How to Find Nuggets

Stock screens can help.

Panning for quality companies is hard work, no doubt about it. That's where BusinessWeek's Investment Outlook Scoreboard comes in. Made up of America's 900 top companies, grouped into 10 broad sectors, the Scoreboard offers a river of information. To help you find the real nuggets, we pre-screen the list using several classic stock-picking methods. And find them we do. Our cheap stocks rose 14.2% in a tough 2002. Even allowing for disaster areas such as tech, our six lists lost an average of just 1.1%--besting the Dow Jones industrial average, the Standard & Poor's 500-stock index, and most equity mutual funds.

This year, dividends could be a major investing theme. With the White House leaning toward easing double taxation on payouts, dividend-paying stocks might have a sharp run-up. Our list of high-yield, large-cap stocks, whose yields exceed that of 10-year Treasuries, currently about 4%, is the place to start. Tobacco companies Philip Morris Inc. (MO ) and UST Inc. (UST ) top the list, followed closely by J.P. Morgan Chase & Co. (JPM ) and FleetBoston Financial Corp. (FBF ) UST, a maker of chewing tobacco, announced that profits would rise only 2.1% in 2003. Merrill Lynch & Co. says that rising cigarette prices most likely will drive smokers toward UST's smokeless brands.

UTILITY VALUE

Data on price-earnings ratios, dividend yields, and price-cash-flow ratios were provided by Standard & Poor's COMPUSTAT. Thomson Financial/First Call provided earnings estimates and projected long-term growth rates.

As you might guess, utilities dominate our screen of stocks having an S&P rating of A- or better that trade at a discount to book value. That's no big surprise: They have high book values because of their hefty investments in plants. And with the industry distressed in the wake of the Enron scandal, utility shares sell at a discount. More surprising is the presence of retailers Dillard's Inc. (DDS ) and Longs Drug Stores Corp. (LDG ) The good news at Longs is that overall sales and same-store sales are up. At Dillard's, things are less promising: November sales were down, but the comparison is complicated by the late start this year to the holiday shopping season.

The past three years have not been kind to tech or momentum investors, but avoiding these areas risks missing big gains, since they represent the most innovative sector of the economy. We came up with a tech momentum list by screening tech companies for their estimated growth in earnings per share and year-to-date share price change. Topping the list is personal-finance software maker Intuit Inc. (INTU ) Its revenues soared 32% year-over-year, to $223.3 million, in its fiscal first quarter, and the company reiterated that it expects pro forma per share earnings to be up 37% to 42% in fiscal 2003. The key to Intuit's success? New products and a focus on individuals and small business. Bryan C. Keane, who covers Intuit for Prudential Securities, says the company will outperform the market.

Our high-growth tech list is dominated by chipmakers, especially the likes of Linear Technology (LLTC ) and Texas Instruments (TXN ), which design and make the analog chips that go into cell phones, MP3 players, and personal digital assistants. Electronic Arts Inc. (ERTS ), the No. 1 game-software maker, made both of our tech lists. Its sales rose 88.8% in the second quarter of fiscal '03. Hit products, such as The Lord of the Rings: The Two Towers and James Bond 007: NightFire, are driving the results, says WR Hambrecht's William Lennan, who rates EA a buy.

Bargain hunters will want to comb through our list of cheap stocks. Last year, CompuCom Systems Inc. (CMPC ) was the big winner, with a 219% rise. But this year, the list is strictly for investors with nerves of steel. Four companies on it--Reliant Resources (RRI ), Allegheny Energy (AYE ), TXU (TXU ), and AES (AES )--are utilities. They're cheap because their shares plummeted nearly 76%, on average, in 2002.

DON'T GET BURNED

Clearly, caution is needed: The utilities sector is the weakest in the S&P, says Merrill Lynch's Richard Bernstein. Unregulated multiline utilities such as AES and Reliant Resources are the stocks that analysts are downgrading the most aggressively. If the utilities remain solvent, then their stocks might turn out to be bargains. But watchful folks can sidestep them. R.J. Reynolds Tobacco Holdings Inc. (RJR ) is cheap and also pays a handsome dividend, which analysts say will probably rise in 2003.

Value investors should look at our low price-to-sales, low price-to-cash-flow screen. We added cash-flow data to the mix this year to test companies' ability to meet obligations. Two auto-parts makers, Visteon Corp. (VC ) and Tenneco Automotive Inc. (TEN ), ended in the top 10. John A. Casesa, an auto analyst at Merrill, is recommending investors look at auto suppliers because they are more profitable and are cheaper than the auto makers. Visteon, part of Ford Motor Co. (F ) until being spun off in 2000, says it will gain about $500 million in non-Ford business in 2003.

So get out the pickaxes, and start digging. Amid the data lies gold.

By Robert J. Rosenberg

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