Five Investing Keys for 2003

You won't be able to just throw a dart, says BusinessWeek's Marcia Vickers, who has specific things smart stock-pickers should look for

With stocks still in a bear-market rally, recovery will not come overnight. In the meantime, investors need to do their homework to practice "quality investing" -- the theme of BusinessWeek's yearend double issue on "Where to Invest in 2003."

"You can't just throw a dart," says Marcia Vickers, associate editor of BusinessWeek, who reported five criteria for investors now: Look for low price-earnings and price-book ratios, "squeaky-clean" balance sheets, prices below the 52-week highs, strong growth momentum and growth potential, and a history of paying dividends. She quotes Warren Buffett, "Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price."

Vickers predicts that the Standard & Poor's 500-stock index will end 2003 with a percentage increase in the mid to high single digits. Among sectors that look promising she cites industrial cyclicals and financials. And in the bond market, she warns of risks from possibly higher interest rates and suggests looking at municipals.

These were some of the points Vickers made in an investing chat presented Dec. 19 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Marcia, before we look into 2003, let's look back at the way 2002 is ending for the market -- not too happily the last three days. Has the rally run out of energy?


I think this is typical of a bear market rally, where it looks as if it's going to continue forever, and then it loses steam, simply because there are too many fundamentals that are still awry, such as the potential war with Iraq. Investor confidence is still pretty low, and the scandals have yet to completely abate on Wall Street and in Corporate America.

So I think many people were willing to believe that we were going right back into a bull market, whereas any time you've been in a bear market, it can take some time to recover. It never happens overnight. In fact, I think over the next year, we'll still be in a bear market recovery phase. So you'll probably see several more rallies like we've seen, starting in October, that end up not going very far.

Q: What do the pros on Wall Street see ahead for 2003, in terms of what kind of returns to expect from stocks?


We polled lots of different strategists as well as economists, and most of them have a fairly bullish outlook for 2003. The consensus seems to be that the market (the S&P 500 in this case) will be up in the mid-to-high [percentage] single digits, which may not seem like a lot to people who are used to bubble returns like 20% to 25%, but it's a heck of a lot more than being down 30%.

Q: The phrase BusinessWeek uses on the cover of the yearend issue is "Quality Investing." Can you expand on that and what it means for investor strategy?


Sure. It means that you can't just throw a dart and find good stocks. You've really got to do your homework. There are five different things that we're saying that are really important in this market.

The first thing is that you want companies that are selling at reasonable valuations -- that means they've got a relatively low p-e ratio and price-to-book ratio.

Secondly, you want companies that have squeaky-clean balance sheets. Actually, a recent study that we quote in this issue shows that companies that do things like expense their stock options consistently outperform their peers. And that's especially true in this environment, where investor confidence is so low. Third, you want to look for companies that are selling way below their 52-week highs. Fourth, look for companies with strong growth momentum and long-term growth prospects.

And last, in this market, it's wise to look at stocks that pay dividends, because these companies often have more stable earnings. And if Bush's proposal to cut taxes on dividends goes through, that could really help these stocks.

We quoted Warren Buffett in the article on quality stocks. He said, "Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price." And that's good advice.

Q: Speaking of Buffett, should investors lean more toward value or growth -- or both -- in the coming months?


Really, they should keep an eye on both styles. Value, of course, has been in vogue over the last few years as growth stocks have been slammed, but that doesn't mean that growth stocks are down for the count. There are still some good tech companies, for instance, that have been beaten down but still have good growth prospects, such as Cisco (CSCO ) and Network Associates (NET ). On the other hand, the value camp still has some great plays as well. Some experts that we polled liked some value stocks such as DuPont (DD ).

Q: Where to invest today? CDs, bonds? What's the outlook for interest rates?


Over the next year, it's almost certain that interest rates will rise. That doesn't mean we won't have another cut in the meantime, but the general direction of rates is almost certain to be upward, according to experts. Bonds, especially Treasuries, are an especially risky play right now, because if rates rise -- as they're almost certain to do -- bond prices will surely fall. In our investor roundtable, one of our experts made an excellent point: Joan Loppin, a market strategist, says, "The bond games are over. If bonds go to 5% yield, people will lose 25% of their capital."

So the best way to play the bond game is to consider muni bonds over Treasuries, typically because they're high-grade, and they pay comparable or higher rates than Treasuries. They also have a tax advantage. If you want to go with Treasury bonds, the best bet would be to stick with Treasuries with extremely short-term maturities, six months or less.

Q: What do you think about gold? Some people think it's going to double or go even higher.


You always get this mentality in any kind of bubble, and over the past year gold has risen almost 60%. That's an incredible return. From what I gather from the people that I've spoken with, it may be a bit late to get into the gold game. But if you insist on it, be careful, and don't try to time the gold market. Only put a relatively small portion of your portfolio in it, maybe 5%. And even diversify that between physical gold and gold stocks. I think that it's definitely a frothy market right now.

Q: Is this a good time for a growth mutual fund? I'm sitting on approximately $250,000 cash and am looking for a good solid growth fund.


I think, especially in this market, you need to diversify. It's not really wise to put your money all in one strategy, stock, or sector. I would certainly divide my money up between growth and value, as well as various sectors -- and perhaps even fixed-income investments, tangible investments like real estate, as well as stocks.

