A Game Plan for the Next Cycle

Get real.

That's what I said in my Top-10 column at the end of last year. Buy real companies with real assets and real profits. It was true then -- every pick has outperformed the market -- and it is just as true today.

The market bubble of 1998-2000 was based on illusions. Illusions die hard. Just because the Nasdaq has had a nice rally off of the lows does not mean we are returning to the go-go days of a couple of years ago. Recoveries from major market dislocations take a long time.

And there is a fundamental reason why. Speculative fervor attracts large capital flows. The larger the rally, the larger the capital flows. As capacity is built, margins fall and returns on equity drop in the face of additional competition. It will take time to work through the glut of tech capacity. And to the extent demand is weak, it will take even longer.

Get Real in 2001 and 2002

I am continuing the theme of "get real," with my 20th recommendation below. But first, here are the highlights of what I believe is a prudent game plan for the next couple of years:

• Be very selective in technology. Most of the big names that led the last cycle are still too rich, given the level of uncertainty.

• Ignore economic analysis. You don't need a Ph.D. in economics to figure out what you need to know as an investor. I'll give it to you straight and simple: Business is bad. I don't know when it will get better, but it will. It may even get worse before it gets better.

• Emphasize small-caps and mid-caps in your portfolio.

  In retail, I would rather own Office Depot (ODP Quote) than Dow component Wal-Mart (WMT Quote).

  Wal-Mart is big and rich and it's going to get bigger and richer. But I believe Office Depot, as a stock, will easily outperform Wal-Mart. In chemicals, I prefer smaller and cheaper companies like HB Fuller (FULL Quote) and Georgia Gulf (GGC Quote) over Dow component Dupont (DD Quote). And in the industrial sector, I would rather own TRW (TRW Quote) and my new pick Textron (TXT Quote) over Dow components United Technologies (UT Quote) and Boeing (BA Quote).

Mistakes, Mistakes

I want to apologize for a couple of bonehead mistakes. My first mistake, recommending United Airlines, a subsidiary of UAL (UAL Quote), still bothers me because I broke one of my cardinal rules. When considering alternative value stocks, you don't have to buy the cheapest of the group. Quality comes first. In other words, don't reach!

Based on my metrics, UAL was much cheaper than competitors Delta (DAL Quote) and Continental (CAL Quote). Even though I knew management is superb at Delta, maybe the best at Continental, I blatantly reached when I selected UAL (which I still own), where management is inept.

My second mistake is that I sat on the Textron pick (see below), knowing that Textron is a superb company to own in the new cycle. I sat on it in hopes of a lower stock price because I knew business was going to deteriorate at Textron -- and it has. While I sat, and while the economy has slipped, Textron stock continues to go up. Learn from my mistake. First, when you can buy a terrific company at a terrific price, do it. Second, stock selection (my strength) should always trump a macro view (where I am mediocre).

Textron

Business is bad and getting worse at Textron. This leader in aircraft (Cessna and Bell Helicopter), industrial products, automotive, and fastening systems thinks it can make $4.65 per share in 2001. I'm dubious. But I don't buy stocks for their near-term prospects anyway. As a bargain hunter, near-term conditions at my companies are almost always poor. I like to buy solid companies, like Textron, in anticipation of better times.

Today the Blues, Tomorrow the Takeoff Current woes won't prevent Textron from paying off later

Led by a strong management team, Textron posted double-digit earnings increases for eight consecutive years going into 2001. Textron is not only poised to start another growth cycle, but the current manufacturing restructuring program has the potential to significantly lift operating margins over the next couple of years.

Textron represents one of my favorite themes -- buying companies that are getting lean and mean in front of a new cycle of growth.