Surveying S&P's STARS

Chief Investment Strategist Sam Stovall discusses the brightest shares -- as well as some dim ones -- in the S&P universe

The broad outlook for the economy and the market is for recovery, although growth in gross domestic product this year will be a relatively slow 2.3%, climbing to 4.4% in 2004. That's Standard & Poor's forecast, according to Sam Stovall, S&P's chief investment strategist. The forecast has higher numbers for operating earnings of companies in the S&P 500-stock index, Stovall adds -- up 17% this year and an additional 13% next.

Of the 1,200 stocks in S&P's Stock Appreciation Ranking System (STARS), some 100 are ranked 5-STARS, or strong buy, Stovall says. The financial sector alone has 18 strong buys, including Citigroup (C ), AmSouth Bancorp (ASO ), and Allstate (ALL ).

Ten of the strong-buy names are in S&P's recommended Top 10 portfolio, to which Intel (INTC ) was recently added. The others are Boston Scientific (BSX ), Comcast (CMCSA ), Compass Bancshares (CBSS ), Corinthian Colleges (COCO ), D.R. Horton (DHI ), Fair Isaac (FIC ), Flextronics (FLEX ), Martek Biosciences (MATK ), and Jacobs Engineering Group (JEC ).

Stovall made these and many other comments on stocks in an investing chat presented July 29 by BusinessWeek Online and Standard & Poor's on America Online. Following are edited excerpts from this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Sam, the consumer-confidence number took a toll on the market today. How confident is S&P in recovery for the market and the economy?

A:

S&P is fairly confident that the U.S. economy is already in a recovery mode and that corporate earnings will continue their upward climb. Specifically, we see U.S. real GDP advancing 2.3% this year but climbing 4.4% next year. Operating earnings for the S&P 500, in our opinion, are expected to climb 17% in 2003 and then an additional 13% in 2004, led by the economically sensitive areas of the market.

Q: What's your feeling, short and long term, about Corning (GLW )?

A:

Before I give our recommendation on Corning in particular, let me say a few things. First, a bit of disclosure: I'm an employee of S&P Securities. I don't own any of the shares I will be mentioning today, nor does S&P. Yet, S&P may provide services to these companies.

Second, a bit of description: There are approximately 1,200 companies in S&P's Stock Appreciation Ranking System, or STARS. Those companies that are ranked 5-STARS are expected to outperform the market and their peers in the coming 12 months. Those ranked 1-STAR are expected to underperform their peers and the market in the coming 12 months. Stocks ranked 3-STARS are expected to keep pace with the overall market. So as a result, we only have one time frame that we focus on, which is the coming 12-month period.

Corning shares are currently ranked 3-STARS, or hold. We see them earning 6 cents per share in 2003 and 23 cents in 2004. We currently view Corning shares as fully valued, trading at two-times book value, which is in line with its peers.

Q: What's your opinion on Citigroup?

A:

Citigroup shares carry a 5-STARS ranking. We see this leading financial-services company as a good way to invest in the economic recovery here in the U.S.

Q: Financials form the largest sector in the S&P 500 -- what else do you like in that arena?

A:

We currently have 18 stocks in the financials sector ranked 5-STARS. Some areas of the sector that we favor include regional banks, like AmSouth Bancorp and Compass Bancshares. We favor consumer-finance companies such as Capital One Financial (COF ) and IndyMac Bancorp (NDE ), as well as MBNA Corp. (KRB ). And we also favor selected insurance companies such as Allstate, Hartford Financial Services Group (HIG ), and finally MetLife (MET ). But because we think there are better opportunities in other sectors, in particular health care, the overall recommendation on financials is market weight.

Q: What's your opinion on Morgan Stanley (MWD )?

A:

Morgan Stanley carries a 4-STARS ranking. We see the company earning $2.98 in fiscal 2003 (ending in November), rising to $3.41 in fiscal 2004. But if you're looking for a company with better price-appreciation potential in our opinion, look to Lehman Brothers (LEH ), which we have ranked 5-STARS. We expect Lehman Brothers shares, which currently trade at about 12 times our fiscal '03 estimate of $5.22, to significantly outperform the market in the coming year. We also believe the plan to acquire Neuberger Berman (NEU ) to be a good strategic fit that will help reduce Lehman Brothers' dependence on bond trading.

Q: Over to utilities: What are your views on the group? And what's your opinion on Public Service (PEG )?

A:

Two utilities carry 5-STARS rankings -- Questar Corp (STR ) and Williams Companies (WMB ). In general, we have a market-weight recommendation on this sector. However, we have a 4-STARS ranking (accumulate) on Public Service Enterprises. We see it earning $3.80 this year and $3.85 next year. The company offers a 5.2% dividend yield and has an average S&P earnings and dividendquality ranking of B+.

Q: How does FPL Group (FPL ) rank with S&P?

