Top Prospects

A guide to the best investment prospects. This year's hot tickets: Homebuilding, consumer finance, and electronic retailing
The BusinessWeek 50

Picked one by one and arranged together, the BusinessWeek 50 make a gorgeous bouquet. But flowers wilt -- some sooner than others. Which among the BW50 have staying power? That's the question for investors. There seemingly are as many ways to pick stocks as there are floral varieties. But consistency counts, and that's why I'm sticking with the method we used a year ago.

Another is that our short list of nine stocks chosen from last year's BW50 has performed pretty well. In the 12 months ended Mar. 12, the nine averaged a 39.7% total return, nearly six percentage points better than the average BW50 stock's return. The Standard & Poor's 500-stock index returned 36.8%. Most heartening to a risk-averse investor like me, only one, Mattel (MAT ), fell in price.

So, once again, I narrowed my search to the industry groups performing best in the stock market. That's where Sam Stovall, Standard & Poor's chief investment strategist, comes in. The author of Sector Investing, 1996 (out of print, but available used via for $225), Stovall ranks each of 112 industries by the strength of their stocks relative to the broad market over the past 12 months. The reason, in a word, is momentum. Industries that have been doing well in the market tend to keep outpacing the averages, Stovall notes. So he uses his rankings as a starting point, not a substitute, for fundamental research into prospects for sales, profits, cash flows, and such. Over the 1991-2003 period, only industry groups that ranked in his top 30% in any given year went on to outperform the all-industries average.


Which of the BW50 are in sectors that lately have risen into the top 30% of Stovall's ranks? Health care, high in relative strength last year, has fallen out. Enter the homebuilders, among them Centex (CTX ), KB Home (KBH ), and Pulte Homes (PHM ) from the BW50. Then it's a sprinkling of 11 other industries, including casinos and gaming; consumer finance; computer and electronics retailers; restaurants; food distributors; hotels, resorts, and cruise lines; semiconductors; communications equipment; auto parts; online retailers; and Internet software and service providers. Within these industries -- which are subsets of those in the tables starting on page 153 -- you will find 14 of the BW50.

Next, I wanted to know which of these 14 stocks might offer particularly good value. So I checked to see which were selling at lower price-earnings ratios and which go for relatively low "PEG" ratios (that is, the relationship of a stock's p-e ratio to its estimated earnings growth rate). As a shortcut, I used the portfolio tool at Yahoo! (YHOO ) Finance and clicked on the "Fundamentals" view, which presents several valuation measures, including the PEG ratio. Finally, I checked the companies' debt-to-capital ratios as reported by S&P at BusinessWeek Online. Those with less debt and more financial strength may give up some opportunities in good times but hold up well when things get tough.

In the end, I settled on seven finalists for your consideration (table). I picked only one of the homebuilders, Pulte (PHM ). It has the lowest debt-to-capital ratio among the BW50's trio of homebuilders -- 36%, vs. KB Home's 45% and Centex' 70% -- and its range of regions and types of housing is wider than KB Home's. Pulte has set itself ambitious targets: annual revenue growth of 20% over the next three years and a sharp rise in earnings per share, to $10 or $11 by 2006, from $4.91 last year.

The Best of the Bunch

Electronics retailer Best Buy (BBY ), buoyed by the unsinkable American consumer, keeps posting surprisingly strong earnings. With some 750 outlets in North America, its comparable-store sales have been rising at nearly 10%. Big drivers include digital and plasma-screen televisions, digital cameras, and home-office equipment. In this fiscal year, Best Buy plans 73 new outlets, including a flagship superstore in West Hollywood, Calif.

Cruise operator Carnival's (CCL ) Cunard line has just launched its own new flagship, the Queen Mary 2. It's just one of scores in Carnival's fleet, which includes a dozen brands. If terrorism puts a chill on tourism, bookings and pricing will suffer. But Carnival's balance sheet is in much better shape than rival Royal Caribbean Cruises' (RCL ) and so figures to weather the storms.

When it comes to balance sheets, few can best Intel (INTC ). At yearend, Intel held $13.5 billion in cash, against $1.2 billion in total debt. With that muscle, Planet Earth's biggest chipmaker is pushing into such new markets as high-end TVs and WiMax, or wireless Internet access across wide areas. This year, profits will get a boost from gross margins that Intel sees widening.

A steadier stock is Johnson Controls (JCI ), the veteran maker of auto parts and building controls. While Intel's stock is about twice as volatile as the broad market, Johnson Controls' shares are only about 80% as jumpy. The company sees a double-digit gain in 2004 profit and a reduction in its debt-to-capital ratio, to under 30% from about 36%. Johnson Controls yields 1.6% via a dividend it has paid consistently since 1887.

Credit-card issuer MBNA (KRB ) also has an alluring dividend record, having raised it each year since going public. The stock lately yields 1.8%. This year, MBNA is going down a new avenue of growth as it begins issuing credit cards with the world-renowned American Express logo.

Far less familiar is food distributor Sysco (SYY ), which is often confused with computer networker Cisco Systems (CSCO ). Sysco has spent years consolidating the huge business of supplying restaurants and such other food-service outlets as hospitals with everything from ready-to-heat bacon cheeseburgers to hand soap. It now delivers to 420,000 locations and enjoys formidable economies of scale.

Will each of these picks pay off in the year ahead? Doubtful. Last year's group ranged from the one loser, Mattel, off 12.6%, to the short list's best performer, slot machine maker International Game Technology (IGT ), up 109%. Had I been forced a year ago to bet which would do better, I would have got it backwards. So don't forget: It's a diversity of flowers, and stocks, that makes for a beautiful arrangement.

By Robert Barker

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