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This column was originally published on RealMoney on Feb. 21 at 8:51 a.m. EST. It's being republished as a bonus for readers.

I don't try to predict the market, and I'm not going to start now. But there is a theme starting to emerge in the market that I believe is worth noting. In fact, others have been singing its praises for some time, though their timing has been off. I'm referring to the prospect that large-cap stocks might rise again and start outperforming small-caps.

Yes, you've heard this before, but indications are that this time, it really might prove accurate -- no guarantee, but large-caps do seem to currently trade at discounted valuations, which could indicate they will start outperforming the market. And to help you put this idea into action, I've chosen some large-cap stocks that are selected by the guru strategies I follow as attractively priced. More on them in a moment.

The Rationale

What makes me believe large-caps might soon start to shine? In December,

BusinessWeek Online

reported it had surveyed market strategists, and a


editor said about the survey results: "Small-cap stocks have outperformed large-caps for seven years now, and even though every year the pundits keep calling for a change, this year seems more promising because the profit outlook is slowing. In addition, real interest rates are rising. Those two forces tend to favor large-caps, and they're happening now in earnest."

In another survey, Russell Investment Group found that out of 112 U.S. money managers, 80% favored large-cap growth stocks above all others. Managers have never before been so heavily in favor of one investment style.

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The director of U.S. equity research at Standard & Poor's has publicly stated, "large capitalization stocks are poised to resume a leadership position in 2006, following six years of underperforming the S&P MidCap and S&P SmallCap Indices."

The chief U.S. stock strategist at Goldman Sachs has been quoted in the press as predicting the

S&P 500

index will hit 1,400 and the

Dow Jones Industrial Average

12,000 in 2006. The S&P closed last year at 1,248 and is now about 1,280, while the Dow closed at 10,717 and is now about 11,060. If she is right, the Dow will go up 12% this year, while the S&P will increase about 9%. These indices, of course, are essentially made up of large-caps.

TheStreet Recommends

There's also a theoretical underpinning to the idea that large-caps should be performing well here. It's based on the simple idea that large-caps tend to grow more slowly than small-caps. Whoa! Why would large-caps do well in a market that loves growth? In an interview in

TCS Daily

, Jeremy Siegel, of Wharton Business School and author of

Stocks for the Long Run

and more recently,

The Future for Investors: Why the Tried and True Triumph Over the Old and New

, made the observation that, over the long run, companies with high growth tend not to do as well for investors as those with lower growth.

The reason for that, says Siegel, is investors pay a premium price, as measured by the price-to-earnings ratio, for companies with high growth. The market likes growth and therefore charges more for companies enjoying considerable growth: You


for that growth; it's not free. Plus, slow growers often pay higher dividend yields than fast growers. This combination of cheaper price and higher yield results in a better return for investors from lower-growth companies, and most large-caps are in the lower-growth category.

What does one make of all this? Large-caps have been out of favor for years, and many are low-growth. Combine these factors and it seems likely that large-caps will soon return to favor and over the long-term, particularly given today's prices, should do well for investors.

The Picks

So which large-caps are most likely to be star performers? Here, I've put my guru strategies to work. I started by running the 30 stocks that make up the Dow Industrials through the guru strategies. From the analysis that came back, I picked the stocks that received the highest ratings. Let me discuss several of these.


(C) - Get Citigroup Inc. Report

, the country's largest bank, is a favorite of the strategy I base on Peter Lynch's writings. It's considered a "true stalwart" because, of course, it grows at a moderate (11.4%) rate. (A company needs to grow at a rate of 20% or more to be considered a fast grower under this strategy.) Citigroup's yield-adjusted P/E/G ratio, which compares the P/E ratio with the company's growth rate, is 0.75. That's just fine, as this number needs to be 1.0 or less to be acceptable to this methodology.

Another criterion of my Lynch strategy is that EPS be positive, which it is for Citigroup, at $3.83 (2005 EPS). This methodology uses the equity-to-assets ratio as a way to determine a financial intermediary's health. The minimum for this is 5%, which Citigroup easily surpasses with its E/A ratio of 8%. The final criterion is return on assets. This measure of profitability must be at least 1%, and Citigroup's is 1.37%. Citigroup passes all of the Lynch strategy's criteria.

