Skip to main content Ratings assembled a portfolio of two stocks, two ETFs, and two mutual funds that we think will outperform the market over the balance of this year. All six of our recommendations are highly rated by our proprietary models, and offer attractive growth to investors based on a number of other nonquantitative factors. Moreover, we believe each of these investments offers some downside protection, should the market suffer from a downdraft over the balance of the year. That said, we suggest investors use our recommendations as initial points of reference for their own due diligence.

Our first stock pick is

F5 Networks

(FFIV) - Get Free Report

, a leading provider of software and hardware devices that distribute and monitor data traffic across servers and provide a number of other security and application optimization functions. The stock, which is trading at a

price-to-earnings ratio of 25.7 times fiscal 2008 consensus EPS estimates, is hardly a value play. Still, it is well off its 52-week high of almost $46 (on a split-adjusted basis). The retreat is mostly due to concerns that its recent acquisition of Acopia Networks will dilute earnings and could be difficult to integrate.

Despite these risks, we see several reasons to like the stock. First off, our model rates FFIV a buy based on consistently strong revenue and cash flow growth, strong balance sheet measures and attractive returns on invested capital. Of those, FFIV's balance sheet strength is particularly noteworthy: It has approximately $420 million in cash and equivalents, or almost $5.00 per share, post acquisition.

Next, we think the concerns regarding Acopia are short-sighted. Management's projection that the acquisition will dilute operating income by 5% through fiscal year 2008 is already incorporated into analysts' earnings estimates, which remain strong. The consensus view is for revenue for the fiscal years ending September 2007 and September 2008 to rise 33% and 27%, respectively. The company has rarely, over the past two years, failed to meet estimates for quarterly revenue and non-GAAP EPS, and we see no reason why that streak won't continue.

More important, we think the purchase makes strategic sense over the long term, since it extends the ability of FFIV's equipment to intelligently manage data traffic.

Finally, we have a favorable view for the market for data networking and management products, particularly for industry leaders and companies that generate a significant percentage of their revenue outside the U.S. FFIV is the leading provider of deep-packet inspection and traffic management products (or what are commonly referred to as Layer 4-7 switches) and international sales represented about 40% of revenue last quarter.

If the company meets earnings expectations for the second half of this calendar year, we can see the stock reading between $45 and $50 early next year.

Our next stock pick is

MedcoHealth Solutions


, which provides pharmacy benefit management, or PBM, services, such prescription drug benefit programs, plan design, clinical management, clinical services, pharmacy management, physician services and Web-based services.

MHS, which was spun off from


(MRK) - Get Free Report

in 2003, is the 700-pound gorilla in the PBM market, with over $40 billion in annual sales. As such, it should benefit from rising spending on pharmaceuticals, escalating use of prescription drugs by an aging population in the U.S. and Japan and efforts by corporations, state governments and Medicare/Medicaid to contain costs by relying more heavily on generic drugs.

MHS' revenue is growing at least twice -- and perhaps three times -- as fast as the economy. In addition, unlike many of its pharmaceutical cousins, which depend heavily on "hit" drugs, the company has been growing steadily as more drugs go off-patent. MHS' year-over-year earnings growth in each of the last five quarters has ranged from the midteens to over 20%. We think that this trend should continue.

Longer term, MHS should continue to benefit from a new mail-order facility and client renewals; together these now account for around 20% of its revenue. The company has also been bulking up in specialty pharmaceuticals (primarily newer biotech or chronic illnesses drugs).

The stock is not without risks; it has already had a strong run, rising about 60% this year. Moreover, despite MHS' role in containing health care costs, the stock tends to trade in line with the broader hospital, medical devices and pharmaceuticals sectors, which are increasingly in the crosshairs of consumer groups and politicians.

Nevertheless, we think there is still some room for the stock to run, given MHS' strategic position and its long-term growth prospects. And, with a P/E-to-sales-growth ratio not too far above 1.0 (around 1.25 times today based on a price-to-earnings ratio of roughly 20 times 2008 earnings), it's not that expensive, either on an historical basis or relative to its peers. Based on consensus earnings estimates, MHS could easily appreciate by 21% without any expansion in its P/E.

For those who prefer the diversification that mutual funds can provide to individual stocks, we have two recommendations, both of which are value plays because they focus on companies and industries that tend to do well in any kind of market environment. Both funds also carry a strong buy rating from our model.

The first is the

(SWHFX) - Get Free Report

Schwab Health Care Focus Fund. As its name implies, the fund invests primarily in pharmaceuticals, which represent 46% of assets, and health care products, at 21%. Its holdings are also highly concentrated in a few stocks, with the top 10 positions representing approximately 44% of total assets. All 10 are large, solid companies that are virtually certain to prosper from the health care needs of aging baby boomers.

