Four Great Companies on Sale
Abandoning stocks is not the best response to the turmoil gripping the markets. Stocks will roar back at some point. We suggest you find ports in the storm that will keep your money relatively safe while giving your portfolio a fighting chance to grow, even through this downturn.
What kinds of stocks are we talking about? Cheap ones, for starters. As recession fears rise and credit woes deepen, price-earnings ratios are shrinking. But even stocks with low P/Es are vulnerable if a recession cuts into profits, so you want a solid business with steady earnings prospects.
In this environment, big is certainly better. A fortified balance sheet is also a must -- this is no time for a company to need to borrow money or issue new shares. And even though their share prices may look tempting, we would avoid firms with ties to the financial and housing sectors for now. Below are four attractively priced stocks we think meet all these criteria.
eBay (symbol EBAY)
EBay has been pummeled lately because growth has been slowing in its core online-auction business. Granted, the company will never be the growth stock it once was, but at its October 7 close of $16.50, eBay trades for a measly nine times expected 2009 earnings of $1.92 per share. "At 20 or 25 times earnings, you could argue whether it's an attractive stock," says Larry Coats, manager of Oak Value fund, which owns the shares. "But at these levels, there shouldn't be a whole lot of debate."
Auctions account for only about one-third of revenues, and eBay has plenty of other businesses that are growing at breakneck pace. PayPal, the online-payments system, saw its second-quarter revenues rise 33% from the same period in 2007, and revenues from Internet phone service Skype were up 51%. Together, these two businesses also account for one-third of eBay's revenues.
Other bright spots include ticket seller StubHub, shopping sites such as Shopping.com, and several classified-advertising sites. Moreover, eBay announced on October 6 that it will buy Bill Me Later, a service similar to Pay Pal that large retailers favor, for $945 million. Although some of these businesses don't have the profit margins of the auction business (as is the case for fixed-priced sales, which are a growing share of eBay's business on its shopping sites), analysts still expect overall earnings growth of 14% in 2008 and 10% next year-not bad considering anemic consumer-spending forecasts.
EBay's financial strength should allow shareholders to sleep well at night. It has no debt and $3.7 billion in the bank, and it generates $2 billion annually in free cash flow (earnings plus depreciation and other noncash expenses, minus expenditures to maintain and expand the business). A lot of that cash ($4.7 billion in the past two years) has been returned to shareholders in the form of stock buybacks. The rest can be used to bolster eBay's growing businesses and buy new ones.
Like eBay, AT&T has fallen from favor because of slowing growth in a core business -- in this case, old-fashioned, wire-line phone service. (The company lost nearly one million such customers in the second quarter alone.) But residential wire-line service accounts for just 18% of the company's revenues.
AT&T has more wireless customers (73 million) than any other U.S. carrier. That business, which generates one-third of revenues, is growing nicely. Second-quarter revenues were 16% higher than a year ago, thanks in part to burgeoning demand for wireless data -- much of it from users of Apple's iPhone. AT&T, based in Dallas, is also a leading provider of phone and data services to corporations (a slow-growing business) and broadband high-speed Internet service to consumers (a fast-growing one).
Overall, analysts see AT&T's earnings growing 8% this year and 10% in 2009. At $25.74, the stock sells for eight times estimated 2009 profits of $3.25 per share. Robert Wyckoff Jr., one of the managers of Tweedy Browne Worldwide High Dividend Yield Value fund, estimates that AT&T's various businesses, if sold off separately, would be worth between $37 and $42 a share. In addition, the stock pays a $1.60 annual dividend, resulting in a fat, 6.2% yield.
How safe is the dividend? Very. Although AT&T has $80 billion in debt, it is profitable enough to meet its debt payments easily. Beyond that, the company was able to produce about $16 billion in free cash flow in 2008. AT&T expects its free cash flow to be more than enough to fund the dividend, which is estimated to cost $9.6 billion a year at the current rate. The company is also in the midst of repurchasing about 6.6% of its outstanding shares over a two-year period that ends in 2009.
3M is an old-fashioned conglomerate, with 35 businesses organized into six divisions. The company sells more than 51,000 products, ranging from Scotch tape and Post-it notes (its best-known brand names) to medical devices and fire- protection equipment. Many of its products are consumed quickly and carry high profit margins. During the second quarter, five of 3M's six divisions showed growth in sales and profits, and all six produced operating profit margins of 20% or better.
The company's diverse product lines and global customer base (it gets two-thirds of its revenues from outside the U.S.) should appeal to shell-shocked investors in search of a safe haven. At $59.97, 3M's stock trades for just ten times estimated '09 earnings of $5.89 per share.
Why so cheap? Investors may be focusing too much on 3M's lagging display-and-graphics business, which has been hurt by tough competition and shrinking profits in the segment that makes optical film coatings for flat-panel TVs. But this business accounts for less than 10% of the company's revenues. Rising raw-materials costs and a slowing global economy are concerns as well.
3M's size and financial strength give it a lot of advantages, however. The St. Paul company can invest in new products, make acquisitions and retool manufacturing operations to improve profitability. Earnings per share grew at an 18% annualized rate from 2001 to 2007, and analysts expect profit growth of 10% this year and 8% in '09. Add to that a dividend yield of 3.3%, and you get a nice potential return on this underpriced stock.
Although Microsoft's profits have nearly quadrupled since mid 2002, its shares have barely budged since then. Instead, its P/E has steadily contracted. At $23.23, the stock trades for just 11 times the $2.14 in profits per share that analysts expect for the fiscal year that ends next June. That's a remarkably low P/E for a company coming off a year in which profits jumped 26%.
Granted, the Redmond, Wash., software giant says that earnings will grow only 13% to 16% in the current fiscal year because of fewer new products and a slowing global economy. Investors worry, too, that Internet-based services developed by Google and others will ultimately loosen Microsoft's iron grip on the programs that run 90% of the world's personal computers. And the company's failed attempt earlier this year to boost its online-advertising market share by acquiring Yahoo only underscores its shortcomings in that crucial area. Microsoft will have to spend billions of dollars to meet both challenges, which will inevitably cut into its enviable 40% operating profit margin.
Arguably, the low share price already reflects these concerns and ignores the company's ability to respond. With $24 billion in the bank and $18 billion in annual free cash flow, it can patiently develop its Internet-based software and online-advertising businesses, supplementing them with key acquisitions. For evidence this strategy works, look at its corporate-server-software business, which barely existed ten years ago and now accounts for 22% of the company's $60 billion in annual revenues.
Microsoft has plenty more to offer. Relatively little of its business relies on struggling consumers; the company pays an ultra-safe, 52-cent annual dividend (the stock yields 2.2%); and Microsoft promises to boost earnings per share further by repurchasing $40 billion worth of shares over the next five years. Microsoft, which recently announced it would issue debt for the first time, received a coveted triple-A rating from both Standard & Poor's and Moody's. Only five other industrial companies boast the top rating.