I don't think this decline in the market is over just because of a few days of rally.The true stock market pessimist knows that the universe is swarming with malevolent spirits that delight in crushing investors' hopes.
A sustained rally is an invitation to the irrational exuberance that decimates a portfolio in the ensuing crash. A quick rally after a slump -- like that which took the
Dow Jones Industrials
up 300 points on June 14 and 15 -- is only a chance to load up on "bargains" before they head even further south.
But confirmed pessimists don't even trust their pessimism. Planning for any specific disaster just leaves you wide open to the unexpected disaster. Bury gold in the back yard to prepare for the worst, and the world shifts to a palladium standard.
So, I began building the Pessimist's Portfolio by outlining the different things most likely to go wrong. Although my two worst-case scenarios don't by any means exhaust all the possible worst-case outcomes, they do cover much of the pessimist's turf: Either the
will punt on its current campaign to fight inflation, leaving economic growth and inflation higher than expected, or it will stay the course and raise interest rates high enough to tank the economy.
Of course, I concluded, in true pessimist fashion, that the two most likely worst-case scenarios favor decidedly different kinds of stocks, and that it's almost impossible to find stocks that will do well under what I outlined as Scenario 1, which favors cyclical and commodity stocks, and Scenario 2, which favors big-cap growth stocks and financials.
Almost impossible. But not completely impossible. Both scenarios would produce a kind of "growth famine" that would leave the stock market searching for the rare, predictable growth stock that would hold up in any replay of the market tumble that began on May 10 and that could beat expectations even if the economy as a whole stalls.
There can't be many of these rarities, so they'll be hard to find. But because they're rare, they should be extra valuable if the pessimism about the 12 months ahead turns out to be justified.
In today's column, I'm naming five stocks that I think fit the bill. They're all relatively inexpensive. They're all projected to show very solid growth ahead. And in each case, that growth is relatively independent of how fast the economy as a whole grows. The growth catalyst at each of these companies is largely internal. (The list is alphabetical and not in order of my preference.)
Play the Product Cycle
There's not much that's more predictable than a software company's upgrade cycle. As products age, sales growth slows, and that slowdown reaches its maximum just before a new version is released. That's because customers virtually stop buying the old version in anticipation of the upgrade. And almost always, growth slows more than the company had projected or Wall Street expected before it picks up again.
This is exactly where
finds itself now. On June 15, the company reported second-quarter revenue below expectations and then lowered its outlook for the full year to between $2.54 billion and $2.6 billion from a prior $2.7 billion estimate. The company's next version of its Acrobat document reader and manager for the Web is due in the fourth quarter of 2006, and the new version of its Creative Suite, which includes the next version of Photoshop, is scheduled for release in the spring of 2007.
This should keep pressure on the stock, pessimists know, until the market starts to anticipate the revenue and earnings growth to be produced by the new products. Wall Street projects 27% earnings growth for the fiscal year that ends in November 2007. The stock recently traded at 22 times projected fiscal 2007 earnings per share.
Bet Against the Hurricane Forecast
Everybody now expects the 2006 hurricane season to be worse than that of 2005. That's a stance attractive to pessimists -- until they remember that whenever everyone expects bad news, they're generally wrong. So, instead of shunning property and casualty insurance stocks, it may be time to embrace them -- or at least one of them:
Hurricanes produced record losses for the insurance industry in 2005. Insured catastrophic losses hit $62 billion last year. This year the record losses of 2005 are producing record premium increases. And a lot of those increases seem to be going to Berkshire Hathaway.
Berkshire Hathaway has increased its property and casualty sales because rivals have been cutting back. In the first quarter, the Berkshire Reinsurance unit showed earned premium growth of 19%. If you're afraid that the hurricane season in 2006 will be as bad as the 2005 season, that doesn't seem like a good reason to buy an insurance stock. Except that premiums have soared so far that in the most damage-prone areas, insurance companies are getting so well paid for the risk that anything short of a true disaster will produce a big bottom-line windfall.
Berkshire Hathaway's prices are as much as 20 times higher than they were a year ago, and on some policies, premiums are so high that they're equal to half the maximum payout on the policy. So far, it looks like Berkshire Hathaway is writing policies only when the price is right. In the first quarter, the company said earned premiums dropped by 14% at the company's General Re unit because it was walking away when premiums weren't high enough to make the risk attractive.