So it could be a good time for a good growth fund, but like anything, it's important to pick the right growth fund, and to remember to diversify your entire portfolio. Many people have waited for a couple of years for these so-called growth stocks -- tech darlings like Lucent (LU ) and Nortel (NT ) -- to rebound. But we haven't really seen much recovery in stocks like that. So if you go with a growth fund, make sure you're with a great manager who has done his or her homework, weeded the portfolio of these losers, and is focusing on stocks with much better long-term growth prospects.

Q: What do you think about pharmaceutical companies?


Pharmaceuticals could have a much better year next year. That's because of several things. First of all, their year-over-year earnings comparisons will start to look better, and a lot of the companies that have been experiencing patent expirations will no longer have that problem, since those expirations are starting to slow. A lot of these stocks have been really beaten down over the last couple of years. The pipelines have also been improving over the last few years, especially at Novartis (NVS ), Pfizer (PFE ), and Eli Lilly (LLY ).

Q: Beyond the pharmas, do any sectors look better than others?


Yeah, sure. For instance, if the economy continues to rebound, you might want to play some of the industrial cyclicals. Some names there that experts like are Alcoa (AA ), DuPont (DD ), and Caterpillar (CAT ).

Also, media companies may do a bit better in 2003. U.S. ad sales are expected to rise 5%. That may not seem like a whopping amount, but it's more than double last year. And there are some beaten-down bargains out there in terms of media companies that could start to stage a revival. Some experts like AOL Time Warner (AOL ), Liberty Media (L ), and Fox (FOX ).

Another area that's kind of interesting is financials. A lot of these companies have been beaten down -- largely because the market has been doing so poorly but also because of those news headlines about Wall Street scandals, etc. Yet some of these companies are quality companies that probably haven't deserved the beating, such as Wachovia (WB ), J.P. Morgan Chase (JPM ), and, surprisingly, even Citigroup (C ), which is down around 30% from its 52-week high. Citigroup is a global company, and it has consistently made money, yet it has been pummeled due to all the scandals that have tainted Wall Street, and other headlines. But it's still a great company.

Q: Can you assess what the downside risk in this market is?


There are a few things that are weighing on the market still. First, the economy is still in relatively slow-growth mode. Corporate profits have not really taken off, and it could be another year or so before that happens. Secondly, you've got a potential war with Iraq and fears of more terrorist attacks hanging over the market. Third, though it seems like the accounting scandals for the most part have abated, nobody can be 100% sure about that.

So, although we're saying that next year's [percentage growth in stocks] should be up in the mid-to-high single digits, there are always uncertainties out there. But from talking to the experts, it seems like, unless something unexpected happens -- like a major terrorist attack in the U.S. (or abroad), or business-related scandals of some sort -- it's unlikely that we'll have another year like 2002, where the market was down significantly.

Q: What about energy stocks? The price of oil is shooting higher again on the trouble in Venezuela.


Yeah, that's true. And the good news about energy stocks is that their prices have sunk, on average, about 11% in the last year. And with what's happening in Venezuela as well as the Middle East, most people don't think oil prices will drop much in 2003. That could make next year a pretty good year for some of these beaten-down oil companies, like Royal Dutch (RD ) and Unocal (UCL ).

Q: Is there any percentage in real bottom-fishing with disaster stocks such as WorldCom (WCOM ) or United Airlines (UAL )?


I think that's a real dangerous game, and I think it's a game some of the hedge funds are playing. Because you see how volatile these stocks have become, such as Nortel or Lucent. But you may get lucky, and since these stocks are so cheap, you can get a 25% gain in a day, yet the next day you could lose 50%. And nobody knows whether or not a lot of these companies are going to go out of business. Of course, if we were all brilliant stock-pickers, we could pick the ones that were going to be bought at some sort of premium, but then, if we were all that smart, we wouldn't be here -- we'd be having a drink with Warren Buffett right now.

Q: What did BusinessWeek find out about real estate investments -- and REITs -- for 2003?


Well, first of all, the real estate market has had a huge runup, starting really almost when the bear market started back in 2000. It almost parallels the bear market, so it's unlikely that real estate, especially residential real estate, is going to go much higher. And that's also because interest rates are likely to rise in the next year. So the cheap-mortgage frenzy will fade, and, in certain areas of the country, I think housing prices will start to fall, or at the very least soften.

REITs have had a pretty good run over the last couple of years, but I also think commercial real estate could be slowing. At the same time, some REITs still pay good dividends. A couple that some of the experts we talk to like are Boston Properties (BXP ) and Mills (MLS ), which is the largest operator of regional megamalls. That said, you need to be careful with any kind of real estate investing at this point, if you're looking to buy low and sell high.

Q: How about aerospace and defense stocks, especially in light of Iraq?


Several strategists have been recommending them, so they certainly could be good bets in light of the current geopolitical environment. A couple of names off the top of my head might be Boeing (BA ) and Lockheed Martin (LMT ).

Q: Do you see the techs coming back in the latter half of 2003?


I think you have to be really careful when you're playing techs, because corporations still haven't started spending money on tech upgrades.... With the economy still somewhat soft, you're probably going to want to stick with large, well-known tech companies that can continue to gain market share in this economic environment, and...continue to have strong growth prospects. Some of these names are the obvious ones, like Microsoft (MSFT ), Cisco, and SAP (SAP ).

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