Scouring Among Blue Chips, Here are 20 Great Picks for ’99

The challenge: Find the 20 best stocks to buy for 1999.

Our strategy: Devise a scoring system based solely on statistics that have been shown to be profitable indicators of future stock movement. No garbage in, none out.

We began by limiting our search to big stocks, using the top 200 companies in the Standard & Poor’s 500 index based on market capitalization (stock price times shares outstanding). We did this for two reasons: first, to offer an opinion on widely followed stocks; but mainly, since the S&P; 500 is the blue-chip benchmark most investors are measured against, why not get a boost by using S&P;’s own universe? The index has been hard to beat: These folks know how to pick winners.

We call our list ‘The Growlue Portfolio’ because it gives equal weight to the two main schools of stock selecting: growth, which emphasizes shares with rising earnings and strong prices; and value, which focuses on overlooked or underappreciated equities.

The ranking process was a kind of mathematical sausage-making. We chose six factors, sorting them into three categories: growth, value and combination. The growth stats were used to rank the stocks from 1 to 200 in that category, then similar calculations yielded rankings for the value and combo categories.

Finally, all three rankings were averaged to produce our 1-to-200 ranking, with the top 20 making up the portfolio listed here. The ranking of all 200 stocks is available on The Times’ Web site at http://161.35.110.226/beststocks.

Analyst Mark Draud of Houston-based research firm Telescan Inc. compiled the bulk of the data, using figures through Dec. 21, but we also included earnings forecasts from IBES Inc. and “Timeliness” rankings from the Value Line Investment Survey, a weekly publication that scrutinizes 1,700 stocks.

The Growth Factors

To compute the growth ranking, we started with one-year price performance, a yardstick author and money manager James O’Shaunessy found to be a potent predictor in his book “What Works on Wall Street,” which analyzed 45 years of market data.

It might seem counterintuitive to favor stocks that have just had a big run, but proponents of price performance--also known as relative strength--aim to buy high and sell higher.

Relative strength can be measured many ways, but we simply took the share price percentage change over the last 52 weeks. Some investors use shorter periods, such as 13 or 26 weeks, but Richard Bernstein, chief quantitative strategist at Merrill Lynch & Co., said his research shows that ‘the longer the time frame, the better. In shorter spans, weird things can skew the results.’

We assigned 200 points to the top price performer, America Online Inc., 199 points to second-place Dell Computer Corp., and so on down to 1-point Sara Lee Corp., whose price shrunk by nearly half last year.

Then we adjusted the points for each stock based on “earnings momentum” in four categories:

* The change over the previous 30 days in analysts’ estimates of per-share profits for the fourth quarter of 1998.

* Whether analysts projected positive, flat or negative earnings for 1999.

* The change (either up or down) over the previous 30 days in estimated 1999 earnings.

* The change (either up or down) in estimated earnings this year versus 1998.

For each of those four variables, we added 25 points for a positive change or total, subtracted 25 points for a negative change or total (such as a projected loss), or made no adjustment for flat earnings or no revision.

Joseph J. Abbott, equity strategist at IBES, notes that stocks with rising earnings estimates outperform the S&P; 500 over the next year, on average, while those with falling forecasts trail the index. And hardly anybody likes stocks of companies that lose money--unless they’re super-patient or selling short.

After making the adjustments, the stock with the highest point total got the No. 1 growth category ranking, and so on down the list.

The Value Factors

To compute the value ranking, we started with price-to-earnings ratios. Research by Merrill’s Bernstein shows that, over the last decade or so, they have had the most predictive power of any valuation tool for S&P; 500 stocks.

P/E is stock price divided by most recent 12 months’ earnings per share. The higher the P/E, the more investors are willing to pay for a slice of the company’s profit; the lower the P/E, the more out-of-favor the stock. Value investors believe stocks with low P/Es offer more stability and upside than highfliers.

O’Shaunessy also found P/E useful, but price-to-cash-flow ratio is even more potent when looking at large caps. P/CF measures stock price divided by cash flow--or net income plus depreciation--per share. Though the tools are similar, some consider price to cash flow truer than P/E because, they say, it’s harder to manipulate through accounting.

Some say “tomayto,” some “tomahto.” We compiled 1-to-200 lists for both measures, then averaged them to get the final value ranking.

The Combo Factors

O’Shaunessy’s research found benefit in combining growth and value measures. He recommends, for example, screening for stocks with high relative strength and low price-to-sales ratios. To compute our combination ranking, we started with the PEG ratio, or P/E divided by annual earnings per share growth rate. The PEG is a simple way to gauge value and growth characteristics in tandem.

Some know it as “The Fool Ratio,” in the parlance of the Motley Fool Web site. The Fool suggests looking for stocks with ratios of 0.5 or less--in other words, those with growth rates twice as high in raw numbers as their P/Es--though that’s a strict standard in today’s growth-tilted market.

The PEG is the stock screening version of pasta primavera--everyone’s recipe is a little different. Some use P/Es based on the trailing four quarters, but estimated earnings growth for the current year; others use year-ahead projections for both P/E and earnings growth.

We took the advice of Bernstein, who said the latest research shows that the best combination is five-year earnings projections with trailing 12-month price-to-earnings ratios, since “using projections on projections can compound errors.”

We then adjusted the PEG ranking by adding or subtracting points based on Value Line’s 1-to-5 Timeliness ratings, which project performance for the next 12 months based on a variety of statistics. The publication’s analysts assign the top 100 stocks it covers a “1,” the next 300 a “2,” the middle 900 a “3,” the next 300 a “4” and the bottom 100 a “5.”

The team uses a secret formula, but this much is clear: Stocks rated 1 and 2 have consistently beaten the broad market for the last several decades, while those rated 4 and 5 have routinely under-performed.

We added 100 points to the publication’s top-rated stocks, 50 to the second tier; made no adjustment to those in the middle group or unrated by the publication; and subtracted 50 from the fourth tier, 100 from the bottom set. (Value Line doesn’t rate certain major stocks because they have short trading histories or for other reasons.)

The stock with the most points was ranked No. 1, and so on.

Then we took some aspirin and tallied the lists to produce the overall order.

The Top 20

Our portfolio leans toward the investment, lending and insurance industries, probably because they carry reasonable valuations. Eight of the companies--Cigna Corp., Morgan Stanley Dean Witter & Co., Fannie Mae, MBNA Corp., Progressive Corp., Hartford Financial Services Group Inc., Associates First Capital Corp. and Aetna Inc.--come from those sectors.

But the list has something for almost everyone, with two grocery chains (Albertson’s Inc., Safeway Inc.), two computer companies (Oracle Corp., IBM), two transportation firms (Burlington Northern Santa Fe, FDX Corp.) and two retailers (Dayton Hudson Corp., Gap Inc.), plus car maker Ford Motor Co., building supplier Lowe’s Cos., aerospace firm AlliedSignal Inc., and--for the politically incorrect crowd--tobacco seller Loews Corp.

Ford, which ranked No. 38 for growth, No. 1 for value and No. 18 for combination, was No. 1 overall, while Dell headed the growth list but missed the portfolio cut because of its steep valuation. Several other tech stocks, such as EMC Corp., Intel Corp. and Sun Microsystems Inc., also scored well but missed the cut for the same reason.

Will our picks outperform the dreaded S&P;? No promises. Nine of 10 professional money managers fall short of the index most years, and stock screens are simply educated guesses. But this much is clear: On the whole, these stocks have fared well, their prospects look good and they’re selling at fair prices.

Josh Friedman can be reached by e-mail at josh.friedman@latimes.com.

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20 Big Caps With Promise

These picks comprise “The Growlue Portfolio”--stocks with what may be the best combination of growth and value characteristics. Data are as of Dec. 21 except Monday closing prices.

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52-week Earnings Ticker Monday price momentum Rank Stock symbol close index (4 grades) 1 Ford Motor F $57.75 179.9 +++- 2 Cigna CI 77.63 144.6 0+++ 3 Morgan Stanley MWD 72.75 143.6 ++++ 4 Dayton Hudson DH 54.06 157.7 ++++ 5 Fannie Mae FNM 72.13 132.3 ++++ 6 Lowe’s LOW 50.81 215.3 ++++ 7 MBNA KRB 24.00 136.6 ++++ 8 Progressive PGR 169.63 134.4 ++++ 9 Burlington Northern BNI 33.44 110.1 ++0+ 10 Oracle ORCL 43.00 186.9 ++++ 11 AlliedSignal ALD 43.56 118.5 ++-+ 12 Hartford Financial HIG 55.25 127.7 ++-+ 13 Albertson’s ABS 62.56 142.6 ++++ 14 Associates First Cap. AFS 42.25 115.3 ++++ 15 Safeway SWY 60.81 192.7 -+++ 16 IBM IBM 183.00 179.7 ++++ 17 Loews LTR 98.00 98.3 0+0+ 18 Gap GPS 56.63 236.6 ++++ 19 Aetna AET 80.06 119.0 -+-+ 20 FDX FDX 86.63 150.9 -+++ S&P; 200 average 138.1

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Price-to- Price-to- Value earnings cash-flow PEG Line Total ratio ratio ratio rating score 1 Ford Motor 2.9 2.2 0.5 NA 57 2 Cigna 13.0 12.2 1.2 3 94 3 Morgan Stanley 15.7 14.3 1.3 NA 94 4 Dayton Hudson 26.3 14.2 1.7 2 95 5 Fannie Mae 23.5 9.2 1.8 2 105 6 Lowe’s 37.0 23.5 1.8 1 130 7 MBNA 25.9 19.8 1.3 2 131 8 Progressive 24.1 21.8 1.6 2 140 9 Burlingon Northern 15.0 8.5 1.2 3 142 10 Oracle 35.1 29.1 1.5 1 144 11 AlliedSignal 18.8 13.2 1.3 2 144 12 Hartford Financial 13.9 11.8 1.3 3 145 13 Albertson’s 28.5 17.4 1.9 2 148 14 Associates First Cap. 24.5 18.9 1.4 2 151 15 Safeway 36.6 22.2 2.2 1 161 16 IBM 28.3 15.4 2.4 2 162 17 Loews 10.5 6.5 1.1 3 162 18 Gap 42.2 29.9 2.2 1 165 19 Aetna 13.6 9.7 0.9 3 166 20 FDX 25.9 8.6 1.8 3 169 S&P; 200 average 44.1 26.0 2.9

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What the Numbers Mean

* Price index: Dec. 21 share price as a percentage of the share price months earlier. A score of 100 means no change, 200 means the stock has doubled, and 50 means it has declined by half.

* Earnings momentum: Each stock is graded four times.The first grade refers to change over the previous 30 days in analysts’ consensus earnings-per-share estimates for fourth-quarter 1998; the second grade reflects whether analysts project positive, negative or flat earnings for 1999; the third grade reflects the change over the last 30 days in the consensus earnings estimate for ‘99; the fourth reflects the projected change in earnings for ’99 versus ’98. A + symbol indicates positive earnings or revision; a -- symbol indicates negative earnings or revision; 0 indicates flat earnings or no revision.

* Price-to-earnings, or P/E, ratio: Stock price divided by most recent 12 months’ earnings per share. The lower the number the better, according to value-oriented investors.

* Price-to-cash-flow, or P/CF, ratio: Stock price divided by annual cash flow (or net income plus depreciation) per share. The lower the number the better, according to value-oriented investors.

* PEG ratio: P/E ratio for the trailing year divided by projected annualized earnings growth for the next five years. The lower the number the better.

* Value Line Investment Survey’s ‘timeliness’ rating: The publication’s assessment of a stock’s prospects for the coming year. Scores range from 1 to 5, with 1 the best.

* Total score: Total of rankings for growth, value and growth/value combination. For instance, Ford ranked No. 38 in growth, No. 1 in value and No. 18 in combination, totaling 57.

NA = not applicable

Sources: Telescan, IBES, Value Line

For the complete ranking of 200 stocks via the Internet, visit

http://161.35.110.226/beststocks.