The Barker Portfolio: Top Prospects

Focusing on enterprise value, I assembled three portfolios of promising stocks for investors with different risk appetites
The BusinessWeek 50

Quality rarely comes cheap. If that doesn't startle you, hold on: No fewer than 7 in 10 of the BusinessWeek 50 stocks are trading within 10% of their 52-week highs. None is selling below 60%. From global energy titan Exxon Mobil (XOM ) to Rust Belt hero Cummins (CMI ), the BusinessWeek 50 may make up today's elite among U.S. public companies. Yet as every stockpicker knows, great companies don't always make great stocks. Nor is every potentially great stock the right one for every portfolio.

With these cautionary guides in mind, I set out this year to select a handful of BusinessWeek 50 stocks that should prove suitable for you. Do you put a high premium on safety in your portfolio? Or maybe you can handle a bit of extra risk, so long as your downside isn't too steep? Perhaps you are aiming for the highest returns -- and are willing to court the higher probability of rapid southbound volatility? For each level of risk, I've developed mini-portfolios for your consideration.

For help in combing through the list in search of these stocks, I turned this year to Capital IQ, a division of Standard & Poor's (like BusinessWeek, a unit of The McGraw-Hill Companies (MHP )). Capital IQ's online screening tools, which are used by financial professionals at more than 800 client firms, allowed me to evaluate the BusinessWeek 50 on scores of categories taking into account both company fundamentals and stock market trading data. For example, instead of simply measuring the list's current valuation ratios based on stock market values -- that is, share price times shares outstanding -- Capital IQ reckoned each company's total enterprise value, or stock market value plus total debt, net of cash and liquid investments.

Why bother? Checking enterprise values permits fairer comparisons among companies with vastly different capital structures. This puts companies with no debt and lots of cash -- Apple Computer (AAPL ), for one -- on the same footing as those, such as Nextel Communications (NXTL ), that rely on a load of borrowed money. Apple looks much more expensive than Nextel when gauged by simple market value-revenue ratios (3.5 times, vs. Nextel's 2.4 times). When seen through the wider-angle lens of enterprise values, however, Apple is actually cheaper (2.8 times revenue, vs. 2.9).

Next, once again using Capital IQ's data and computerized screening tools, I developed criteria for stocks worthy of investors with varying appetites for risk:

-- For lower-risk portfolios. If the broad stock market retreats, which of the 50 are more likely to resist the tide? Perhaps those whose past ups and downs have had less to do with the market's general direction -- or, in finance lingo, "low-beta" stocks. A beta of 1.0 indicates that a stock's movements match those of the Standard & Poor's 500-stock index; a stock with a beta of 0.5 has been half as volatile as the index; a beta of 2.0 twice as volatile. Stocks in our current ranking average a beta of 1.03. For lower-risk investors, I decided to look for stocks with betas of no more than 0.7. In addition, I wanted stocks with dividend yields of at least 2%, a tad more than the S&P 500's average yield and much more than the BusinessWeek 50's 0.8% yield. When companies run into trouble -- a quarterly earnings disappointment, for example -- a sturdy dividend lends a pillar of support.

These twin criteria proved sharp, eliminating all but three companies. Bank of America (BAC ) is tops in dividend yield, with a 4% payout. S&P sees earnings growing this year more than 9%. Along with its Oil Patch cousins, ChevronTexaco (CVX ) has been on a stock market tear. Yet it still trades at 10 times S&P's estimate of $6.10 in 2005 earnings per share. Property-and-casualty insurer Chubb (CB ) expects operating earnings to build on big 2004 gains, growing perhaps 7% or so to $7.80 a share.

-- For moderate-risk portfolios. Here, I pursued a similar strategy but loosened the constraints a bit. Which companies have betas of more than 0.7, but less than 1.3? Which of those also offer dividend yields of at least 1%? Finally, to favor cheaper stocks, I accepted only those stocks trading at an enterprise value-revenue ratio of less than 3.6, the average multiple among the BusinessWeek 50.

With these criteria, five companies popped up, including Caterpillar (CAT ). The big equipment maker, and exporter, is on a roll, with S&P estimating growth in earnings per share of 20% or more this year and next. Energy giant ConocoPhillips (COP ) is trading at 11 times the $10.34 a share that S&P expects it to earn this year. At Dow Chemical (DOW ), cost-cutting is adding leverage to earnings growth; the stock is yielding 2.6%, to boot. Nike's (NKE ) new chief executive, William D. Perez, told Wall Street analysts in his maiden quarterly earnings conference call how he has been struck by the rich potential in the company's pipeline of new products. In fiscal 2006, beginning in June, Nike sees mid-teens growth in earnings per share. Truckmaker PACCAR enters its centennial year amid a cyclical upturn in its markets. S&P expects its earnings per share to jump 26%.

-- For higher-risk portfolios. With these selections, I wanted to tilt the odds toward action. So again I checked beta and set the computer screen to include only companies with betas of at least 1.3, or volatility 30% or more above the S&P 500's. At the same time, I aimed to increase the chances that future volatility would be upward, so I settled only on those stocks trading at least 15% off their 52-week highs.

These criteria produced a list of six familiar names, beginning with veteran design software maker Autodesk (ADSK ). It sees revenue growing about 12% this year. Cisco Systems (CSCO ), once earth's most valuable company, now finds itself at No. 24 when ranked by market capitalization. It sees its fiscal 2005 sales growing 12% to 13% or so. Trading near $36 a share, eBay (EBAY ) has suffered a wicked fall since ending 2004 above $59. Yet it keeps producing a torrent of cash and sees earnings per share rising better than 20%. Mighty Microsoft (MSFT ) also made the cut, with a share price that can't seem to get out of a rut. It even yields 1.3% -- unusual downside protection for a tech stock. Soon to battle with Microsoft in security software, Symantec (SYMC ) has seen its stock beaten down by its planned merger with Veritas Software (VRTS ). The riskiest of the bunch? Yahoo! (YHOO ), with a beta above 3. The company keeps reaching to take in more content created everywhere from Hollywood to the blogosphere.

One sure bet is that all of these stocks will not beat the market in the year ahead. If interest rates move sharply higher, BofA will be hurt, while much lower oil prices would punish ChevronTexaco and ConocoPhillips. Government investigations into insurers' complicity in helping companies manage their earnings could damage Chubb, which has been subpoenaed and is cooperating with the probes. Just the same, focusing on quality companies when building an investment portfolio is a step you're unlikely to regret.

By Robert Barker

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