Markets

7 Blue Chips to Hold Forever

With little debt and lots of cash, these global powerhouses should buck the recession.

By Andrew Tanzer, Senior Associate Editor

From Kiplinger's Personal Finance magazine, April 2009

You need courage to buy stocks nowadays. The market's turbulent start in 2009, coming on the heels of 2008's awful beating, hardly leaves investors feeling warm and fuzzy. The economy is in a deep slump, and the outlook for corporate earnings over the next few quarters is somewhere between murky and miserable.

How do you invest in stocks in the midst of so much turmoil and uncertainty? We suggest you focus on the long term -- say, a minimum of seven years -- and look for high-quality, blue-chip companies that have balance sheets as invulnerable as Fort Knox and can generate wads of cash.

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Our thinking goes like this. It will take several years for consumers, the economy and the financial system to recuperate fully. Economic growth and therefore earnings growth are likely to be tepid over the next five or more years. But if you invest in well-managed, financially strong businesses that sell goods and services for which demand is consistently strong (think food and medicine, not arcane financial products), you should do well.

Businesses like these typically display certain characteristics: They carry little or no debt. They generate enough free cash flow (earnings plus depreciation and other noncash charges, minus the capital outlays needed to maintain the business) that they don't have to raise equity or sell debt -- a good thing in today's unfriendly capital markets. They have a proven history of management excellence. They have abundant opportunities for reinvesting capital (or clear policies for returning excess capital to shareholders), and their leaders boast an outstanding record of allocating capital. In addition, they are global in scope. After all, 95% of the world's population lives outside the U.S., and economic growth is likely to be greater abroad than at home.

We suggest that you focus on companies that pay out some of their profits; in a sluggish economic environment, much of your total return will come from reinvested dividends. Judy Saryan, co-manager of Eaton Vance Dividend Builder fund, notes that over the long haul, 40% to 45% of the return on stocks has come from reinvested dividends, a share she reckons will climb to 50% over the next five to ten years.

In choosing seven great growth companies to invest in for the long haul, we didn't obsess over price. But it's hard to argue that any of our picks are overvalued. Price-earnings ratios range from 11 to 18, and all but one of the stocks have been hammered over the past year.

Finally, filter out the short-term noise when you focus on your long-term holdings. Most of the chatter from Wall Street and in media headlines -- such and such a company missed earnings by 2 cents a share this quarter and so forth -- is just that: chatter you can ignore.

Overseas tobacco giant

Philip Morris International (symbol PM) was born in March 2008, when it was spun off from Altria. PM is a U.S. company, but it books all of its sales abroad (in 160 countries), where tobacco consumption continues to grow. As an independent business, PM is the fourth-most-profitable consumer packaged-goods company in the world -- behind Procter & Gamble, NestléÉ and Unilever but ahead of Coca-Cola and PepsiCo -- and it's safe from the long arm of U.S. tobacco litigators. (You'll have to decide for yourself whether investing in a cigarette manufacturer is morally defensible.)

Philip Morris owns seven of the top 15 cigarette brands in the world, including Marlboro, L&M and Parliament, and controls by far the largest market share of any publicly traded producer. Cigarette sales are shrinking in Western Europe but expanding in emerging nations, where brand-name smokes are an affordable luxury. To stimulate that growth, cash-rich PM recently acquired cigarette companies in Colombia and Indonesia, and increased investments in Mexico and Pakistan.

Unlike most industries these days, PM can push through price increases. "Global demand for cigarettes is extremely resilient, which is very important in today's economic environment," says Charles Norton, manager of Vice fund, which holds PM shares.

The beauty for shareholders is that Philip Morris is a fantastically profitable business. Its return on equity is a towering 55%, and the company generates immense amounts of free cash flow (capital-investment requirements are minimal for cigarette companies), most of which is returned to investors through annual share buybacks and a steadily rising flow of dividends. The company is targeting annual growth in earnings per share of 10% to 12%. At the February 6 closing price, PM shares yielded a healthy 6%.

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