David Tepper's 9 Favorite Dow Stocks

BOSTON (TheStreet) -- Dow stocks, still among the cheapest in the U.S. market, are becoming popular investments of value-oriented hedge funds. David Tepper of Appaloosa Management held nine Dow stocks at the end of the fourth quarter. He's perhaps the most closely-watched hedge-fund manager today. Having more than doubled his fund in 2009, Tepper returned about 30% last year. He only buys stocks he considers to be undervalued. Below is an overview of his Dow picks, with a focus on fundamentals and valuation.

David Tepper

9. Bank of America ( BAC) is a diversified financial services company, with retail-, commercial- and investment-banking operations.

Tepper increased his Bank of America stake by 2.6 million shares during the fourth quarter, signaling optimism about the stock's 2011 upside. Bank of America's stock has fallen 2.3% in the past 12 months, underperforming indices. Currently, 21, or 60%, of the analysts covering Bank of America rate it "buy." JPMorgan, ranking the bank "overweight", forecasts a rise of 35% to $20. Deutsche Bank expects Bank of America's stock to fall to $13 during 2011.

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Bank of America swung to an adjusted fourth-quarter profit of 30 cents a share, exceeding analysts' consensus estimate by 41%. But, its top-line figure, at just over $22 billion, missed consensus by 9.6%. The gross margin jumped from 48% to 61% and the operating margin widened from 15% to 24%. Bank of America's stock trades at a forward earnings multiple of 8.1, a book value multiple of 0.7 and a sales multiple of 1.1, 31%, 34% and 40% discounts to financial peer averages. The stock yields just 0.3%, but the dividend is predicted, on average, to triple during 2011.

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8. Cisco ( CSCO) sells networking equipment.

Its stock has fallen precipitously since the fall as, first, 2011 forward guidance missed expectations and, then, fiscal second-quarter margin compression dismayed investors. Cisco's quarterly adjusted earnings decreased 15% to 37 cents, beating analysts' consensus projection by 5.4%. Its adjusted top-line figure climbed 6%, past $10 billion, outperforming consensus by 1.7%. But, the operating margin narrowed from 24% to 16%. Fiscal third-quarter earnings guidance missed analysts' target. Tepper increased his Cisco bet by 36 thousand shares, a modest boost, in the fourth quarter.

Of researchers following Cisco, 27, or 55%, advise purchasing its stock, 21 say to hold and one recommends selling it. Sanford Bernstein rates it "outperform", predicting that Cisco will rally 45% to $27. JPMorgan ranks the stock "neutral" and expects it to rise marginally to $19. Cisco is buying back shares. Its float fell 3% in the fourth quarter. It plans to initiate a dividend in fiscal 2011. Timing is contingent upon repatriating overseas funds at a reasonable tax rate. Cisco sells for a trailing earnings multiple of 14, a forward earnings multiple of 11, a book value multiple of 2.3, a sales multiple of 2.5 and cash flow multiple 10, 59%, 52%, 36%, 40% and 51% industry discounts.

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7. Hewlett-Packard ( HPQ) makes computers, servers and offers outsourcing and consulting services. Its stock has fallen 1% in the past 12 months, underperforming benchmarks. HP is due to release fiscal first-quarter results on Feb. 22.

Its fourth-quarter adjusted earnings advanced 4% to $1.27, exceeding consensus by 4.6%. Sales grew 8.1%, outperforming consensus by 1.5%. HP's quarterly gross margin extended from 26% to 27%. Its operating margin inched up 26 basis points to nearly 11%. Analysts forecast 31% earnings growth in the fiscal first-quarter. Tepper purchased an additional 2.1 million shares of HP during the fourth quarter, nearly doubling his position in the stock.

Currently, 28, or 74%, of the analysts rating HP recommend buying its shares. Citigroup offers the highest target on Wall Street, expecting the stock to rise 43% to $70. Goldman Sachs, on the other hand, ranks HP "sell" and predicts that its stock will drop to $38. Value is compelling. HP sells for a trailing earnings multiple of 13, a forward earnings multiple of 8.4, a book value multiple of 2.6, a sales multiple of 0.8 and a cash flow multiple of 8.9, 37%, 44%, 45%, 74% and 31% discounts to peer averages. A 0.3 PEG ratio indicates a 70% discount based on growth.

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6. Intel ( INTC) is the world's largest chipmaker. Its stock has risen just 4.8% in the past year, despite rapidly improving fundamentals.

Fourth-quarter adjusted earnings of 59 cents beat analysts' consensus estimate by 11%. Its sales outgrew the consensus by 0.8%. Data-center sales increased 15%, sequentially. PC client, Intel architecture and atom revenue remained flat. The CFO noted that the record performance is evident in Intel's 10-year high operating margin of 38%. Tepper's Intel position remained modest in the fourth quarter, at 180 thousand shares, with no expansion.

Of the researchers evaluating Intel, 33, or 61%, rate its stock "buy", 17 rate it "hold" and four rank it "sell." It receives a median 12-month target of $25.13. Raymond James ranks the stock "outperform" and expects that it will climb 45% to $31.50. Jefferies, rating it "underperform", forecasts a drop of 22% to $17. The stock yields 3.3% and its dividend has grown 14% a year, on average, over a five-year span. It sells for a trailing earnings multiple of 10, a forward earnings multiple of 9.7 and a book value multiple of 2.4, 55%, 44% and 39% peer-group discounts.

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5. Johnson & Johnson ( JNJ) is a pharmaceutical, health-care and consumer-products company. Its stock has fallen 4.7% in 12 months.

