Best and Worst Stocks of 2006

Allegheny Technologies led the S&P 500, while Whole Foods Market came in last. But fortunes are bound to change in 2007

Most investors will smile when closing the spreadsheets on 2006. But there's even more reason to celebrate. Heading into 2007, analysts remain generally upbeat, though after the gains seen this year, they're reluctant to forecast a repeat performance (see BusinessWeek, 12/25/06, "Markets: Where Optimism Reigns").

How much better can it get? After all, the Dow Jones industrial average topped 12,500 for the first time, and the Standard & Poor's 500-stock index hit multiyear highs as well, finishing 2006 with a 13.6% gain for the year.

Market pros think that not all of the 2006 stars will continue to shine. The top-performing telecom-services sector is in for a chill, some say, while weaker areas like health care could show signs of life.

The 2006 winner among S&P 500 stocks was Allegheny Technologies (ATI). The Pittsburgh specialty metals outfit jumped about 150% to close the year at $90.68, at the head of an index-beating performance in the materials sector.

From Darling to Dog

Analysts see Allegheny losing momentum after the company's impressive turnaround. Following a loss in 2003 and seeing its share price dip to as low as $2.10 that year, Allegheny has thrived, thanks to strong demand from material-intensive industries like aerospace. Standard & Poor's Equity Research believes the company could continue to perform well amid steel industry consolidation, but doesn't see that translating into more big gains for the share price.

Other top performers included construction-equipment outfit Terex (TEX), office-supply retailer OfficeMax (OMX), and biotech Celgene (CELG).

Coming in last place in the S&P 500 was high-end supermarket chain Whole Foods Market (WFMI). After spending several years as a market darling as organic foods became more popular, the stock hit the (chemical-free) dirt amid slowing growth and pessimistic guidance. It ended the year at $46.93, down almost 40%.

Even Google Is Left Behind

Morningstar (MORN) analyst Mitchell Corwin views the decline in Whole Foods as a buying opportunity. "I think there's some near-term bumps in the road," he admits, but he believes most of the bad news is already priced into the stock. He expects the grocer to nearly double its stores, to 300, by 2010 while continuing to stave off lower-priced competitors jumping on the organic bandwagon. "Whole Foods tends to appeal to a different customer than a Wal-Mart (WMT)," he says.

Other weak performers included a raft of marquee information-technology companies like search giant Yahoo! (YHOO), eBay (EBAY), and SanDisk (SNDK). Even pricey Google (GOOG) stock, which rose above $500 in November, couldn't keep pace with the benchmark indexes.

Sectorwise, the weakest performer was health care, which nonetheless eked out a 6.1% gain through Dec. 28, with information technology performing slightly better, at 7.9%.

The strongest was telecommunications services, which ended the year up 31.7%, followed by a 23.4% climb for energy.

Opportunity in Adversity

"We had such a good and unexpected year for stocks, it's sort of a 'pinch me I can't believe it'" sensation, according to Brian Gendreau, investment strategist at ING Investment Management. One thing that stood out to him is how industries that could hook into growth in India and China have bloomed. All told, he's pretty bullish for the coming year as factors like slow-but-steady gross domestic product growth and in-check inflation are "adding up to not a bad environment for stocks."

For the most part, investors may find more opportunities in the stocks that were shunned, rather than chase the prior year's winners. "The trend that I've observed is that a sector that has underperformed will tend to outperform," says Paul Larson, equity strategist at Morningstar. He sees Cisco (CSCO) powering up tech stocks. As he sees it, the Internet's increasing reliance on video and the growing popularity of Internet telephony accelerates the need for the company's routers and equipment.

Larson sees health care improving mainly because it's unlikely to get worse. News in recent months has dogged pharmaceutical stocks, as Pfizer (PFE) abandoned a promising late-stage cholesterol drug (see, 12/4/06, "Pfizer's Bitter Pill"). The sector also fell after the Democrats won the November midterm election, an outcome that investors fear could lead to legislation that may dampen profits.

So which group is due for a correction? After a strong year for energy stocks, Larson is neutral on the industry and bearish on oil prices. Gendreau is bearish on telecom despite his generally positive outlook.

Eric Pouty, director of U.S. research for the investment bank Canaccord Adams, is slightly more cautious. After a year of broad equity gains, he sees the spectrum of profitable stocks narrowing. "Sometimes the tide lifts all boats," he says. "But once the tide lifts to a certain valuation, investors get selective."

Click here for a slide show of the 10 best-performing and 10 weakest-performing S&P 500 stocks for 2006.

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