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Pharmaceuticals, energy, and defense -- investors should look in those three areas for stock values, in the view of John J. Garrity, associate research director of Investec Ernst & Co. Garrity thinks it's time for caution in the market because the bears may be approaching, though he remains optimistic about the economy as a whole.
His favorite stocks include Pfizer in pharmaceuticals, Centocor in biotech, Sprint in telecom, and Global Marine and Kerr-McGee in oil services, as well as United Industrial in defense electronics. In technology, he would avoid "pricey" stocks such as Cisco and focus on issues that have come down significantly.
Garrity was the guest in a June 15 America Online chat presented by Business Week Online. The following are edited excerpts of his answers to questions posed by Jack Dierdorff and Amey Stone of BW Online and by the audience. For a complete transcript of the chat on AOL, go to keyword: BW Talk.
Q: John, the stock market has been rallying moderately. Do you think the bull is marking time, or perhaps waiting to give way to the bear?
A: I think probably waiting to give way to the bear. We believe that there's more than a 50-50 chance that Greenspan will raise rates at the upcoming June 28 FOMC meeting, and most investors are betting that rates will not be raised.
Q: Given that you're siding a bit more on the bearish side now, which sectors do you think investors should emphasize?
A: I think investors should remain cautious and defensive, and in this particular market environment, we favor the pharmaceutical sector as well as the oil and oil-services sector, because of the recent surge in oil prices.
Q: Right to one of the hottest areas in tech: What do you think of the fiber-optic sector? A: We tend to look not so specifically at fiber optics but rather at the telecommunications sector as a whole. Within the sector, we see wireless as leading the charge because earnings in the wireless group are expected to rise at about twice the rate of the fixed-line telecommunications stocks...
Q: So what do you like in the wireless area?
A: We think that Sprint [PCS] is a good choice. The company is down 11% this year, largely on concerns that regulators might stop WorldCom [WCOM] from buying the company. We do think the deal will go through, and therefore Sprint stock will be a big winner. We also like AT&T [T] because it, too, is down 30% for the year, but we think we should see surging revenue from the sale of high-speed Net connections, and there is the possibility that AT&T will create a tracking stock for its cable-TV unit.
Q: And, backing up, what are your pharmaceutical favorites?
A: ...By far my favorite would be Pfizer [PFE]. I would say that Pfizer's merger with Warner-Lambert [WLA] will create the world's second-largest pharmaceutical maker -- the combined company should achieve compounded annual earnings growth of over 25% through the year 2002...
Q: What do you like in biotech? A: ...We think the best company is Centocor, which is owned by Johnson & Johnson [JNJ]. We also like Biogen [BGEN] and Amgen [AMGN] as well.
Q: How would you play tech and Net stocks now? A: Technology stocks in general were ridiculously expensive in March -- and now are very expensive. As a general rule, we would avoid the high p-e stocks and focus more on growth at a reasonable price. We believe that investors can no longer throw a dart at the tech sector and expect to make money. We think there is further shakeout to come in the Internet sector, and therefore, we would focus on stocks that have already come down.
Q: John, you've told us to look for stocks that have already come down, in the Internet sector at least. Would you describe yourself as a value investor? What is your main strategy for picking stocks?
A: I would not classify myself as a value investor, per se. We tend to look at the underlying fundamentals of a company, the technical trends of the sector as well as the specific stock, and weigh these against historical data...
Q: What are your thoughts on Cisco [CSCO]?
A: ...We would avoid pricey stocks like Cisco. However, we believe the company will hold on to at least 75% of the high-end router market, which we believe can grow to almost $2 billion this year and $10 billion by 2003. We think the stock could hit $75 by the end of the year if we see a rebound in the markets overall.
Q: Any recommendations in the semiconductor industry? A: Semiconductor stocks, like the rest of the tech sector, have tumbled by a third over the past few months. My favorite stock, if I had to pick one in the group, would be Texas Instruments [TXN]. Over the past several years, the company has eliminated most of its unprofitable businesses, such as memory chips, and has focused more on digital signal processors. These chips are found in nearly every product from cars to cell phones to toys.
Q: Early on you said you liked energy -- what are your picks there? A: ...Our two favorite stocks are Global Marine [GLM], which is showing improving rig-utilization rates, and its two largest markets (the Gulf of Mexico and West Africa) are showing accelerated growth. We expect year 2000 earnings to be 60 cents, with $1.25 forecast for 2001. Our other favorite stock is Kerr-McGee [KMG], whose stock sells at only 10 times estimated earnings and is expected to earn $6 a share for 2000 and sells at 4 times estimated cash flow of $16 per share.
Q: How about the defense stocks? A: We like the defense industry, mainly because, for the first time since Ronald Reagan's Administration, defense budgets are going up, not down. We also believe that the possibility of a new Republican Administration bodes very well for defense stocks as a whole. We believe that there will be a second round of consolidation in the defense industry...we see them now switching their focus to some of the smaller, more specialized defense-electronics companies. We are currently recommending a company by the name of United Industrial Corp. [UIC], which is a leader in this specialized field...
Q: Inevitably, considering the news, what about MSFT [Microsoft]? A: We think the worst is behind Microsoft, and we see the stock as a very compelling buy at these levels. As time passes, the business value of Microsoft will be increasing at 20% to 30% rates per year. If a remedy to break up the company is ever enforced on Microsoft in the future, Microsoft will be larger and financially stronger...
Q: Over to the consumer area, what about WMT [Wal-Mart]?
A: We like Wal-Mart. Wal-Mart has been able to buck the trend of declining sales in the retail sector, experiencing a 7.4% rise in sales this past May. Wal-Mart is presently entering the food business, and within five years the company could develop into one of the biggest grocery-store chains in the market. Currently, Wal-Mart trades at a p-e multiple of 36, which does not appear quite that excessive when you consider the company's dominant market position and growth rate of 18%.
Q: Can you give us a final four or five favorite stock picks, John?
A: These stock picks are what I would term "special situations": No. 1, Andrea Electronics [AND]. No. 2, United Industrial [UIC]. No. 3, 3Com [COMS]. No. 4, Ziff-Davis [ZD]. No. 5, Zila Pharmaceuticals [ZILA].
EDITED BY JACK DIERDORFF
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