Keep the Best Company

Think of your investments as businesses in the real world, then join up with the best of the best. Here are some stellar suggestions.

What if you had the opportunity to join the world's most exclusive golf club (say, Augusta National) -- or buy a house in a beautiful neighborhood, or send your kids to the best college, or buy a fabulous car -- at an affordable price? The choice would be yours alone. No one could keep you out of the club (and the house would be available for the asking).

This happy circumstance is precisely what prevails today in the stock market. Every investor has the chance to become a partner in some of the greatest global companies -- and the partnership interests (call them shares of stock) are going for a discount.

Wonderful businesses

Don't be spooked by all the talk of the subprime-credit crisis. Don't worry about what the Fed will do next or whether the next administration will raise taxes. Your job is to find wonderful businesses whose profits you can share for the next few decades. Or you could ask someone else, such as a mutual fund manager, to find them for you.

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Rarely have such clearly excellent companies been available at such clearly terrific prices. A recent letter to clients from Diane Lob, chairwoman of the private-client investment policy group at AllianceBernstein, points out that the equity risk premium -- that is, the extra return from stocks compared with ten-year Treasury bonds -- was 6% at the end of the first quarter, "well above average" and the highest since the collapse of tech stocks in 2000. That's a strong indication that the market is a bargain. "We see potential for outperformance across both the value and growth investing styles around the world," writes Lob.

Of course, prices may go even lower. But no one can accurately predict what a stock will do in the short term, so don't even try. What I am urging is that you stop thinking of your investments as stocks listed in a newspaper. Instead, think of your investments as businesses selling products and services in the real world. Find the best of the best and join up.

Consider Pfizer (symbol PFE). Medicine is shifting from treating acute ailments to chronic ones, to the benefit of long-term drug therapies. Baby-boomers are entering their sixties. The developing world is getting richer and demanding more than the health-care basics. Drug research is getting more efficient, thanks to breakthroughs in genetics. Pfizer is the largest global drug company, with a market capitalization of about $134 billion, sales of close to $50 billion, net profit margins of more than 30% and a balance sheet that merits the top rating for financial strength (A++) from Value Line Investment Survey.

Pfizer stock, however, has dropped 28% in the past year and now trades at a price-earnings ratio, based on 2008 profit projections, of a mere 8 and a dividend yield of 6.5%. Pfizer has problems: Its super-profitable cholesterol drug, Lipitor, will lose its patent protection in 2011, Viagra has many competitors, and the presidential candidates are talking about punishing drug companies for charging too much . These short-term difficulties are well-known and incorporated in the price. But the macro trends are what count for the long-term investor, and they look awfully good.

Forget Pfizer's price and focus on its dividend, which has risen 41 years in a row and is now $1.28 a share, up from 12 cents in 1992. Value Line projects that the dividend payout will rise 5.5% annually. If that rate continues, the dividend will reach $3 in about 15 years. If you pay $20 (the price at the close on May 9) for a share of Pfizer today, then your investment's annual yield by 2022 will be about 15% and rising.

But this is just speculation. What is fact is that you can become a partner in a respected, well-run business, founded in 1849, for about one-third of what you would have paid in 1999.

Companies on sale

Other companies that appear to be on sale include Boeing (BA), founded in 1916 and now the dominant aerospace company in the world, with an A++ rating for financial strength, a return on equity last year of more than 40% and a forward P/E of 14; Walgreen (WAG), the widely admired operator of 6,000 U.S. drugstores, founded in 1901, with a dividend that has tripled in ten years and a stock that has dropped 20% in the past 12 months; and JPMorgan Chase (JPM), created by the merger of two of America's historic financial firms, with a stock yielding the same as a five-year Treasury note in early May.

Great companies are not necessarily venerable. Take Starbucks (SBUX), founded by Howard Schultz in 1985. True, with gasoline at $4 a gallon, some consumers are balking at paying $4 for a cup of coffee. But while economic slowdowns may be bad for stock prices in the short term, they can be good for solid businesses in the long term. Recessions flush out weak competitors, provide opportunities for retailers to acquire prime locations at low cost, and force fast-growing companies to learn how to operate leaner.

Coffee king

For the quarter that ended March 30, Starbucks increased its sales by 12%, to $2.5 billion. Profits, however, fell sharply. Meanwhile, the company is maintaining an impressive balance sheet as it opens more stores abroad, where the surface is just being scratched. Starbucks now has more than 16,000 coffee shops worldwide, including 5,000 outside the U.S. The company's shares are down by nearly half in the past year and, in early May, were trading at about the same price as in late 2003, a year when sales and profits were less than half what they're expected to be in 2008.

Another badly bruised innovator, Cisco Systems (CSCO), the world's top supplier of networking products, has a similar story. You can become a partner in this spectacular business today for less than it would have cost you nine years ago. Yet in 1998, according to Value Line, Cisco earned $1.9 billion; this year, it will earn $7.9 billion.

When it comes to innovators, it's hard to improve on Toyota Motor (TM), the cutting-edge manufacturer that just produced its millionth hybrid car. Toyota's vehicle sales in the U.S. rose 3% in April as General Motors and Ford were posting double-digit declines. Despite all its charms, Toyota's stock price has been dragged down with practically everything else. It's off 17% in the past 12 months, lowering its P/E for the 12-month period ending next March to 12 and boosting the dividend yield to 2.2%.

With the goal of creating a portfolio of great businesses at depressed prices, I searched newsletters and advisory services and went back to my old lists of favorites. In addition to the companies already mentioned, I found the following large-cap stocks, all suffering declines for the year ending May 9, even with dividends taken into account (these are just examples of the bounty that's out there):

Medtronic (MDT), maker of medical devices; Microsoft (MSFT), the world's largest software company, now carrying a 1.5% dividend; eBay (EBAY), online auctioneer; Goldman Sachs Group (GS), home to what is probably the largest collection of financial smarts ever; NYSE Euronext (NYX), operator of the New York Stock Exchange and other markets; Simon Property Group (SPG), the largest real estate investment trust, with shopping centers in the U.S., Asia and Europe; Metropolitan Life (MET), the giant insurance company whose shares are off 13% from their high; Unitedhealth Group (UNH), health-benefits provider with a stock down 45% since December; Walt Disney Co. (DIS), broad-based entertainment; Home Depot (HD), yielding 3.2% and down by nearly one-third in value; Waste Management (WMI), the leading environmental-services company; and International Paper (IP), forest products.

Powerful brands

Although there are never guarantees in stock investing, all of these companies are solid citizens, with powerful brand names and a tradition of fine management. Many have stumbled in the past and will do so again in the future, but they are precisely the kind of partners that investors should seek. And talk about timing!

When stocks fall, the impulse is to run for the exits -- or, at the very least, to trim your portfolio and hunker down. But in other human endeavors, we see low prices as a signal to buy, not to sell or hold. If Toyota cut the price of its cars by one-fourth, would you sell your five-year-old model, pocket the cash and walk to work? That's precisely what you would be doing if you sold Toyota stock right now. Instead, here's your chance to buy it.

James K. Glassman is a senior fellow at the American Enterprise Institute. he owns shares of Walgreen.

James K. Glassman
Contributing Columnist, Kiplinger's Personal Finance
James K. Glassman is a visiting fellow at the American Enterprise Institute. His most recent book is Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence.