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4 Cheap Stocks to Buy Now

Steven Goldberg

Low-risk blue chips in health care and defense are bargains. So is Fairholme fund.



Stocks and bonds have rallied sharply since March 9, helping to reassure investors that the U.S. -- and indeed, the world -- isn't on the verge of a depression. But the economy still faces a long, hard slog as businesses, governments and individuals struggle to pay down debt.

What to do? Fortunately, some sectors and many individual stocks should be able to produce decent returns even if the broad market treads water for a long time to come. And many of these companies are so solid and their stocks are priced so cheaply that they carry surprisingly little risk should the market head south again. Investors would do well to buy these companies-or good funds that specialize in them.

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Bruce Berkowitz, manager of Fairholme fund (symbol FAIRX), has found a passel of these stocks in two sectors. "A poor economy will have little impact on health care and defense," Berkowitz says. Yet the sectors are priced as if they were on their deathbeds, he adds.

True, investors are concerned about the effects of health-care reform. But the impact on health-care companies depends on precisely what Congress passes -- assuming it enacts anything at all. Plus, you can argue that health-care share prices already assume that some reform measures will pass.

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As for defense, yes, the Obama administration is trying to save money by scaling back some weapons projects, most notably the F-22 fighter jet. "But given the state of the world, it's hard to see how we're going to spend much less on the military," Berkowitz says.

What's more, only a small number of military contractors have the heft to produce the ships, aircraft and other major systems the Department of Defense needs. The government has little choice other than to keep these companies purring on all cylinders.

Exhibit A of underpriced health-care stocks is Pfizer (PFE). The stock closed July 13 at $14.76, close to a 12-year low. It trades at eight times estimated 2009 earnings of $1.96 per share and sports a 4.% yield.

Problems? Of course. Patents will expire soon for Lipitor and other big drugs, and Pfizer scientists haven't come up with any promising replacements in recent years.

But, Berkowitz says, Pfizer has evolved into the biggest merchant banker of the drug industry, acquiring and partnering with small companies that need its clout to help develop and market their drugs. He also believes cost-cutting will help Pfizer's bottom line, particularly after its merger with Wyeth closes. Berkowitz has so much confidence in the company that he's put 15% of Fairholme's assets in it.

There's nothing wrong with health-insurance companies, either. WellPoint (WLP) insures 35 million people, more than any other company, and owns the Blue Cross or Blue Shield brand names or both in 14 states. At $49.78, it sells for nine times estimated '09 earnings.

Among defense stocks, Northrop Grumman (NOC) is a Berkowitz favorite. Like many other companies, it lost money over the past 12 months, but, on average, the analysts who track the company expect it to earn $4.97 per share this year. The stock, at $44.26, trades at nine times that estimate and yields 3.9%. Northrop is involved in information technology, aerospace and ship construction.

General Dynamics (GD) is another underappreciated military contractor. Trading at nine times earnings with the shares at $52.29, it builds ships, armored vehicles and information-technology systems. It owns three of the six yards that make Navy ships.

Fairholme fund

For my money, I'd buy Fairholme fund, a member of the Kiplinger 25, rather than piggyback on Berkowitz's stock picks. Berkowitz is a savvy investor. Since he launched Fairholme nine and a half years ago, the fund has returned an annualized 11%-compared with a 3% annualized loss for Standard & Poor's 500-stock index. Fairholme lands in the top 1% of all domestic stock funds.

Fairholme has beaten the S&P every year since 2003. The fund tumbled 30% last year, but that was seven percentage points less than the index's loss. Year-to-date through July 10, the fund gained 10% -- 11 percentage points more than the S&P 500.

One key to Berkowitz's success, I think, is his practice of contracting for experts who help him understand sectors and companies. He's currently getting advice from former congressional aides who've been involved in previous health-care-reform efforts, as well as retired generals who were involved in defense procurement. In addition, Berkowitz has three full-time analysts.

Fairholme is not a typical mutual fund. Berkowitz usually keeps a big portion of assets in cash to cushion market declines and to deploy in case opportunities arise. He currently has a 13% cash stake. He also has 8% of the fund's assets in a few high-yielding bonds.

None of this amounts to a market call. "I've never been good at predicting markets," he says. "Every time I've gone that way, it's ended up badly."

Instead, he makes his money by picking a few beaten-down sectors that he thinks will revive and plunking a chunk of his money into the best stocks he can find in those sectors.

He needs only a few good stocks. Putting 15% of his fund's assets in a stock, as he has done with Pfizer, isn't new for Berkowitz. He also has several 4% positions. He rarely owns more than 20 to 25 stocks.

Yet Berkowitz doesn't see himself as a high-risk manager. Instead, he tries to buy good companies at very low prices. "So much of your safety is in the price you pay for a security," he says.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.



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