Six-Pack of Premium Stocks at Discount Prices

BOSTON ( TheStreet) -- IBM ( IBM), Johnson & Johnson ( JNJ) and Wal-Mart ( WMT) are among premium stocks languishing in the bargain bin, says Hank Smith, chief investment officer of Haverford Investments.

But not for long, he says.

Quality companies -- those with sound businesses, long track records, competent management and large dividends -- typically sell for a premium, whether in the stock market or the supermarket. Investors have fancied small-cap stocks, as well as sectors including technology and commodities, leaving blue chips by the wayside.

Smith says his strategy has collected a group of six value stocks make up what he affectionately calls a "six-pack," offering a different type of flavor for investors than a six-pack of beer.

"The concept is that the U.S. large-cap quality space has been more or less ignored for the past 10 years," Smith says. "There were many years when the space was a relative underperformer, but business fundamentals have not underperformed. So you look at companies where you've seen tremendous growth of earnings in the neighborhood of 170% to 300% with very similar dividend growth."
Hank Smith
Hank Smith, chief investment officer of Haverford Investments

Stock prices are out of line with business fundamentals to a degree, Smith says. That means price-to-earnings ratios, a key valuation tool, have been compressed.

In addition to earnings multiples, Smith also looks for stocks that have barely budged over the past 10 years. The companies must have increased earnings two- or three-fold over that time while increasing dividends by the same magnitude. Finally, they must have exceptional balance sheets and good fundamental prospects.

The strategy has paid off for Smith and clients of Radnor, Pa.-based Haverford Investments. With $6 billion in assets under management, Haverford serves wealthy and institutional clients. Since inception, the firm has outperformed its benchmark, the S&P 500, in 19 of 20 rolling 10-year periods.

"We're not trying to hit home runs," Smith says. "Where this strategy and the quality of investing hold up is particularly in down markets. We keep up when the market is up, but we hold up much better in the down markets."

Smith expects this strategy to pay off as the stock market reverts to the mean after the so-called "lost decade," when U.S. stock indices like the S&P 500 and the Dow Jones Industrial Average returned nearly nothing to investors over the past 10 years.

"It's hard to think you're going to have another 10 years of the stocks going nowhere. If we did, we'd have P/E ratios down to four or five times earnings," Smith says. "Part of this strategy tries to build the intellectual case for the low probability for another lost decade. In doing that, we emphasize that the past 10 years wasn't a lost decade in terms of fundamentals."

Here are six large-cap value stocks that Smith holds in client portfolios.

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Company Profile: IBM is the world's biggest computer-services provider.

Closing Price: $138.85 (Oct. 8)

Current Dividend: 1.9%

Smith's Take: "IBM has a tremendous global exposure, particularly to emerging markets. As we look forward to the drivers for earnings growth, having global exposure will be an important theme. IBM has transformed itself over the past 10 years from hardware-oriented to service- and software-oriented. That has resulted in greater predictability of earnings."

Analyst Consensus: Seventeen of 22 analysts with coverage of IBM rate the stock a "buy." The other five say investors should hold on to shares.

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Johnson & Johnson ( JNJ)

Company Profile: Johnson & Johnson sells consumer products including Tylenol, Rolaids, Imodium, Band Aid and Rogaine.

Closing Price: $63.23 (Oct. 8)

Current Dividend: 3.4%

Smith's Take: "You have exceptional financial strength and cash flow with this company. In the health-care space, you get tremendous diversification with J&J, thanks to the pharmaceutical, medical supplies and consumer products as well as global-markets exposure. Part of what has impacted J&J is the whole debate over health-care reform. Also, earnings growth recently has decelerated. That said, we expect over the next three to five years that earnings growth can get back into the double digits from where it is now in the single digits."

Analyst Consensus: Fourteen of 21 research firms covering J&J say investors should buy shares. The other seven have a "hold" rating.

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Wal-Mart ( WMT)

Company Profile: Wal-Mart is the world's largest retailer, operating Walmart discount stores, supercenters, Neighborhood Markets and Sam's Club locations in the U.S.

Closing Price: $54.41 (Oct. 8)

Current Dividend: 2.2%

Smith's Take: "Wal-Mart is the largest retailer, and in some respects that may be a mark against it. In the U.S., it has gone everywhere that it can go. But there is an international growth story to Wal-Mart. As an example, they recently announced an acquisition in South Africa. But the downside, given the valuation, is very limited in our view. You're looking at a company selling at 12 times earnings over the next 12 months. You are getting earnings growth and tremendous financial strength. What you're going to see with Wal-Mart is more aggressive dividend hikes. They've already done so much build out in North America that they can now focus on returning more capital to shareholders, like what we saw with McDonald's over the last few years."

Analyst Consensus: Nineteen researchers have a "buy" rating on Wal-Mart while only one analyst has a "sell" rating on shares. Another six firms say investors should hold shares of the retailer.

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Walt Disney ( DIS)

Company Profile: Best known for Mickey Mouse, Disney is an entertainment company with operations in media, resorts, studio entertainment and consumer products.

Closing Price: $34.51 (Oct. 8)

Current Dividend: 1%

Smith's Take: "It's certainly one of the most recognizable brands in the U.S. and, now, globally as they gain more exposure in Europe and Asia. You have terrific management at Disney. We actually purchased Disney in early 2009, when we were still in the recession mentality. At the time, no one at our firm was entertaining thoughts of going to Disney World. That was exactly the time to buy the stock. Even though that was last year, it still has tremendous potential."

Analyst Consensus: Disney garners 12 "buy" ratings from analysts covering the stock and another 13 "hold" ratings. Only two researchers covering the stock say investors should dump shares.

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Exxon Mobil ( XOM)

Company Profile: Exxon Mobil is the largest U.S. oil company.

Closing Price: $64.38 (Oct. 8)

Current Dividend: 2.7%

Smith's Take: "Even with the incredible move in the energy sector in the last few years, Exxon Mobil's appreciation has been 59% over the past 10 years while earnings have grown cumulatively by 485%. Exxon has been an outperformer of the broad markets in every decade since the 1950s. That is remarkable. It is arguably the best-managed company in the entire oil sector. It is a core long-term holding in any portfolio, and you're getting it now at 10 times earnings."

Analyst Consensus: Seven analysts have a "buy" rating on Exxon, and another 11 firms have a "hold" rating. No analyst following Exxon says investors should sell shares.

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Procter & Gamble ( PG)

Company Profile: Procter & Gamble sells consumer-packaged goods including Duracell, Old Spice, Bounty, Gillette and Pampers.

Closing Price: $61.86 (Oct. 8)

Current Dividend: 3.1%

Smith's Take: "It is the best marketing company, perhaps ever. P&G has incredible brands, incredible management of brands. It's a bit under pressure right now because this recessionary environment has caused a trade-down effect. That's not unusual at this point of any cycle. So you can get a company that has grown earnings cumulatively at 189% over the past 10 years. You've had dividend increases of practically the same magnitude as earnings growth. The stock is selling at 14 times next year's earnings. It has great management and great financial strength. In addition, P&G has tremendous global reach. That's an important factor because of the creation of a middle class, one with purchasing power. As this continues in places like China and India and wealth develops, people will want quality and brand-name products. Right now, they're fighting the trend toward trading down to less expensive generic products, but that's a short-term cyclical phenomenon. The secular phenomenon will be the global creation of wealth, which plays into great brands."

Analyst Consensus: Eighteen of the 24 analysts with coverage of P&G rate the stock a "buy." The other six researchers say investors should hold shares.

-- Written by Robert Holmes in Boston.

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