STOCKS & BONDS


7 Cheap Stocks Experts Love

Editor's note: Since the original publication of this article, J. Crew, one of our seven experts' top picks, has entered into a buyout agreement with two private-equity firms, TPG Capital and Leonard Green & Partners, for $3 billion, or $43.50 a share -- about 28% above the closing price of $34 when we went to press.

Over the past year, stocks rose, fell and spent a great deal of time going sideways. After all was said and done, the net result was a respectable, double-digit gain. And that, naturally, raises the question of where you can find value in this market. We asked seven leading fund managers to identify stocks that they believe still trade at alluringly cheap prices. They came up with seven very different ideas.

Feeding the World

Wintergreen Fund's (symbol WGRNX) David Winters embraces global investing, so it's little surprise that his stock pick is Nestlé (NSRGY.PK), the quintessential multinational corporation. "Nestlé is a gigantic food company that is growing all over the planet," says Winters.

Indeed, Nestlé's revenues of $107 billion are nearly evenly split among the U.S., Europe and emerging markets. Its formidable lineup includes brands such as Nescafé coffee, Perrier mineral water, Häagen-Dazs ice cream and Kit Kat candy. In emerging markets, where Nestlé expects to generate half of its sales within a decade (compared with 35% now), the Swiss company dominates in categories such as instant coffee and infant formula.

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Let's not forget pet foods, a $12-billion-a-year line of business. In the U.S., where Nestlé leads with brands such as Purina, Alpo and Friskies, 170 million cats and dogs need to be fed. "People generally like their pets better than their relatives," says Winters. "Pets are a simple relationship."

But what Winters particularly likes is the "number of ways to win with Nestlé." The company has a rock-solid balance sheet bolstered by $28 billion coming in this year from the sale of its stake in Alcon, a maker of eye-care products. Nestlé enjoys both strong growth in its existing lines and a tradition of making savvy acquisitions of food lines that it can push through its powerful global distribution system.

Between dividends (which Nestlé has hiked for 14 straight years) and share buybacks, the company annually returns about 5% of its stock-market value to shareholders. After subtracting Nestlé's cash holdings and the value of its $20-billion stake in L'oréal from the company's market value (stock price times shares outstanding), Winters figures that the stock sells for less than 12 times earnings. "It's a first-class company selling at a reasonable price," he says.

Delivering Content

David Marcus, like David Winters, cut his teeth working for the legendary Michael Price (the former head of the Mutual Series funds) and then set forth on his own. Now he roams the globe with Evermore Global Value Fund (EVGBX), which he launched late last year. His pick is a U.S. company, DirecTV (DTV), the dominant satellite pay-TV operator. Unlike many cable-TV operators, media mogul John Malone's DirecTV is still adding customers in the U.S., where it has 19 million subscribers. And in less-penetrated Latin American markets, such as Mexico and Brazil, the company has eight million subscribers and is growing rapidly. In the second quarter of 2010, DirecTV boosted revenues by 12%. Average revenues per subscriber in the U.S. rose by 6% (to $90 a month), thanks to price hikes for programming and for pay-per-view and other services.

Marcus says DirecTV's killer app is its numerous sports packages. You can watch every NFL game every Sunday, view eight games simultaneously on the screen, and stream games to a mobile device, such as an iPad. "People are sports fanatics everywhere in the world," says Marcus.

DirecTV generates gigantic amounts of free cash flow (the cash profits left after the capital outlays necessary to maintain the business), which it uses to expand and to buy back shares. The share count has shrunk by one-third in five years, and Goldman Sachs estimates that the firm will repurchase 17% of its shares this year alone. No wonder analysts expect earnings per share to grow by 19% annually over the next three to five years.

Benefiting from Weakness

Charles de Vaulx, co-manager of IVA Worldwide (IVWAX), another global fund, is downbeat on the U.S. economy. He anticipates only modest economic growth over the next three to five years, which implies that unemployment will remain stubbornly high. That's one reason he's so keen on Wal-Mart Stores (WMT), which is built for hard times. "That environment should make shopping at Wal-Mart more compelling than ever," reasons de Vaulx. "People won't want to pay up to shop at fancier stores."

In fact, this goliath, which generates annual sales of $424 billion, flourished during the Great Recession. Earnings grew 9% annualized over the past five years, and the company gained market share. And the stock was one of only two in the Dow Jones industrials to rise in 2008's treacherous market. Even though inflation is practically nonexistent, Wal-Mart should be able to boost its profits by 10% in the current fiscal year. If inflation starts to creep up, says de Vaulx, Wal-Mart will be able to raise prices and benefit as the land it owns beneath many of its 8,500 stores rises in value.

This predictability appeals to de Vaulx. "Unlike with Microsoft [another IVA holding], I think I know where Wal-Mart will be ten to 15 years from now," he says. Wal-Mart will have an even greater presence abroad, in countries such as Mexico, England and China. The company books one-fourth of its sales in foreign markets, but it is expanding the square footage of its stores twice as fast overseas as at home. In September, Wal-Mart offered to buy Massmart, one of South Africa's largest retail chains, for $4.4 billion. De Vaulx thinks Wal-Mart stock is worth $70 a share, 30% above its recent price of $54.

