My 10 Stocks for 2006

Call it smarts or just plain good luck, but the performance of my annual list of stocks gets better and better. Most years since 1995 (I took a hiatus for three years), I've offered readers of The Washington Post and now Kiplinger's Personal Finance ten stock picks, culled from the choices of experts whose opinions I value. The list for 2005 was my personal best, returning 23%, including reinvested dividends, compared with just 5% for the benchmark Standard & Poor's 500-stock index. My 2004 list beat the SP by 11 percentage points, my 2003 list by seven. It's time to test my good luck (or skill) once more.

Before we start, some disclaimers. First, the stocks were chosen for their likely results in 2006, even though I emphatically object to any investment strategy with such a short time horizon. Second, although these stocks vary by sector and company size, don't mistake them for a truly diversified portfolio. And third, no guarantees.

Now, the list. Once you get past the condescending writing style of The Little Book That Beats the Market, money manager Joel Greenblatt will teach you important lessons and give you good stock tips. Greenblatt developed a two-number formula that, judging from history, can produce huge returns. One stock that passes the Greenblatt test is American Eagle Outfitters (symbol AEOS, $25), with an annual return on capital (by Greenblatt's definition) of more than 100% and a PEG ratio of 0.87, meaning that its price-earnings ratio is a lower number than its rate of earnings growth. A casual-clothing chain, American Eagle sports a gorgeous balance sheet, with no debt and a half-billion in cash and short-term investments.

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My guru for micro-cap stocks, Jay Weinstein, of Oak Forest Investment Management, in Bethesda, Md., picked a winner for the list last year in Atrion (ATRI), a medical-products company that soared 57%. He still recommends it. Prodded for a new name, Weinstein picked Astronics (ATRO, $10), a maker of airplane parts, with a market capitalization of just $84 million (and a symbol just one letter away from Atrion's). This stock is not for the squeamish. Astronics lost more than 80% of its value in the two years ending in mid 2003; but by the end of 2005, it had regained about half those losses. Weinstein expects earnings to double this year and predicts that "the up cycle will be as long as the down cycle was brutal." This stock doesn't trade much, so you might pay a premium to buy many shares and face a discount when you sell. Weinstein and his clients own 7% of the stock.

Whitney Tilson, a money manager and former columnist for the Motley Fool, describes himself as a disciple of the late Benjamin Graham, the great value theorist. It's hardly a surprise then that Tilson characterizes Berkshire Hathaway (BRK.B, $2,952) as "our favorite stock idea" for 2006. Berkshire's chief executive officer, Warren Buffett, was Graham's most famous acolyte. But Tilson thinks Berkshire is an especially good buy today because it's cheap (a "75-cent dollar") and has tons of cash. Berkshire is a holding company, owning highly profitable firms, such as See's Candies and Geico in their entirety, plus large stakes in public companies, such as Procter & Gamble and American Express. Tilson Focus fund, launched last year, has more than a tenth of its assets in Berkshire.

Bright future. Value Line Investment Survey, my favorite research service, has a spectacular long-term record picking winners. It's second only to The Prudent Speculator over the past quarter-century, according to the Hulbert Financial Digest, which tracks investing newsletters. Value Line gives only 100 stocks its top rating for timeliness. Of those, I am attracted to Brightpoint (CELL, $20). Every portfolio needs a highflier that might fly higher still. Brightpoint, a small-cap stock that doubled last year and carries a P/E of 25, seems pricey, but its business -- providing logistics services to mobile-telecom operators -- is booming.

The Prudent Speculator may have the best ten-year record of any financial newsletter, but Global-Tech Appliances, my 2005 choice from editor John Buckingham's sizable recommended list, was a clunker, down 58%. Despite this, I have high hopes for D.R. Horton (DHI, $40), the largest homebuilder in America. Even with rising interest rates, Buckingham expects Horton to increase its earnings by 15% to 20% annually over the next five years. Shares traded at year-end 2005 at a P/E of 7, based on projections of this year's profits.

Fidelity favorite. Will Danoff had another spectacular year managing Fidelity Contrafund in 2005 -- up 16.2%. His ten-year record, through 2005, beats the SP by an annualized three percentage points, which is amazing for a huge, diversified fund. One of his big movers last year was EnCana (ECA, $46), the large Canadian oil-and-gas company out of Calgary. According to Contrafund's latest report, EnCana is Danoff's number-one holding, and he's still acquiring shares. No wonder. EnCana's price has more than doubled in two years, but the stock trades at a P/E of just 11.

For the 15th year running, Bill Miller's Legg Mason Value fund beat the benchmark SP 500 -- even after expenses of 1.7% annually. Miller's portfolio changes very little year to year (average turnover is 9%), and at last report, he had added just two new names to his top 25 holdings: Sprint Nextel and Expedia (EXPE, $26). Because Miller has a talent for picking online businesses (he scored big with Amazon and Google), I am going with Expedia, which went public in July. Expedia is an Internet-based travel agency, offering airline, hotel and car-rental reservations. Its P/E, based on 2006 projections, is a modest 20.

Shares of First Marblehead, a student-lending facilitator, dropped by more than half between March 2005 and last December. But Tom Brown, a hedge-fund manager who is probably the best financial-stock analyst in the business, is not worried. "I'm a big fan," he writes, "and believe that the company's skeptics are way, way too negative." Brown says that First Marblehead (FMD, $32), which designs and underwrites loan products and services them for big national lenders, is widely misunderstood by Wall Street. To me, the numbers aren't mysterious. The company has doubled its earnings in each of the past three years, but still trades at a P/E, based on 2006 estimates, of just 9. Says Brown: "First Marblehead at these levels is one of the most attractive investment opportunities I've come across over the past decade."

For the past ten years, the annual Analysts' Best Picks list from Raymond James & Associates has beaten the SP 500 -- and in nine of those years, by ten percentage points or more. Last year, the stock I selected from the Raymond James list, Ultra Petroleum, was my best performer, up 131% -- and happily enough, I own it personally. This year, I am going with Dublin-based Ryanair Holdings (RYAAY, $56), the largest low-cost carrier in Europe. Ryanair's earnings, writes RJA's James Parker, "are forecast to grow 17% to 20% on a compounded annual basis for at least the next three years." A ruthless competitor, the company earns about one-fourth of its profits from travel services, such as rental cars and hotel bookings.

A home run? You may remember my column last year on James O'Shaughnessy (see "The Man Who Broke the Code," Sept.). O'Shaughnessy's stock-picking formula -- combine a low price-to-sales ratio with rising earnings and above-average recent price increases -- is used by Hennessy Cornerstone Growth fund, which returned 12% in 2005, the seventh year in a row the fund beat the SP 500. In the current portfolio, which is heavy on energy and homebuilders, I'm attracted to Sierra Health Services (SIE, $39), a fast-growing managed-health-care organization based in Las Vegas. Sierra has a lower P/E than industry leader UnitedHealth Group, which gets most of the attention from analysts.

That's the list. Just remember disclaimer number three.