A Bargain Hunter's Top 10

With an eye for cash flow and an opportunist's appetite for controversy, CAZ's Christopher Zook finds large-caps like AIG and Disney too good to miss

By Amey Stone

Christopher Zook, chairman of Houston-based money managers CAZ Investments, has devised a solution to a thorny problem many individual investors face: You want to own the best large-cap domestic stocks for the long term, but when is the right time to jump in?

The trick is to make your purchases when the stocks are trading at a discount to the overall market. To find such opportunities, each week Zook's team picks through a database of companies with at least $3 billion in market capitalization, solid balance sheets, long-term track records, and which are inexpensive relative to cash-flow growth. He favors cash flow over earnings, since it is harder to manipulate.


  Zook ends up with a list of between 100 and 120 stocks, about 30 to 40 of which he deems worth looking into. After additional fundamental research, he makes his buys.

There is something to Zook's technique. His picks have returned about 5% a year on average since 1999, vs. less than 1% a year for the Standard & Poor's 500. Lately, Zook's methodology has turned up a crop that includes both household names and headline-grabbers.

"I don't go by controversy, but often, where there's controversy there is opportunity," says Zook, who offered BusinessWeek Online a list of 10 stocks that, over the past two months, he has either increased his holdings or purchased for the first time. Here's the list and some of the thinking behind the picks:

American International Group (AIG ): Despite investigations into alleged earnings manipulation at the insurance giant and the ousting of long-time chairman Hank Greenberg, AIG is still an attractive company to own -- and a cheap stock, argues Zook. "It's got a phenomenal franchise with a one-time fixable problem," he says. "People will look back a few years from now and say, 'Why wasn't I buying when it was $50 a share?" The stock plunged from $73 to $50 from February through April, but has since rebounded to $55.

Wal-Mart (WMT ): Judging by its price-to-cash flow of 12, the world's largest retailer is selling at the lowest valuation since 1995, says Zook. The stock reached a high of $57 late in 2004, but fell to $47 on worries about the strength of consumer spending. In recent weeks it has bounced back to $49.

Zook sees plenty more growth ahead. While Wal-Mart is increasing cash flow at a 10%-to-12% rate, Zook thinks that growth will accelerate as it pursues more international opportunities.

Eastman Kodak (EK ): Photography's transition from film to digital has been tough on Kodak, but Zook thinks the outfit is finally getting it right. The stock is cheap -- trading at just seven times cash flow -- and it has a 1.78% dividend yield. While skeptics abound, "You have to look past the valley," says Zook, who made his initial purchase of the stock, now trading at around $28, in early June.

Cisco Systems (CSCO ): Zook rates this as another great company which, while not achieving soaring growth, is trading at its cheapest valuation since the bear market lows of 2002. That's because the stock price has not kept pace with steady cash-flow growth. Zook also sees strength in Cisco's newer storage and router lines. The stock has recently regained some lost ground to reach $20 a share, from $17, in early May.

Morgan Stanley (MWD ): Now that chief executive Philip Purcell has agreed to retire and more management changes are afoot, some of the uncertainty plaguing the brokerage and investment banking giant is gone. "There is opportunity for a fresh start," says Zook. He thinks the board is in for a further period of painful transition, but sees the strength of the underlying business eventually shinging through (see BW Online, 6/16/05, "Still Marching to Purcell's Drumbeat"). So far, at $52 a share, he says he has just "put his toe in the water."

Comcast (CMCSA ): Zook believes Comcast has the best management and balance sheet in the cable business. Now offering video, Internet, and telephone services into the home, he sees cash flow continuing to grow: "It's a solid company in a good long-term business we like." He bought at around $26, but still sees the stock as a good buy at $31.

Xerox (XRX ): Despite its long-term struggles, Zook thinks the copying and printing Goliath still has a great brand name going for it, and he also believes it has fixed many of its problems. Now it's growing the top line, and has a lot of operating leverage to boost earnings. As Xerox convinces investors that it is back on track, Zook thinks the stock, now $14, will rise.

Amgen (AMGN ): Investors are less excited about this biotech giant than they once were. Still, Zook values it as a cheaply priced leader in a market with high barriers to entry. "Nowhere else can you get 15% growth for this kind of valuation," he says. "We want to participate in that growth."

Microsoft (MSFT ): Wondering where future growth will come from for the software king? Zook isn't. He sees it coming from the Xbox gaming system as well as the rollout of its new operating system, known as Longhorn. Plus, mountains of cash give Microsoft tremendous financial flexibility to raise the dividend or buy back stock. "There are a lot of good things happening that the market is not appreciating," says Zook. He has owned Microsoft since early 2002, and has been buying more lately. "I really think it is cheap here, with a lot of catalysts," he says.

Disney (DIS ): It may still be a little early to buy this beleaguered entertainment giant, Zook concedes, but with the stock now going for around $26, he is giving it a try. First, he believes the Mouse House will benefit from CEO Michael Eisner stepping aside. And he also notes that the outfit's core businesses in movies, television, and theme parks are doing better. "I think it could pull back from here and I would like it even more," he says.

Zook's method may not be fail proof, but for investors wondering if the time is right to jump into leading stocks that have been bruised and battered in the past few years, his moves could serve as a handy guide.

Stone is a senior writer for Business Week Online in New York

Edited by Beth Belton

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