AABP Award 728x90

Strategies for the conservative investor


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Dear Mr. Berko:

If you knew when the economy would turn around, which one stock would you recommend for a conservative growth and income portfolio? And would you please explain once again your description of how you generate a 9 percent to 12 percent total return in this market with minimum downside risk?

D.L., Bethlehem, Pa.

Dear D.L.:

When the economy begins to turn around, one of the stocks I’d own in a Sioux City second is General Electric Co. (GE-$13.13), even though its dividend sucks. This $170 billion revenue company traded at $42 a share in 2007. This year, GE expects to earn $1 a share with net profit margins of 6.5 percent, compared with 2007 earnings of $2.28 per share and net profit margins of 13 percent. That’s quite a flop.

GE is one of the largest, most diversified companies in the galaxy, with 310,000 employees in 114 countries. It’s in the water-treatment business and makes jet, turbine and electric engines, sub-sea drilling systems and floating rigs. GE is in insurance, aerospace products, cable and satellite TV, lighting, electrical equipment, power generation, security technology, business and consumer finance, etc.

GE positions itself as a world leader in every market it competes in. This is an impressive company, and I’m comfortable suggesting a potential $30 stock price in the coming five years.

A few conservative and forward-thinking money managers think that the quest for capital appreciation in quality equities will be considerably more difficult in the new economy. They believe that revenue and earnings expectations will be lower in the coming decades, and that metrics such as price to earnings (P/E), price to sales, price to book, etc., won’t return to the heady levels of the past 20 years. Basically, the size of the inch has changed.

P/E ratios for companies like DuPont (DD-$30.90), with a current 5.3 percent dividend, have averaged 23 times earnings since 1998. Today’s P/E ratio will likely average 14 to 15 times earnings for the foreseeable future. Since 1998, the average P/E for AT&T Inc. (T-$25.20), with a current 6.5 percent dividend, has been 17 times earnings, and future expectations place T’s P/E ratio at 11.

I’m comfortable suggesting that the dividends of both DD and T will either remain the same or increase very modestly in the next five years, and that DD’s and T’s share price could increase an average of 3 percent annually in that same time frame.

Although 3 percent a year is not worth a hambone in bragging rights, if you add that 3 percent to DD’s 5.3 percent dividend yield, you can have an 8.3 percent average annual total return in the next five years. Add that 3 percent to T’s 6.5 percent dividend, and you have a 9.5 percent average annual total return.

Now, doesn’t this make a lot more sense for a conservative income/growth investor than buying GE at $12 and hoping to sell it at $30 in the coming five years, or Cisco at $21 and praying it can be sold at $42, or Bank of America at $17 and wondering if it can be sold at $33? Conservative investors prefer the safety of certainty versus a reliance on risk for their portfolio income.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net. © Copley News Service

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