A:

Everybody is batting four these days. The FPL shares carry a 4-STARS ranking, which is actually relatively high for utilities. That's because STARS focuses on price appreciation, not total return. But in the case of FPL and other utilities we have mentioned this afternoon, our analyst believes that stable earnings and dividend growth, combined with a 3.8% dividend yield and a valuation that's attractive relative to its peers, should offer some attractive upside potential.

Q: Do you think Rent-a-Center (RCII ) deserved a $6 crash today?

A:

We issued a story today on S&P's Advisor Insight service maintaining our accumulate opinion on Rent-a-Center shares. The company posted earnings that were below estimates. We think it's on track to open 80 new stores in 2003 and expect operating earnings to grow 22% this year, to $5.90, and 15% next year, to $6.82. The shares trade well below the S&P 500 valuations, and we still think they're attractive for accumulation.

Q: How do you rank energy outfits Noble (NE ) and GlobalSantaFe (GSF )?

A:

Noble Corp carries a 4-STARS ranking. GlobalSantaFe is ranked 5-STARS. In both cases, we're optimistic about the increase in capital expenditures by international integrated firms and the benefit that has on such worldwide drillers. In general, however, we recommend a market weighting for the entire energy sector but favor the drillers and E&P [exploration and production] companies.

Q: Which is the better pick, Johnson & Johnson (JNJ ) or Eli Lilly (LLY )?

A:

In this case, you'll have to do the selecting for us. Both companies carry 4-STARS, or accumulate, rankings. In fact, none of the major pharmaceuticals that we cover carries a 5-STARS, or buy, ranking. Other big pharmas that carry 4-STARS rankings include Pfizer (PFE ) and Wyeth (WYE ). You would have to look to Mylan Labs (MYL ) -- a generic pharmaceutical firm -- to find a 5-STARS ranking.

Q: What do you think of Intel?

A:

The Intel shares are ranked 5-STARS and on July 16 were added to our Top 10 Portfolio, which consists of our research director's favorite 10 stocks (out of about 100 that are ranked 5-STARS). We believe a steady recovery in worldwide semiconductor demand will help drive revenue and earnings growth, and we believe some associated valuation expansion will follow.

Q: What's your long-term rating of Exxon Mobil (XOM )?

A:

We also rank Exxon Mobil 5-STARS. With oil demand set to rise in the second half of this year for seasonal reasons and amid rebounding worldwide economies, we remain bullish on the international integrated oil industry as well as drillers. Our 5-STARS recommedations include Total Fina (TOT ), ENSCO International (ESV ), GlobalSantaFe, and Nabors Industries (NBR ).

Q: Over into media: How about Clear Channel Communications (CCU )?

A:

The CCU shares are ranked 3-STARS, or hold. We see earnings at $1.20 this year, rising to $1.40 next year. If you're in the market for a broadcaster, we suggest taking a look at Comcast, the shares of which are ranked 5-STARS.

Q: How about Charter Communications (CHTR )?

A:

Charter is also ranked 3-STARS. If you're looking for some other attractive broadcasting opportunities, take a look at Hispanic Broadcasting (HSP ) and Univision (UVN ), which are both ranked 4-STARS, or accumulate.

Q: What do you think about Mattel (MAT )?

A:

We have Mattel ranked hold. The company should earn $1.21 this year and $1.32 next year. We think that investor concerns of further market-share losses and marginal top-line growth in 2004 will limit near-term share-price movement. The Hasbro (HAS ) shares, however, carry a 4-STARS ranking. The company should benefit from strong sales growth and continued cost-cutting efforts.

Q: American International Group (AIG ) seems to be standing still. Thoughts?

A:

Well, at least we expect them to do a little more than stand still in the near term, since the shares are ranked 4-STARS. The company earned $2.10 per share last year and should earn $3.85 per share this year, rising to $4.40 per share in 2004. Recent profits reflected higher property/casualty insurance underwriting, and the company believes that commercial casualty lines' premium pricing will remain very strong. Also, Asian life operations are said to be recovering from the SARS-driven slowdown.

Q: Nortel Networks (NT ) stockholders have approved a 1-for-10 reverse split. Is this good or bad for NT?

A:

The NT shares are ranked 3-STARS. The company posted recent results that were a bit better than expected. We don't think Nortel will see a strong fundamental recovery until 2004 and therefore think it's best to just hold the shares at this point. Our analyst has made no mention of the recent reverse-split decision.

Q: Sam, why don't you wind up by giving us the S&P Top 10 -- you already meantioned Intel.

A:

The stocks are found in S&P's Top 10 Portfolio, which year-to-date through June 30 had risen 13.7%, vs. a gain of 11.8% for the S&P 500. It consists of, in no particular order: Flextronics, Martek Biosciences, Boston Scientific, Comcast, D.R. Horton, Fair Isaac, Corinthian Colleges, Intel, Compass Bancshares, and Jacobs Engineering Group.

Edited by Jack Dierdorff

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