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Home Is Where the Investor Should Be

The boom in housing will keep consumers buying stuff for their homes. And that bodes well for the stocks of makers of appliances, carpets, furniture, and more -- even though home sales themselves may slow when interest rates rise. That's among the forecasts of Thomas Graves, group head for consumer discretionary stocks at Standard & Poor's. Accordingly, Graves likes names such as Whirlpool, carpet supplier Mohawk Industries, and Leggett & Platt, a furniture company.

Despite the warming economy, Graves expects consumers to continue to be price-sensitive. Thus he recommends discount retailers such as Costco and Wal-Mart. For obvious reasons, S&P has branded Kmart a stock to avoid. Consumer discretionary stocks form one of the three areas S&P recommends investors overweight in their portfolios now. The other two: information technology and materials.

Graves made these and many other points in a chat on Mar. 26 presented by BusinessWeek Online and Standard & Poor's on America Online, in the course of responding to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts follow. A full transcript is available from BW Online on AOL at keyword: BW Talk.

Q: Tom, how does the broad market look? It has been sort of like watching a tennis match the past several days.

A: Yes, the market has shown quite a bit of volatility. Today, we saw the market benefit from strong consumer confidence numbers. That bolsters the outlook for economic improvement ahead.

Q: Can you identify what areas make up consumer discretionary stocks?

A: Consumer discretionary stocks are those that are likely to be significantly affected by consumers' use of their disposable income. It includes a wide variety of stocks, ranging from retail to homebuilding.

Q: A troubled name here -- in or out on Kmart (KM)?

A: We advise people to avoid Kmart. There are other retail stocks that we prefer, including Costco (COST) and Wal-Mart (WMT). Our feeling is that the consumer will continue to support the economic recovery, although we do not expect there to be as large an increase in consumer spending following this recession as there was after earlier recessions. Among our favorite stocks in the group are Mohawk Industries (MHK), Whirlpool (WHR), and Costco.

Q: Your buy ratings on Mohawk and Whirlpool suggest consumer spending on the home. Are there stocks you like among homebuilders?

A: Our favorite among the homebuilding stocks is Clayton Homes (CMH). However, we view this as rather a special situation. We look for the company to benefit from improved conditions in the manufactured-housing area. Overall, we recommend slightly underweighting homebuilding stocks, largely because mortgage rates have likely reached the bottom of the current cycle.

Q: Durable goods and commodities are rising. What are some low-pressure sectors that could benefit during the recovery?

A: S&P is recommending investors overweight their investment positions in three sectors: consumer discretionary, information technology, and materials. In our view, these sectors are especially economically sensitive. And they should benefit from the economic improvement we expect ahead.

Q: Tom, can you please further define the sectors S&P has recommended overweighting?

A: Let's start with consumer discretionary stocks. That group provides a wide range of investment opportunities, including retailers and consumer durable stocks. Our second recommended sector is information technology. That includes a wide range of technology issues. Examples of favorites include IBM, Sun Microsystems (SUNW), and Symantec (SYMC).

[In] consumer durables, an example of a stock we like is Whirlpool, the appliance company. We feel Whirlpool will benefit from the high level of housing sales. We also like shares of Leggett & Platt (LEG), a maker of furniture and other furnishings.

Q: Can Best Buy (BBY) move up from here, and should we look for a split?

A: Our feeling is Best Buy is an attractive stock. It's our favorite among the consumer-electronics retailers we follow. In terms of a stock split, it's reasonable to look for a split from Best Buy in the year ahead.

Q: Most people I know are tapped out in terms of disposable income. How can this bubble continue, and aren't you worried about this?

A: We realize economic conditions have been difficult for many people. That includes many job layoffs and increased job insecurity. However, we feel the consumer's balance sheet overall is in adequate shape to continue to bolster the economic improvement we're expecting in 2002.

Q: What do you think of the restaurant sector for the remainder of '02? Any favorites there?

A: We are now neutral on restaurant stocks. There recently has been a cautionary statement from McDonald's (MCD), the world's largest restaurant company.

