A Year for the Choosy Buyer

With no one sector likely to be the standout star of '05, S&P's Kenneth Shea urges the greatest care when picking individual stocks

"Solid positive momentum" -- that's the prospect for the economy and the market in 2005, according to Kenneth A. Shea, managing director of Standard & Poor's Equity Research Services. S&P expects an approximate 9% increase in the S&P 500-stock index this year, to 1,300, plus roughly a 2% dividend yield, he says.

Still, it will definitely be a stockpicker's year, Shea predicts, with no sector or stock type showing leadership. S&P currently gives an overweight ranking to only one sector, the industrials, with consumer staples rated underweight and all other sectors at market weight. With financial stocks representing some 20% of the S&P 500 by market capitalization, however, that means market results will be strongly influenced by that sector's performance, Shea adds. Plus, investors are cautious about financials because of rising interest rates.

These were a few of the points Shea made in an investing chat presented Jan. 18 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. AOL subscribers can find a full transcript at keyword: BW Talk.

(Kenneth Shea is a Standard & Poor's Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All views expressed accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com. Click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts.")

Q: Ken, we're into the third week of the New Year. How does the market look to you?


Although the market has gotten off to a sluggish start, S&P remains of the opinion that both the economy and the equity markets are poised for solid positive momentum throughout the year. S&P sees the S&P 500 rising to 1,300 at the end of the year, for an increase of about 9% from where we're at. Tack on roughly a 2% dividend yield, and that's not a bad return.

Q: What about Lucent Technologies (LU )?


S&P recommends investors hold the shares of Lucent. S&P sees signs of recovery in the overall telecommunications market, with pockets of opportunity in areas such as services, metro optical, voice over Internet protocol (VOIP), broadband access, and high-speed wireless data. However, we believe the company may continue to lag behind its competitors -- those carriers that are deploying GSM and UMTS wireless systems. Given some execution risks and an indebted balance sheet, S&P recommends hold.

Q: Please list some of the top stocks you like for 2005.


S&P maintains a Top 10 model portfolio, which is intended to capture what it believes are the 10 stocks poised for superior gains over the next 12 months. All of the stocks in the model portfolio are ranked 5-STARS [strong buy in the S&P Stock Appreciation Ranking System] by S&P equity analysts, and are reviewed by the staff's research director and myself as well. The current stocks are: Cooper (COO ); MBNA (KRB ); Burlington Northern Santa Fe (BNI ); Ingersoll-Rand (IR ); Amgen (AMGN ); Chattem (CHTT ); Guitar Centers of America (CGTR ); FMC (FMC ); Qualcomm (QCOM ); and Landstar System (LSTR ).

Q: I have General Motors (GM ) at 51.588 -- buy, sell, or hold all, or part?


S&P recommends selling the shares of General Motors, as last week we lowered our operating margin and net income estimates on the company for this year. Our cautious outlook reflects our expectations of higher raw materials costs, weakening profitability in Asia, losses in Europe, increased pension and health-care expense, and greater margin pressure from increased competition in the U.S. Our 12-month target price is $34. The stock's 5%-plus dividend yield is considered secure and attractive relative to other S&P 500 companies.

Q: How about Manitowoc (MTW )?


S&P recommends investors buy Manitowoc, as our forecast of economic growth through 2008 has become more positive on industrials, and we now see the company's business cycle lasting longer than we had previously expected. Its gains are being driven almost entirely from its crane division, which we believe should benefit from increased global-distribution efforts, healthy demand in foreign markets, contributions from acquisitions, and an expected improvement in U.S. commercial-construction activity.

Q: Your opinion of Vishay Intertechnology (VSH ), please.


S&P recommends investors hold the shares of Vishay . We expect the company's revenues to grow about 11% this year, as we expect good momentum to continue for the global electronics industry. However, recent bookings did not show the strength needed for us to have sufficient optimism or confidence that the shares will outperform near-term. Our 12-month target price is $13.

Q: Your opinion on AFLAC (AFL ), please.


S&P recommends investors hold the shares of this provider of supplemental health and life insurance in the U.S. and Japan. Our neutral stance on the shares reflects recent slowing sales growth and the likelihood that earnings growth may not get the same boost from currency translation this year as it did in 2004.

Q: Are you concerned about the weak dollar and large trade deficit? Are you making any defensive moves?


