A Veteran Bull Ready to Charge Again

Joseph Battipaglia of Ryan Beck & Co. acknowledges that investors have reason to be anxious. All the same, he expects 2004 to finish on a strong note

Joe Battipaglia is a legendary bull -- and the stock market's recent lack of direction hasn't changed his views. That's Joseph V. Battipaglia, executive vice-president and chief investment officer of Ryan Beck & Co., of course, and he sees the Standard & Poor's 500 index at 1300 by yearend (it's hovering around 1100 currently).

Battipaglia acknowledges investor worries over terrorism, the election ("anyone's guess," he calls it), and corporate earnings that were good but didn't meet "inflated" expectations. However, if these factors dissipate and the economy grows strongly, he looks for good gains in the market.

As for sectors that look promising, Battipaglia suggests technology and capital goods as good plays on economic expansion, health care and financial services as beneficiaries of demographics, and energy. In picking individual stocks, one of his criteria, he notes, is a scarcity of analyst recommendations, which can lead to surprises on the upside. Among the better-known stocks, his choices include Johnson & Johnson (JNJ ), Hewlett-Packard (HPQ ), and Neiman-Marcus (NMG ).

These were some of the points Battipaglia made in an investing chat presented July 29 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 full transcript is available from BW Online on AOL at keyword: BW Talk.

Q: Joe, the stock market doesn't seem to be able to get anywhere. Are you still a bull?

A:

Yes. In fact, if we look at the fair-value range for the S&P 500 and the equity-risk premium that's built into stock prices, we find that we're essentially at a point like where we were right prior to the invasion of Iraq, where worry was at a high. That turned out to be a strong inflection point for a stronger market. I believe the same is true today.

Q: Why are investors so worried?

A:

Well, certainly they have reason to be concerned about the next terror attack, wherever that may occur, along with naggingly high oil prices, which have been affected by that concern. They also have an eye on the election, which is stacking up to be anyone's guess. And even quarterly earnings, which were quite good, didn't meet the excessive expectations that investors carried, giving rise to a difficult earnings season.

In fact, July has been a treacherous month, with the NASDAQ down twice as much as the Dow and S&P 500. Only with the passing of time, [in the absence of terrorist] attacks, and the public coming to grips with who John Kerry is relative to George Bush, will investors come to see that we still have a strong economy, rising profits, and a Fed that's willing to go slowly. This will yield an S&P 500 that's trading at 1300 by this time next year.

Q: What do you think a Kerry Presidency would do for the market?

A:

Perhaps on a short-term basis, the market would weaken. However, looking carefully at the emerging picture of what Kerry would like to do, we see that there's no fundamental change on Iraq. On the domestic-policy front, while Kerry might raise the marginal tax on income, he aims to keep the favorable policy on capital gains and dividends. We have to discount the long list of promises the candidate makes regarding health care, etc., as so much political banter, since it's in the hands of Congress to determine which policies are put into place.... As more is known of candidate Kerry, perhaps more of the risk that's built into the market now will abate.

Q: What are your top stock picks for right now?

A:

In no particular order, and we own all of these stocks: Alderwoods (AWGI ), Centennial Communications (CYCL ), Lo Jack (LOJN ), Neiman-Marcus (NMG ), Planar Systems (PLNR ), Ingram Micro (IM ), Hewlett-Packard (HPQ ), Johnson & Johnson (JNJ ), Capital Title Group (CTGI ), and Weingarten Realty (WRI ).

Q: Can you give us any highlights of why you like those stocks?

A:

The most common elements for each of these stocks are the strength of their underlying businesses, the capital and cash flows to support them, relatively few (in many cases) analyst recommendations, and generally lower expectations for performance from investors. Surprises can be to the upside, which will allow for meaningful revaluation for these companies.

Q: Any thoughts on investing in China and the Net? Opinion on Sina.com (SINA )?

A:

I would advise a broadly diversified portfolio of Chinese stocks, with a time horizon over the next 5 to 10 years.... I believe China will be incredibly volatile in both directions as they continue to experiment with capitalism and capital markets. SINA has been as low as 22 and as high as 49.5, and like many Chinese issues, it will be all over the map, based upon government dictates and the actual growth of the market in China.

Q: Any opinion on Applied Materials (AMAT )? It seems cheap. Do you like the chip sector in general?

A:

I think the chip sector has another round of good growth ahead of it, particularly the contract manufacturers. The capital-equipment side, of which AMAT is a leader, has been slow to recover, but I think their order rates in '05 and '06 will be meaningfully improved, and I'd agree that the stock looks cheap here. I believe it should trade toward the mid-20s, ultimately.

Q: Which sectors have a fighting chance?

A:

I would say technology and capital goods both are cyclical plays on economic expansion. I wouldn't despair on health care or financial services, as both have demographics, as well as the economic cycle, going for them. Obviously, energy has a renewed vigor, given the higher-than-average selling price for a barrel of oil.

Q: Where do you think Microsoft (MSFT ) goes from here? Long-term outlook?