Changing Its Chips

Wally Weitz, impresario of the Weitz fund family, says that one of today's best bargains is a venerable technology leader: Texas Instruments (TXN). He thinks the market still views TI as a maker of calculators and chips for wireless phones, when in fact the company has remade itself to focus on analog products. "This is a different company than it was just five to eight years ago," says Weitz.

Analog semiconductors go into sensors and other devices that measure real-world data, such as temperature, pressure and sound, and convert the measurements to digital data that can be processed by other chips. There's a huge market for analog chips in products such as amplifiers and power-management systems. Weitz thinks of TI as a kind of Johnson & Johnson of electronics. Both firms are well diversified in their sectors and produce thousands of inexpensive, but important, individually designed products that have relatively long life cycles.

Weitz is also enthusiastic about TI's financial condition. The firm has $2.3 billion in cash, no debt and rising free cash flow. Over the past five years, TI has spent $17 billion to buy back stock, reducing the share count by one-third. In September, the company boosted its dividend by 8% and authorized an additional $7.5 billion (an amount equal to one-fourth of TI's market value) to repurchase shares. Weitz thinks TI will earn more than $3 a share within three years, and the stock should sell at 15 times earnings, or $45. That implies plenty of upside potential.

Dominating the Seas

Carnival Corp. (CCL), operator of cruise lines such as Princess, Holland America and Cunard, navigated the stormy seas of a savage recession with skill and remained highly profitable. Sales declined 10% last year, but they are rebounding along with earnings in 2010, thanks to price increases and higher occupancy rates. Wendy Trevisani, co-manager of Thornburg International Value (TGVAX), says the shares of Carnival are a bargain (Carnival has dual headquarters in Miami and London).

The cruise business is also a long-term growth story. Historically seen as a leisure activity for seniors, cruises now appeal to a younger, broader demographic. The business, says Trevisani, is "one of the few industries growing strongly in Europe," which accounts for 40% of Carnival's revenues.

Carnival, the leader in a concentrated industry (it's twice as big as its nearest competitor, Royal Caribbean Cruises), is best positioned to meet the demand. It operates 98 ships and has another ten vessels on order (new ships can cost $500 million each, which creates a significant barrier to new entrants). Analysts, on average, see Carnival boosting earnings by 15% a year over the next three to five years, while the stock trades at just 14 times estimated earnings for the coming year.

Returning from the Edge

MBIA (MBIA) is in a situation that maybe only a lawyer, an accountant or Fairholme Fund's (FAIRX) Bruce Berkowitz could love. Best known for insuring municipal bonds, MBIA suffered devastating losses in 2007-08, when its other main business -- insuring securities backed by assets such as residential and commercial real estate -- collapsed. The firm lost its coveted triple-A bond rating, and its stock plummeted from $70 in October 2007 to $2 in early 2009. It has since recovered to $11. A tangle of litigation still prevents the insurer from writing new business and makes analyzing MBIA devilishly tricky.

Yet Berkowitz, who has a long history of investing in insurers, spies a great opportunity. "MBIA mirrors what's going on in the financial system," he says. "First, catharsis and destruction of capital; now, the rebuilding and resuscitation of the system." He says that MBIA has continued to honor its obligations when bond issuers default, a course of action that is sure to be a huge plus when the company is again able to insure new policies.

But what really intrigues Berkowitz is the headway MBIA is making on the legal front. It has filed multiple lawsuits against mortgage sellers and servicers that it claims fraudulently originated or improperly placed mortgages in the securities that it guaranteed. In some cases, sellers and servicers are being forced to buy back the mortgages. In others, MBIA is bargaining down its liability -- for example, MBIA recently settled one $4.4-billion insurance exposure by agreeing to pay just $72 million. "MBIA will prove to be seen as the 800-pound gorilla in the business," says Berkowitz.

Adding More Brands

Cliff Greenberg, captain of Baron Small Cap Growth (BSCFX), has owned J. Crew (JCG) since the clothier went public in 2006. He has held tight to the stock as it has taken him on a roller-coaster ride: It sank from $50 in 2008 to less than $10 in early 2009, then rebounded to $50 this year. Now that it has pulled back to $34, Greenberg is buying again.

J. Crew makes reasonably priced, high-quality merchandise for men, women and children. The brand, which is sold only in J. Crew stores, is strong (Michelle Obama is a customer). Earnings have grown at an annualized rate of 21% over the past five years, and return on equity (a measure of profitability) is a healthy 30%.

Greenberg foresees strong growth ahead. Under Mickey Drexler, the former chief executive of The Gap, the company is expanding all of its formats, including J. Crew stores, Crew outlet stores, a chain of bridal stores and a new group of stores called Madewell, which sells fashion for young girls. Sales over the Internet are booming, and the firm recently began selling factory-outlet merchandise online (the previous year's styles for one-third off).

J. Crew should earn $2.31 a share in the current fiscal year. Greenberg, who looks out several years when he evaluates stocks, thinks the company will earn more than $4 a share in 2014, which leads him to believe that the stock will more than double, to $75, by 2013.

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