Home Depot

(HD) - Get Home Depot, Inc. Report

, the giant home-improvement retailer, gets the nod from the strategy I base on Warren Buffett's approach to investing. The first thing the Buffett strategy wants to know is if the company is a "Buffett-type" company, which means it is dominant in its industry or otherwise has important competitive advantages. Home Depot is the largest player in the home improvement market and is the country's second-largest retailer after


(WMT) - Get Walmart Inc. Report

. It definitely is a Buffett-type company.

The strategy wants earnings to be predictable -- rising every year for the last 10 years. That's true of Home Depot. The strategy likes conservatively financed companies. Home Depot has a debt of $2.7 billion and earnings of $5.5 billion. That means it could pay off its debt in less than six months, which is considered exceptional.

The Buffett strategy likes companies with a return on equity of at least 15%. The average ROE for Home Depot over the last 10 years is 17.4%, which is high enough to pass. But it is not enough under the Buffett methodology that the average be at least 15%; for each of the last 10 years, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last three years must also exceed 15%. Home Depot's ROE has never dipped below 14.7% during the past 10 years, and averaged an impressive 19.2% over the past three years.

Another criterion relates to how management has spent retained earnings. Has it spent earnings in a way that benefits shareholders? To figure this out, the strategy takes the total amount of retained earnings over the previous 10 years of $9.63 and compares it to the gain in EPS over the same period of $1.92. Home Depot's management has proven it can earn shareholders a 19.9% return on the earnings it kept. This return is more than acceptable. Essentially, management is doing a great job putting the retained earnings to work.

As you can see from the above calculations, Home Depot is in fine financial health. But that's not enough. It has to be priced well, which hearkens back to of Siegel's emphasis on paying attention to not just the company and its growth but also the price you must pay for the stock. The strategy uses a couple of different methods to calculate an expected return on investment given the stock's price and projected earnings growth. The bottom line is one can expect about a 13.7% return from Home Depot. The strategy would like this to be 15%, but this is close enough, and given Home Depot's market and financial strengths, this is an acceptable level of anticipated return.

A third large-cap stock to consider is the venerable consumer products giant,

Procter & Gamble

(PG) - Get Procter & Gamble Company Report

. The strategy I base on the writings of James P. O'Shaughnessy believes this company is a winner. One reason is that P&G's big -- very big, in fact, with a market cap of more than $195 billion. Second, it has strong cash flow. To be at an acceptable level, the company's cash flow per share must be greater than the mean of the market cash flow per share. The market's is 25 cents, which pales next to P&G's $3.70.

This particular strategy looks for companies whose total number of outstanding shares is in excess of the market average, which is 625 million shares for the market as defined by the S&P 500. These are the more well-known and highly traded companies. P&G has more than five times the market's average, with 3.5 billion shares outstanding.

A company's trailing 12-month sales are required to be at least 1.5 times greater than the mean of the market's trailing 12-month sales. The market's is $17.2 billion, while P&G's is more than 3.5 times that at $61.7 billion.

The final step is to select the 50 companies from the market leaders' group (those that have passed the previous four criteria) that have the highest dividend yield. P&G, with a dividend yield of 1.89%, is one of the 50 companies that satisfy this last criterion.

Citigroup, Home Depot and Procter & Gamble are all companies that are large, not tremendously fast-growing and priced right. Companies like these offer excellent long-term investment opportunities. By the way, other large-cap stocks that find favor with the guru strategies are


(CAT) - Get Caterpillar Inc. Report



(MCD) - Get McDonald's Corporation Report



(DIS) - Get Walt Disney Company Report


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As originally published, this column contained an error. Please see

Corrections and Clarifications.

At the time of publication, Reese was long Citigroup and Home Depot, although holdings can change at any time.

John P. Reese is founder and CEO of, an investment research firm, and Validea Capital Management, an asset management firm serving affluent investors and companies. He is also co-author of the best selling book,

The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best

. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback.

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