A:

Unfortunately, Microsoft is a single-digit-growth entity, which trades at a premium multiple because of its prior success, its enormous cash position, and its financial strength. I don't find the stock compelling here and would rather go with an HP in the tech category vs. Microsoft or any other software company at this time.

Q: Why isn't General Electric (GE ) moving up?

A:

GE still carries an above-market price-earnings ratio, and as a result, consistent expected earnings do not enliven the stock price. In fact, you could argue that it has become a proxy for the market overall, moving up and down in tandem with the overall market.... GE is broadly diversified and quite large, and also widely followed. So the chance for real upside surprise is minimal.

Q: How do you feel about the high-tech sector right now?

A:

Well, technology-company earnings overall are good. They're playing off the capital-spending cycle and the tax incentives that exist, and it should carry into next year. The problem with the stock prices is that many of these have moved into negative valuations, anticipating recovery, and have sold off onto the expansion.

The best bet is to focus away from that on smaller technology plays, where there are some compelling earnings results, like Planar and Ingram. HP is interesting in that there are as many negative opinions as positive -- and therein lies your opportunity.

Q: Your thoughts on Ford (F )?

A:

I would take profits in the U.S. auto manufacturers at this point, since I don't believe unit sales are going to expand much from here. Not much in the way of profit improvements coming -- try to move into a different sector.

Q: What do you think of brokerage stocks like Schwab (SCH )?

A:

Full-service brokerage firms, particularly the likes of Merrill Lynch (MER ), should do well in the environment ahead, as new markets open and do better, trading volumes improve, etc. Schwab is a special situation in that it relies most directly on customer transactions, at the discount price level that is subject to significant competition from online brokers. The stock has always carried a premium multiple and at one point carried a market value greater than Merrill Lynch. That's no longer the case -- there's obviously turmoil in the management suite, and I cannot make a case for the stock at this time.

Q: What's your view for the health-care sector?

A:

Health care's a fairly broad sector. I'd say in the pharma arena, the large-cap companies are of limited appeal, except for J&J. The large biotech companies have appeal -- Amgen (AMGN ), Genentech (DNA ). A portfolio of small biotech companies makes sense as well.

The HMOs, under either party's leadership, will continue to see an expansion of demand for their services. Hospital-management companies will still suffer through a consolidation phase that has been hurtful to their earnings. Medical technology companies are also an area of interest -- companies such as Guidant (GDT ).

Q: Verizon (VZ ) -- what do you think are the long-term prospects?

A:

The stock has made a near-term fast recovery. Earnings have been better than expected, and the stock has an earnings yield of about 4%. With all the changes that have occurred, and with all those coming, Verizon is among the survivors of the original Bell company. I do think they'll continue to suffer from relatively slow growth rates in their base land-line business, but their wireless is doing quite well. I would be inclined to take profits on a short-term basis, as the stock could decline into the low 30s.

Q: Is Yahoo! (YHOO ) for real as a long-term investment to consider?

A:

Yes. Clearly their business model is working. Keep in mind again the valuation question. It still trades at a huge premium to its underlying earnings, so you would have to have a much longer-term view on this company for an investment at this level to make sense.

Q: What do you think of the Google IPO? Google over $100 a share? Get real.

A:

Clearly, the market will set the price for this late-stage Internet play. I see they've run up against a barrage of questions and demands for data that they've yet to fulfill, so this would be worth watching. Outside of the insiders enjoying a tremendous lift in valuation, I would be suspicious of the early trading for this one.

Q: Another tech giant here -- would you buy IBM (IBM )?

A:

I think IBM has the potential to run to a new high in the next 12 months, which would give it roughly a 15% to 20% gain from here. Which for a large-cap tech company in this environment isn't too bad. Their strategy seems to be paying off, and in an economy that's continuing to expand, they should get their share of revenue and earnings.

Q: Any hopes here? Your thoughts on airline stocks?

A:

The best I can offer on airline stocks is to speak of them in terms of trading vehicles. The long-term prognosis for full-service airline companies is not good. We're at an inflection point where the discounters will now fight among themselves for market share, but these stocks will respond to good news vis-à-vis fuel costs if they ever come down, avoiding bankruptcy.

So you could trade these stocks, but right now I would be neutral on them. I don't see a long-term value build -- this industry has perhaps lost as much money for investors as even biotechnology.

Q: Cisco Systems (CSCO ) -- buy, hold, or sell?

A:

I believe Cisco has come down to attractive levels. The opportunity for them is in Internet telephony, and they should be able to get a leading position in the equipment side of that equation. Once the earnings visibility becomes more apparent from this particular avenue of business, it should reflect favorably on the stock price.

Q: What stance would you recommend right now for long-term investors?

A:

Long-term growth investors should be 75% in equities, 15% in real estate investment trusts, 5% in corporate bonds (short-term), and 5% in cash.

Q: What do you project for small and mid caps?

A:

Over the next 12 months, a single-digit performance at best for the S&P 400 and 600 -- we find both of these indexes above their fair value at this time and find better opportunity for large-cap companies in the S&P 500. That doesn't mean there aren't good opportunities among small and mid caps -- there are just not as many of them as there were a year ago at this time.

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