hit the other day. Investors are certainly worried about those companies that have to take special charges or were adversely affected by September 11. But I certainly don't know of any companies that are hiding things on their balance sheets.

Q: Sun Microsystems (SUNW) -- buy, sell, hold?

A: We have Sun ranked 5-STARS. Their December-quarter loss of 3 cents per share was better than the Street estimate. Their revenue increase of 9% from the September quarter met expectations. The company sees improvements in revenue, gross margins, and bookings in the March quarter, aided by new products. We think the shares are attractive at prices below their intrinsic value of $16 to $17, based on our discounted-cash-flow analysis.

Q: Your opinion of Exxon Mobil (XOM), as well as Check Point Software (CHKP)?

A: We have a 5-STAR on Exxon Mobil. Our analyst believes that with the sector poised for growth as a result of recovering worldwide economies, we see the company's shares trading at a more than 35% discount to our valuation.

We have a 4-STAR (accumulate) ranking on Check Point Software.... Our favorite security-software company is Symantec (SYMC), which is ranked 5-STAR. Its ratio of p-e to projected growth is at 1.2, and the shares are also trading at a discount to the market and its security-software peers.

Q: What will perform best in 2002 -- value, growth, or fixed-income?

A: Our feeling is that growth is likely to perform best in 2002. And it all points back to an economic recovery. Since 1960, the stock market has bottomed midway through an economic recession. If this current recession is average in duration, then the mid-September low will mark the launch point for a new bull market.

If history holds true and our earnings projections come true for 2002, we see small-caps outperforming large-caps, the economically sensitive sectors beating the defensive sectors, and growth stocks outperforming value stocks. At least 50% of the stocks on our buy list come from the mid- and small-cap areas.

Q: Sam, what are some of the S&P 5-STAR stocks among the small- and mid-caps?

A: Some recent additions include PolyCom (PLCM), which is a network-solutions company in the tech sector. Other small-cap names include Commerce Bank (CBH), FTI Consulting (FCN), and Landstar System (LSTR), which is a trucking firm.

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