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Look for the 'boring industries' to excite
in 2004
Heydon Traub, Boston Business
Journal, March 5, 2004
In the last article I wrote, I
included general forecasts for the top 10 investment risks for the year. For
the most part, these were not specific about sectors, so I am back this time
with some specific sectors and industries that should do well over the next
year, and a few that will likely lag.
We have already had a good start to this year, and the favorable interest
rate environment, strong economic growth and high earnings growth should
lead to good stock market returns for the rest of the year (I would estimate
about another 10 percent gain in line with earnings growth will likely come
through this year).
However, as always there will be certain areas of the market that do even
better.
The positives
Homebuilding and related stocks such
as those providing mortgages, title insurance and building products have had
a great run over the past few years, even through the severe bear market.
Normally, I am not likely to favor investments that have had such good runs.
But in this case, the earnings have exploded to the point where the stocks
still are cheap relative to expected earnings. This has occurred due to the
fact that many investors believe we have had a housing bubble and it will
soon burst. But another view, including mine, is that we are not in a bubble
about to burst. Yes, the housing market is likely to cool from what was a
torrid pace, but for most of the housing-related stocks, a modest slowdown
is expected and would still leave the stocks trading too cheaply.
The following are some specific industries to invest in.
The thrifts and mortgage industry trades at a price-to-earnings ratio
(earnings noted here and below are for the current year) of just 10. This
reflects only 4 percent earnings growth for this year, so expectations are
not hard to meet this year. Household durables also are priced reasonably at
a p/e of 12. Growth is expected to come in at 13 percent -- higher than
thrifts, but still a moderate expectation to reach.
A somewhat related industry that looks cheap here is insurance. As a whole
it trades at a p/e of just 13, although that is predicated on a lofty 27
percent growth in earnings this year.
Other positives for this industry are in the life insurance area. People are
living longer and official actuarial tables have recently been updated to
reflect this. As people live longer than expected relative to when policies
are written, this leads to higher profits for the insurers.
Another area that some investors feel is near a peak in its business is
automobiles. This view is what makes them cheap. Autos trade at a p/e of
about 10, and again, growth expectations are a reasonable 12 percent. Autos
usually trade at a discount to the market due to their typically lower
growth over time and the cyclical nature of their earnings. However, they
seem to be priced assuming that sales levels have peaked.
Yet, there are two positives to counteract that view. First, interest rates
are likely to remain very low throughout this year, which helps keep
payments and leases low and spurs sales. In addition, there are probably
more new models or revamped models coming in the next year than at anytime
in the past.
The last area of note is the health care provider and services industry. As
a whole it trades at a p/e of 16 based on expected earnings growth this year
of a reasonable 13 percent.
In particular, HMOs are priced very reasonably, as many trade around 10
times earnings. They have had very good earnings and cash flow growth in
recent years, and although that pace is likely to slow, earnings are still
likely to grow. At a p/e of just 10, any earnings growth will likely push
prices higher.
And now, the negatives
The one sector that everyone likes to
talk about is technology. However, there are very few stocks there that are
good value despite a modest decline over the past few weeks. For example,
semiconductors are priced at 30 times earnings, and that assumes earnings
will more than double this year -- an expected earnings growth rate that is
very tough to accomplish. Even if earnings do double, it still leaves these
stocks trading at p/e's almost double that of the market.
Internet stocks make the semis look cheap. Internet software and services
trades at a p/e of 87. And that assumes earnings grow by 43 percent.
Similarly, Internet and catalog retail (includes companies like E-bay and
Amazon) is at a p/e of 64 based on expected earnings growth of 46 percent.
Lastly, be leery of wireless-telecom stocks. These stocks have had a great
run during the frenzied bidding for AT&T Wireless. The view was that if AT&T
Wireless is worth that much, then these remaining wireless stocks must be
worth more than originally thought. The reality is that AT&T Wireless will
likely turn out not to be worth what Cingular paid. The industry trades at a
p/e of 32, and that assumes earnings grow 62 percent this year.
As is often the case, look for stocks in the "boring" areas of homebuilding
and related stocks, insurance, HMOs and autos. And don't get caught up in
the minibubble that tech stocks and wireless are playing out now -- in a
toned-down rerun of the original bubble.
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