S&P is concerned about the widening trade deficit, and the drop in the U.S. dollar to a record low suggests that it's beginning to bother the market as well. The U.S. trade gap can be closed, though, only if other countries reduce their trade surpluses. The falling dollar will reduce incentives for foreign inflows and thus raise interest rates and bond yields.

As a result, we expect the dollar to drop near $1.50 per euro over the next two years. The short-term impact could be to increase the trade gap, since the weaker dollar will increase dollar costs of imports. But in the longer term, this is the market's price mechanism to balance the trade account. S&P's posture for investors is to recommend an exposure to foreign equities of approximately 15% of their investment allocation.

Q: What's happening with Prudential (PRU )?


S&P recommends investors hold the shares of Prudential. S&P expects solid growth for financial-services businesses, due to continuing strong organic growth, the company's international operations, and contributions from the recent acquisitions of American Skandia, Cigna, and Hyundai [Hyundai Investments & Securities Co. and Hyundai Investment Trust Management Co., units of Korea's Hyundai Group].

S&P remains somewhat skeptical, however, regarding the goal of 12% equity by the end of 2005, in light of its average historical ROE [return on equity] of mid-single digits historically. Although the shares trade at a discount to our forecast of fair value, we think the potential upside is offset by risks that include an investigation by the New York State Attorney General of relationships and practices among group life underwriters and insurance brokers.

Q: Comments about Bank of America (BAC )?


S&P recommends a strong buy on Bank of America. BAC posted fourth-quarter EPS [earnings per share] today that was one penny below our estimate, but in line with the Street's expectations. Results reflect strong momentum across all businesses, good credit quality, and cost savings from the ongoing integration of Fleet. The company expects 2005 operating EPS to exceed $4 despite the rising-interest-rate environment and flattening yield curve. S&P is maintaining its 12-month target price of $54.

Q: How do you rate Infosys Technologies (INFY ), the Indian info-tech company?


S&P recommends buying the ADRs of Infosys Technologies. The company reported third-quarter earnings per ADS that were ahead of our estimate. Revenue grew 53%, and strength was seen in the company's finance, telecom, and manufacturing segments. Infosys said it added new clients and repeat businesses, as well as (having) stable pricing. Our 12-month target price is $75.

Q: Any thoughts on Zimmer Holdings (ZMH )? Pricey?


S&P recommends investors hold the shares of Zimmer. While the company is well-positioned across the orthopedic joint-replacement markets, it faces some challenging comparisons this year with less favorable currency exchange rates likely. The shares appear to us as fully valued at current levels.

Q: What are your short-term and long-term on Agilent Technologies (A )?


S&P recommends investors hold the shares of Agilent. Recent revenues have reflected a cyclical recovery in the company's semiconductor test equipment, but they have since come under some pressure and leave investors uncertain as to future trends. Based on our analysis, we view the shares as fully valued at current levels.

Q: How about retailers? Any comment on Target (TGT ), Kohl's (KSS ), and TJX (TJX ) [parent of TJ Maxx and others]?


S&P's investment outlook on apparel retailers is neutral, with employment and consumer-sentiment trends improving, Please hold while I look something up. S&P recommends a hold on Target. Its recent same-store sales increase in December exceeded our projections. However, with growth partly driven by promotions, Target warned that its January-quarter earnings would likely fall short of its earlier guidance. Our 12-month target price on TGT remains $50.

S&P recommends investors, however, buy the shares of Kohl's, as we see new fashion brands with competitive advantage. Given the recent weakness in the shares, S&P now views them as attractive. S&P recommends investors hold the shares of TJX. The company should benefit from its status as the largest U.S. off-price family-apparel and home-fashion retailer. Although this segment remains favorable, the shares appear fully valued at current levels.

Q: Ken, how does S&P weight the various stock sectors going forward?


Currently, S&P recommends an overweight stance on industrials, an underweight stance in consumer staples, and a market-weight recommendation across the other economic sectors. In essence, S&P is of the opinion that 2005 will truly be a stockpicker's market, meaning that there don't appear to be any obvious sector or asset-class opportunities at hand. The lack of leadership is likely to continue without material catalysts emerging in the highly visible technology, energy, or financial sectors.

With financials now accounting for more than 20% of the S&P 500-stock index by market capitalization, much of the market outlook depends on how that sector performs this year. A flattening yield curve has led investors to be cautious on the sector, but a more sanguine forecast for interest rates and possibly a pickup in market activity could fuel good gains for the sector, which offers above-average dividend yields.

Edited by Jack Dierdorff

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