Finding Stock Gems Among the Rally's Laggards

GREGORY ZUCKERMAN

The stock market is up nearly 40% since early March and investors are breathing a sigh of relief. But a number of stocks in a variety of sectors, including health care, technology and utilities, are still struggling.

Some of these companies deserve to be shunned because their prospects are worsening. FedEx, already down 35% in the past year, said last week it sees deep challenges in the near term. The company, long a bellwether of the broader economy, already has cut costs, leaving little more to do, and is seeing rising pension costs.

Likewise, some investors fear the government will impose restrictions or cut back loans and grants given to students of for-profit education companies, such as Apollo Group and Devry, putting further pressure on companies that have already fallen behind the market.

Lisa Haney

But there are other laggards that appear to be overlooked gems -- companies that some analysts say are worth paying some attention to, especially because it has become harder to find bargains. And if the market's rally peters out, some of these companies likely will be safer havens.

Many of the shares that have lagged have been so-called defensive stocks, those that tend to be safer but promise slower profit growth, such as Johnson & Johnson and Procter & Gamble. Some of these companies were bid up last year by investors who viewed them as a haven amid the market's tumble.

Lately, as investors have become more convinced that an economic recovery is around the bend, they've shifted to companies more likely to bring bigger profits in such a recovery, such as retailers, technology and industrial companies and commodity-related shares, discarding some of the safer stocks.

After inching into positive territory for the year two weeks ago, the Dow Jones Industrial Average fell back last week and remains in the red -- down 2.7% -- approaching the midyear mark. It's up 30% from its bear-market low in March.

Leader to Laggard

But laggard Dow component Johnson & Johnson -- which beat the market in 2008 by dropping only 10% -- is down around 6% this year. The company closed Friday at $56, up just 22% from its 52-week low set in March.

But the drop this year also makes the health-care giant more attractive. It now trades at a below-market earnings multiple of about 12, and sports a sizable dividend yield of 3.5%.

Johnson & Johnson's earnings are expected to grow 19% over the next two years, a respectable clip for a company that sells products that shouldn't see much downturn if the economy slips again.

Another overlooked stock that some analysts and investors say is worth focusing on is Hewlett-Packard, the computer maker with the greatest share of the world-wide market. The stock is up just over 5% so far this year, even though the technology-heavy Nasdaq Composite Index is up more than 15%, and competitor Dell is up more than 25%. H-P is down about 15% in the past year, trading at a price/earnings multiple of about 9 -- well below the market.

Meanwhile, there are indications of improvement for its business. A report last week by Goldman Sachs said personal-computer "unit growth is recovering in June," and that suppliers to the computer business expect sales growth of 15% this quarter, compared with last quarter.

Utility shares also are among the most unloved lately. For one thing, their earnings aren't expected to grow very much, as weak electricity demand likely will weigh on revenues.

But these stocks now are so cheap that these difficulties are priced into the shares. And they're paying their highest dividend yields in years. Even though yields on Treasury bonds are up lately, they still pale in comparison to utility stocks. That could be a lure to investors if the economy slips.

Looking for Laggards

Some company stocks that have fallen behind the market rally may be undiscovered gems and worth investors' attention. But be careful: There are plenty.

	Friday	year-to-date change	52-week high	52-week low
Hewlett-Packard (HPQ)	$38.35	5.60%	$48.41	$25.53
Johnson & Johnson (JNJ)	56.09	–6.3%	72.22	46.6
Devry (DV)	49.68	–13.6	62.63	39.03
Apollo Group (APOL)	66.19	–13.5	89.22	44.2
American Electric Power (AEP)	28.37	–14.8	41.37	24.28
Procter & Gamble (PG)	50.64	–18.2	73.15	44.18
FedEx (FDX)	51.45	–19.8	92	34.28
Mueller Water Products (MWA)	3.83	–54.4	12.48	1.56

American Electric Power, for example, is down about 15% so far this year. But the stock has a current dividend yield of 5.8%; it has a robust balance sheet and trades at a price/earnings multiple of just 9, well below the 16 or so of the overall market and the 10 P/E of competitors like Excelon and Duke Energy.

Construction-Industry Prospect

Some downtrodden stocks are tied to the still-moribund real-estate and construction businesses, such as Mueller Water Products, which makes water and filter products. Despite President Obama's commitment to spend more on infrastructure development, some worry that the continued slow growth of housing construction will crimp Mueller. Troubled municipalities also might not be able to afford projects that Mueller benefits from.

But Neal Berlant, portfolio manager of the PFW Water Fund, argues that Mueller has impressive growth prospects. He estimates that as much as $1 trillion of infrastructure upgrades need to be done over the next 20 years in the U.S.

"When pipes collapse under city streets, and water supply is placed in jeopardy, the repair work will be done" and Mueller will benefit, Mr. Berlant says.

Tobias Levkovich, Citigroup's chief U.S. equity strategist, argues that energy shares look attractive. Even though oil prices are climbing, Exxon Mobil shares, for example, are down about 10% this year.

"If you want a laggard, keep in mind that the S&P 500 is up 36% from its closing low in early March and the S&P energy sector is up about 26%," Mr. Levkovich says.

Still, some Wall Street professionals say it's dangerous to focus on losing stocks -- only some of these companies should be potential additions to a portfolio.

"The problem with focusing on laggards is it will lead one toward investments in companies with real, formidable and persistent fundamental problems," says James Paulsen, chief investment officer at Wells Capital Management. "I think it is too early to approach this stock market with a laggard approach -- the market is still essentially unchanged" over the past nine months.