However, we do feel the demographics of the U.S. population favor casual-dining companies. And S&P believes there are a number of restaurant stocks worth holding on to. In the casual-dining area, among the stocks we're recommending holding are Darden Restaurants (DRI), Brinker International (EAT), and Applebee's International (APPB).

Q: The Oscars are behind us -- what does S&P like among entertainment stocks?

A: Our favorites among entertainment stocks include AOL Time Warner (AOL) and USA Networks (USAI). We favor accumulating both issues. With some of the other entertainment stocks, such as Disney (DIS) and Viacom (VIA.B), we advise holding the shares. We do not recommend new purchases in those two cases.

Q: What about Philip Morris (MO)?

A: We recommend accumulating the stock. In our view, solid operating results and above-average dividend yield make the stock attractive at its current valuation.

Q: Tom, does Pier 1 (PIR) look good to you?

A: Yes, we do like shares of Pier 1. It fits our general theme of looking for stocks that should benefit from the high level of housing sales. In the area of specialty retail, there are other stocks we like: Chico's FAS (CHS) and Electronics Boutique (ELBO), in the consumer-electronics area. We actually have a higher opinion on ELBO than on Best Buy.

Q: Consumers have been spending big on cars -- any auto stocks to choose?

A: Our favorite stock among the auto makers that we cover is General Motors (GM). We expect the company to benefit from economic growth in most regions of the world, a steady flow of new products, and productivity improvements.

Q: A big supermarket name here: Albertson's (ABS)?

A: We like shares of Albertson's. We see a restructuring at the company as being on track, and based on our discounted cash-flow model and better results than expected from restructuring, the stock is attractive.

Q: To back up again, what's the S&P ranking on GM? And, for that matter, on ABS?

A: General Motors is a 4-STARS stock [in S&P's Stock Appreciation Ranking System], which means we favor accumulating the stocks. We expect GM shares to outperform the S&P 500-stock index over the next 6 to 12 months. We have the same opinion on Albertson's.

Q: What accumulate rankings do you have on consumer discretionary names? Besides GM and ABS.

A: To give a brief overview, S&P equity analysts cover about 190 consumer discretionary stocks. Of those, we have our strongest favorable opinion, or buy, on about 17 stocks. There are many others on which we have an accumulate opinion. Examples among those we have not already mentioned: Lowe's (LLW), Maytag (MYG), and GTECH Holdings (GTK).

Q: How does PepsiCo (PEP) look?

A: PEP is one of our favorite consumer staples stocks. We have a 5-STARS [buy] opinion on PepsiCo.

Q: What's the S&P view on Sears Roebuck (S)? It brackets many of the consumer areas.

A: Sears Roebuck is one of our favorite consumer discretionary stocks. We recommend buying S and consider it to be a good value.

Q: Are there any consumer stocks besides KM we should be avoiding -- or even selling?

A: Yes, there are a variety of stocks that we recommend investors should avoid or sell. Examples of stocks we do not like at their current levels are Eastman Kodak (EK), Salton (SFP), and TMP Worldwide (TMPW).

Q: A classic consumer name here -- Procter & Gamble (PG)?

A: We like shares of Procter & Gamble. We advise investors to accumulate the stock.

Q: What about gambling stocks?

A: Our favorite stock among the gambling issues we cover is Park Place Entertainment (PPE). We view it as an attractive cash-flow story. Also, we have an accumulate rating on International Game Technology (IGT) and GTECH Holdings, which we mentioned earlier.

Q: Time's almost up. So, Tom, would you refresh our memories on the best bets for now in the stocks you cover? 5-STAR S&P buys?

A: To summarize, the consumer discretionary area is one of our favorite sectors for stock investors. Among the themes we like in this sector are the idea that consumers will continue to be price-sensitive and increasingly shop at discount-oriented retailers.

Also, we see opportunities in various stocks that should benefit from consumers staying close to home and investing in their residences. Among our favorite stocks in the consumer discretionary area are Mohawk Industries, Whirlpool, and Costco.

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