A Formula for Best Dow 30 Stocks for '07

First, remember there are crucial differences between stocks and bonds. If you buy the 10-year Treasury today and hold to maturity, you'll make a guaranteed 4.52% every year. You'll never make more than 4.52%, but you'll never make less, either. And at maturity you get your entire principal back, no questions asked.

If you pick the right stock, you will make a lot more than 4.52% a year. But risks include:

• Sales. If the company loses a key customer, then earnings may decline.
• Gross profit margin. If the company is unable to pass along higher raw material prices, then margins and earnings may decline.
• Book value. The corporate net worth may be overstated if the company has goodwill and other assets that are at risk of being impaired.
• Dividend. If earnings are not supported by free cash-flow growth, management may have to cut the dividend, which crimps both yield and growth.
• Debt. The more leveraged the capital structure, the greater the likelihood of financial distress. The EYTM formula does not take a borrower's credit-worthiness into account.

So, use this formula for research ideas, not buy recommendations.

The table below shows yield, growth and EYTM forecasts for each of the 30 Dow components, including General Electric, based on trailing 12-month earnings.

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Caterpillar (CAT - commentary - Cramer's Take) is the most promising Dow stock for 2007; its EYTM is 30%, based on a recent $62 stock price. The heavy equipment maker's earnings will grow 16% a year for the next five years, according to estimates. But with $27.4 billion of debt and just $553 million of cash and $9 billion of stockholders' equity (including $7 billion of treasury stock, which reduces cash and corporate net worth), even Caterpillar's most ardent bulls will acknowledge that the balance sheet is not investment grade.

At $72, Mobil Exxon (XOM - commentary - Cramer's Take) enjoys the second-highest EYTM, at 28%. Analysts expect earnings for the oil giant to grow 8% a year for the next five years.

American Express (AXP - commentary - Cramer's Take) takes show place, with a 27% EYTM. Earnings for the financial services giant will grow 13% a year for the next five years, according to estimates.

General Motors (GM - commentary - Cramer's Take) has the lowest EYTM, at negative 89%. The Detroit automaker lost $17.12 a share in the last 12 months, according to Yahoo! Finance. Verizon (VZ - commentary - Cramer's Take) also has dour prospects; its EYTM is just 4%.

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At the time of publication, Heiserman was long Exxon Mobil, although holdings can change at any time.

Hewitt Heiserman conceived the Earnings Power Chart and the Earnings Power Staircase. A graduate of Kenyon College with distinction in history, Heiserman is a member of the Boston Security Analyst Society and the CFA Institute. He also authored It's Earnings That Count. For additional information, please visit www.earningspower.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Heiserman appreciates your feedback; click here to send him an email.

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