J&J's adjusted quarterly earnings inched up 1% to $1.03, narrowly missing analysts' consensus estimate by 0.3%. J&J's sales tally missed researchers' target by 2.3%. The gross margin dropped from 73% to 68%, but the operating margin stretched from 21% to 22%. Tepper held 1.2 million shares of J&J at the end of the fourth quarter. His position was unchanged from the third-quarter, though the stock fell 3%.

Of analysts following J&J, nine, or 36%, advocate purchasing its shares and 16 recommend holding them. None say to sell. The stock has a median target of $63.90, consistent with modest upside. JPMorgan, only ranking J&J "neutral", predicts that its stock will rally 15% to $69. Goldman Sachs, also awarding it a "neutral" grade, forecasts that it will fall marginally to $59. J&J yields 3.6%. Its dividend has grown 16% annually, on average, over a five-year span.

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4. JPMorgan Chase ( JPM) is a diversified financial-services company. It is currently analysts' favorite Dow stock, receiving positive reviews from 85% of researchers in coverage.

Its dividend, currently at five cents, is expected to triple in 2011. One researcher, Credit Suisse, forecasts that it will quintuple. JPMorgan's stock has returned 20% in the past year. Tepper initiated a position in JPMorgan in the fourth quarter, purchasing 541 thousand shares. JPMorgan's adjusted fourth-quarter earnings surged 83% to $1.12, exceeding consensus by 12%. The bank's nearly $24 billion of sales missed consensus by 1.9%.

Its gross margin climbed from 60% to 78% and its operating margin rose from 33% to 52%. JPMorgan's tier one common ratio clocked in at 9.8% and its tier three ratio hit 7%. The bank held $33 billion of credit reserves, with a loan loss coverage ratio of 4.5% of total loans. Its stock trades at a trailing earnings multiple of 12, a forward earnings multiple of 8.5 and a sales multiple of 1.6, 23%, 28% and 14% discounts to financial peer averages. Barclays ranks the stock "overweight" and expects it to rise to 25% to $60. Deutsche Bank expects it to hit $52.

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3. Merck ( MRK) is a global pharmaceutical company, manufacturing drugs for humans and animals. Its stock price has fallen 12% in the past 12 months. Tepper's position in Merck went unchanged in the fourth quarter, at 3.7 million shares. Merck's fourth-quarter adjusted earnings increased 11% to 88 cents, beating analysts' consensus expectation by 5.8%. Merck's adjusted top-line figure stretched 20%, beating consensus by 5%. Management is forecasting $3.64 to $3.76 of 2011 earnings, giving its stock a cheap forward earnings multiple of less than 9.

Roughly 65% of the researchers covering Merck rank its stock "buy" while 35% rank it "hold." None rank it "sell." A median target of $38.49 suggests an impending one-year gain of 17%. Credit Suisse awards the stock an "outperform" rating, predicting that it will rise 33% to $44 in the next 12 months. Jefferies ranks it "hold", forecasting a drop of 9% to $29.90. Merck offers a lofty yield of 4.6%, but the dividend hasn't grown since 2004. Merck sells for a forward P/E of 8.4 and a sales multiple of 2.2, 28% and 36% pharmaceutical industry discounts.

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2. Microsoft ( MSFT) is a software company, selling the Windows operating system and Office product.

Its stock has fallen 5% in the past year, lagging behind techn benchmarks and peers. Tepper more-than-doubled his position in Microsoft in the fourth quarter, bringing his share count past six million.

Microsoft's fiscal second-quarter adjusted earnings increased 4.1%, outperforming consensus by an impressive 13%. Its top-line figure passed the consensus target by 4.2%.The entertainment and devices unit grew revenue 55%, helped by solid holiday sales of Xbox 360 and quicker-than-anticipated adoption of the Kinect sensor. The business division boosted sales 24%, helped by outstanding sales of Office 2010, now the fastest-selling consumer version in product history. Microsoft has sold 300 million Windows 7 licenses to-date.

Microsoft is an analyst favorite, receiving positive reviews from 74% of researchers in coverage. Credit Suisse, ranking the stock "outperform", expects it to rise 33% to $36. Barclays, which assigns it an "equal weight" grade, expects a climb to $30. The stock yields 2.4%. Its dividend has grown 12% annually, on average, over five years. Its trailing P/E of 11, forward P/E of 9.8 and cash flow multiple of 9 represent 70%, 65% and 56% software peer-group discounts.

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1. Pfizer ( PFE) is a drug company.

Its stock has gained just 9% in 12 months, but is up 16% in three months. Tepper held steady, with nearly seventeen million shares, in the fourth quarter.

Pfizer's adjusted fourth-quarter earnings declined 4.1% to 47 cents, but beat analysts' consensus target by 2.4%. Its top-line figure outperformed the consensus target by 3.9%. The gross margin dropped from 81% to 69%, but the operating margin held steady at 20%, reassuring analysts. Primary care sales dropped 10%, established products sales fell 14% and oncology sales fell 14%. But, specialty care revenue increased 36% and emerging markets revenue climbed 25%. The best segments were consumer healthcare, which generated 53% sales growth, and nutrition, which grew sales 158%.

Of analysts covering the stock, 20, or 69%, rate it "buy", seven rate it "hold" and two rank it "sell." JPMorgan ranks the stock "overweight" and predicts that it will rise 30% to $25. In contrast, Citigroup rates it "hold", forecasting a modest return to $20. Pfizer yields 4.2%, but its dividend has fallen from a high of 32 cents, last paid in 2009. It costs 19-times trailing earnings, 8.4-times forward earnings and 2.3-times sales, 28%, 27% and 35% peer discounts.

-- Written by Jake Lynch in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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