My Favorite Stocks for 2000

The best companies at the cheapest valuations, according to the Buysider.
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As we brace ourselves for a particularly tedious period of bombast and prognostication on the year and century to come, I thought you might appreciate it if I took the opposite tack. So here are my 10 (actually 11) best ideas now, which ideally will perform well in 2000 so we can all avoid a lengthy refrain of sometimes early, rarely wrong.

I will break it down to five large- and six small-cap ideas (see the

attached spreadsheet for earnings and valuation estimates). This honors the dual roles I play at

Reed Conner & Birdwell

and underscores my increasingly strong conviction that we will look back at the current environment and rank the buying opportunity in U.S. small-cap stocks right up there with:

  • Buying U.S. real estate and banks in 1990
  • Shorting Japanese stocks at 37,000 on the Nikkei and, of course,
  • Owning Internet and Internet-related stocks over the past two years.

I own everything in size on this list, and I hope to be able to say the same thing a year from now, takeovers excepted.

(Note: I agree 100% with Cramer's

article this week on the touting of thinly traded small-cap stocks, and I have kept this list to my more liquid names.)

Large-Cap

Albertson's

(ABS)

: Despite a dismal performance in 1999 partially due to the

FTC's

holdup of its acquisition of

American Stores

, and partially due to the expense of getting its arms around the breadth of the mess at American, Albertson's is exceptionally cheap and as near a low-risk slam dunk as there exists in the large-cap world. This is simply a story of the best management team in an industry taking on the mess of one of the poorer management teams, and I look for it to block and tackle its way to excellence, a skill that Albertson's has had for decades.

And although Albertson's is taking grocery home delivery seriously and test-marketing the concept, it is a joke to suggest that the Internet upstarts will have any kind of a cost advantage vis-a-vis Albertson's in distribution, buying and cost control. And its drugstore division might be worth what on a standalone basis? Which leaves the core business even cheaper.

Equifax

(EFX) - Get Report

: One of the original companies that pursued the now-famous concept of economic value-added, Equifax has put together a superb record of growth by leveraging its core franchise of credit reporting into new and value-added product lines. Equifax's earnings growth slowed in 1999 due to some problems (now mostly fixed) in its European division and turmoil in Brazil, where it bought itself a leading position, albeit three months too soon. It boasts exceptional free cash-flow generation ability, international growth and yes, Mom, even Internet ventures.

Gartner Group

(IT) - Get Report

: A chicken tech stock that will have some fundamental bumps in the first half of 2000, but as previously

noted, it boasts franchise value in the brand name, in the number of tech-savvy bodies under one roof, and is a free cash-flow machine to boot. Besides, it is one of the cheapest real businesses in the tech world.

ServiceMaster

(SVM) - Get Report

: This used to be considered one of the great steady growth stocks, with management lauded by Peter Drucker, a 20% return on equity and, again, exceptional free cash-flow generation. A tough weather year (which hurt pest control, lawn care, etc.) plus slower results on its nursing home business (written off in 1999, which was our catalyst to buy) has priced the stock like it's now the dumbest group in town. Kind of like

Motorola

(MOT)

at 45 a share.

ServiceMaster will sell at 30 times earnings again once the "holds go to buys." Earnings are understated by 23 cents per share due to goodwill charges (at last -- an example of a consolidator that uses purchase accounting!), so it's cheaper than it looks. The highest quality at a discount.

Tricon Global Restaurants

(YUM) - Get Report

: An enormous economic value-added story as management sells off its capital-intensive, company-owned store base and replaces it with a consistent stream of high-return, free cash flow from franchisees. Again, look under the reported numbers for real operating earnings. This time they are overstated by gains, but the stock is still a great value at current levels. It was pummeled to near-death in 1999 thanks to woes at the company's formerly largest shareholder,

Tiger Management

. Is it

McDonald's

(MCD) - Get Report

? No. But it's more than half McDonald's on a valuation basis.

Small-Cap

ACNielsen

(ART)

Information Resources

(IRIC)

These two own 95% of a duopoly providing consumer products companies with buying habits and consumer information that power marketing and sales dollars. There is a very good conceptual case to make that each should have enough room to price responsibly and earn excess returns for shareholders. ACNielsen has performed decently, but remains reasonably priced, and has an Internet side

to boot.

Information Resources has a new CEO, a European division that currently bleeds red ink, and whose turnaround in progress would represent a huge swing in earnings. The one caveat: There is a billion-dollar lawsuit between the two. A settlement anywhere in the middle of 2000 would benefit Information Resources immensely, as well as relieve an overhang on ACNielsen.

Horace Mann Educators

(HMN) - Get Report

: A unique beast in the insurance world as it has carved out an agent-driven niche in selling life and property-casualty insurance to the educators' market, with an expense base hundreds and hundreds of basis points below the industry average. Management annoyingly put the company up for sale just before the insurance stocks tanked in the third quarter -- and right in the midst of confusion generated around whether

Congress

would pass the financial de-reg bill, HR-10.

When it pulled the deal off the table, the stock tanked. This is a temporary lull, and you should consider it a gift: Management will put the company up for sale again in 2000, and the price will begin with a 3.

Littelfuse

(LFUS) - Get Report

: It makes, well ... fuses ... of all kinds and all sizes. Littelfuse is a simple play on the worldwide growth of electronics in

everything

: leading market shares, high returns on capital, free cash flow and high margins. Earnings and the stock tanked in the Asian crisis and the stock has badly lagged the fundamental improvement of its underlying businesses. Another EPS number understated by 35 cents per share of goodwill charges. A wonderful little company that is not getting any respect.

Superior Industries

(SUP) - Get Report

: The CFO has a plaque on the wall that was awarded to Superior some years ago for being one of the top 100 growth stocks of the decade (the classic sign of a top). That was based on Superior's outstanding performance (based on lowest cost and highest reliability) as the largest supplier of aluminum wheels to the auto industry. There is now a second leg to the story as aluminum is moving off the wheels and increasingly into car bodies. This is a major 10-year trend, and Superior is right in the middle of it. Meanwhile, you are paying nearly nothing for it.

UCAR International

(UCR)

: The process of value investing is sometimes akin to looking for the diamond in a mound of manure. I present to you UCAR International, which I would roughly describe as the

Gillette

(G) - Get Report

of the mini-mill steel industry. It's the worldwide leader in selling replacement graphite electrodes, which are crucial in the process of mini-mill steel making. Over the past three years, it has survived paying the largest fine in

Federal Trade Commission

history, and what some have described as the worst steel slump in the postwar era. Yet it earned close to $2 per share. With a very tough new CEO who claims to be able to nearly double earnings on little industry improvement and a debt restructuring in the first quarter of 2000, it will be interesting to see the numbers.

That's that. Look them up, decide for yourself, and I'll see you here a year from now, hopefully with smiles.

Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long all of the stocks in this column, including Albertson's, Equifax, Gartner Group, ServiceMaster, Tricon Global Restaurants, ACNielsen, Information Resources, Horace Mann, Littelfuse, Superior Industries and UCAR International, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at

jbronchick@rcbinvest.com.