Ordinarily, such a concentrated strategy could be considered risky. However you could argue that when the market is volatile, broadly diversified equity funds are actually riskier than concentrated funds, since they simply gyrate with the overall market. In this environment, we believe doubling up on the right sectors and holdings may in fact reduce risk. And pharmaceuticals and health care stocks are likely to benefit from a flight to quality, since their earnings are so stable.

That said, investors should note the pharmaceutical stocks are vulnerable to a number of things, including product liability issues, patent expirations, a dearth of new drugs in the pipeline and political uncertainty.

Schwab Health Care Focus is up 8.98% year to date through Sept. 6, and has returned an annualized total return of 16.33% over the past three years.

Our second fund pick, the

(PVFIX) - Get Free Report

Pinnacle Value (PVFIX), invests in small-cap value stocks, another area that should hold up relatively well in a volatile or weak market. While small-caps tend to be less liquid than the stock of bigger companies, and their price movements can often be sharp and pronounced, fund managers can minimized these risks through stock selection. Moreover, Pinnacle Value tends to invest in stocks that are not as well covered by Wall Street, and so have the potential to outperform the market. Its top holdings include

Conrad Industries






MVC Capital

(MVC) - Get Free Report





Technology Solutions



The fund has certainly held up well, providing a total return of 13.48% for the year to date through Sept. 6. Even during the difficult month of July, it managed to gain nearly a full percentage point. The fund has also achieved double-digit annualized gains over the past one and three years, producing a positive alpha coefficient (percentage returns over the

S&P 500


Just as important, Pinnacle Value has avoided major swings in performance, as measured by its low three-year standard deviation of 6.29. Standard deviation measures the variance of returns in relation to the average return, including both above-average and below-average returns. Simply put, the lower the standard deviation, the more reliable. Looking at another metric, the fund's one-year R-squared is 0.6, meaning it has an extremely low correlation with the overall market. Finally, the fund has a low three-year beta coefficient of 0.39, meaning that its price fluctuations have tended to be at much lower amplitude than the market's -- another desirable attribute in these uncertain times.

For investors who prefer a lower-cost alternative to actively traded mutual funds, but still want the benefits of diversification, we highlight two ETFs that can weather a volatile market:

iShares DJ US Aerospace and Defense Index

(ITA) - Get Free Report


iShares S&P Global Telecom

(IXP) - Get Free Report

. Both carry our highest overall investment rating of A+, or buy, based on their risk-adjusted performance rankings as of July 31, 2007.

ITA was launched on May 5, 2006. It allocates 82% of assets to aerospace and defense, 7.2% to metal fabrication and 5.0% electronics. Top holdings include


(BA) - Get Free Report


United Technologies

(UTX) - Get Free Report


Lockheed Martin

(LMT) - Get Free Report


Northrop Grumman

(NOC) - Get Free Report


General Dynamics

(GD) - Get Free Report


Over the 12 months ended Sept. 6, only one of the holdings,



, has fallen in value, while the rest have soared. The biggest winners include

Force Protection

(FRPT) - Get Free Report

, up 149.03%;

Precision Castparts


, up 129.15%;



, up 77.23%;

Flir Systems

(FLIR) - Get Free Report

, up 79.05%; and

Taser International


, up 96.75%.

In the near term, the useful life of much of the equipment currently used in the Middle East is limited, so the U.S. Congress will have little choice but to fund the Pentagon's needs for new military equipment. That means continued orders for the majority of the firms in this fund. Their long-term outlook is bolstered by the fact that any pullout from Iraq is not likely to begin until late January 2009.

ITA dipped in the early part of August, but was still up 2.13% for the full month, and 4.45% over the past three months and 36.27% over the last year.

IXP holds a portfolio of phone companies that spans the world. There's no stopping the globalization of the telecom market. That means the gatekeepers of communications should remain well positioned to profit from ever increasing data, video and voice traffic.

IXP's biggest allocation is to U.S. companies, at 34% of assets, followed by 16% in the U.K., 8.1% in Spain, 6.1% in Japan and 4.9% in France. Among its top-performing holdings,

Brasil Telecom Participacoes SA

(BRP) - Get Free Report

climbed by an impressive 154.87% over the year ended Sept. 6 (in U.S. dollars), while Hong Kong's

China Mobile

is up 104.25% and Canada's

Rogers Communications

is up 74.39%. The worst performer has been Japan's

Nippon Telegraph & Telephone


, which lost 9.39%. The fund itself has returned 35.54% over the last year.