Capitalize on Overeating
Here's a stock that's a pessimist's dream: The more Americans overeat, get fat and increase their rates of diabetes and other kidney diseases that require regular dialysis, the faster
revenue will grow.
End-stage renal disease, an irreversible advanced stage of renal impairment that requires dialysis three times a week or a kidney transplant, increased by 4.3% in 2003, according to the last data available from the U.S. Renal Data System. The compound growth in recent years has ranged from 4% to 6%. The aging of the U.S. population is likely to gradually push that growth rate upward.
As of the end of the March 2006 quarter, DaVita provided dialysis and other services to 98,000 patients through a network of 1,241 outpatient dialysis facilities in more than 40 states. About 50% of the company's revenue comes from Medicare and other government programs. Wall Street projects 20% earnings growth in 2006 and 30% in 2007. The stock recently traded at 20.5 times projected 2006 earnings per share and 15.8 times 2007 projections.
Maryland's Energy Deal
The pessimist in me always expects politicians to pander and to generally muck things up. So, it's no surprise that the politicians in Maryland are falling all over themselves to prove that they're tough on energy prices by bashing the proposed merger between
Constellation Energy Group
At issue, supposedly, is a shift by Constellation Energy's Baltimore Gas and Electric subsidiary to market rates that reflect increases in fuel prices and that would result in a 72% rate increase. BG&E's rates have been frozen for the last two years while other utilities in the state moved to market rates, so this increase would only bring BG&E's rates into parity with other utilities in the state.
The state Public Service Commission has required the utility to phase in the rate increase. Nonetheless, with the mayor of Baltimore (who is running for governor) leading the charge, politicians in the state have called for everything from firing the Public Service Commission to barring the merger of Constellation and FPL.
That uncertainty -- the deal could be delayed until April 2007 -- hasn't helped the stock price of either company. But when the deal is finally approved -- as I think it will be -- it will create a very attractive utility in these days of rising fuel prices.
The combined utility would get a huge share of its power from sources that aren't at the mercy of oil and natural gas prices: FPL Group is the nation's leading producer of electricity from wind power, with about 35% of the market, and a combined utility would be the third-largest generator of nuclear-based electricity in the country.
Wall Street projects FPL Group's stand-alone earnings growth at 10.4% in 2006 and 15.3% in 2007. The stock recently traded at 14.4 times projected 2006 earnings per share and 12.5 times 2007 projections. The stock currently pays a 3.6% dividend.
A Balance Sheet Worth Loving
Earnings gains are fleeting; improved balance sheets are forever. (Well, not really, but I think you know what I mean.)
Mitsubishi UFJ Financial Group
, the biggest Japanese bank in assets, showed record profits for the fiscal year that ended in March 2006, but more importantly to the pessimist, the bank reported a big improvement in its balance sheet. By the end of June, the bank should complete paying back the last of the public money it received in the bailout of the Japanese banking sector. To make the last payment, Mitsubishi UFJ Financial will sell stock -- producing a dilution of about 3% in earnings per share.
Once that debt is off the company's books, however, the bank should be able to execute a share-buyback program and raise its dividend. The bank now pays out an extraordinarily low 6% of income as dividends. (In contrast,
pays out more than 40%.)
Take Your Time
As I've stated repeatedly recently, I don't think you need to be in any rush to buy these. The most likely pattern for the stock market is a bounce-back rally over the next few weeks -- at most until mid-July.
That's likely to be followed by another market decline as investors, who have put the June Federal Reserve meeting behind them, start to worry about the August meeting and the odds of another interest rate increase. August and September are typically terrible months for stocks, and that seasonal pattern will weigh on the equity market as well.
At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Berkshire Hathaway and Mitsubishi UFJ Financial. He does not own short positions in any stock mentioned in this column.
Jim Jubak is senior markets editor for MSN Money. He is a former senior financial editor at Worth magazine and editor of Venture magazine. Jubak was a Bagehot Business Journalism Fellow at Columbia University and has written two books: "The Worth Guide to Electronic Investing" and "In the Image of the Brain: Breaking the Barrier Between the Human Mind and Intelligent Machines." As an investor, he says he believes the conventional wisdom is always wrong -- but that he will nonetheless go with the herd if he believes there's a profit to be made. He lives in New York. While Jubak cannot provide personalized investment advice or recommendations, he appreciates your feedback;
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