Virtually every blue-chip company has been focusing on a key
issue for the past two years: Costs. Trimming expenses wherever
possible was an absolute necessity during the scariest phases of
the economic downturn. Those cost cuts, in turn, powered a
remarkable expansion inprofit margins and enabled many companies to
record stunningly large profits.
Those days have passed and most large companies are expected to
post slowingprofit growth in 2011 and 2012. But a few companies
aren't done just yet. Thanks to a combination of more expense
reductions, solid top-line gains and/or improving gross-margin
spreads, it's not hard to find companies that may boost profits by
a combined 40% -- or more -- in the next two years. In fact, I've
found five stocks in the Dow Jones Industrial Average that are
shaping up to beearnings powerhouses for the next two years.
The risk -- and opportunity -- in bank stocks
It's no coincidence that a pair of bank stocks made my list of the
Dow's top fiveprofit growers. (
Citigroup (
C
)
and
Wells Fargo (
WFC
)
would have also made the cut if they were members of the Dow.) The
entire banking sector is still wheezing back to life, so the next
few years could represent a return to traditional banking
profit
margins. Notably, analysts' forecasts anticipate subdued lending
activity in 2011 and 2012 and, more than likely, bank profits will
be meaningfully higher again in 2013 and beyond, granted theeconomy
is truly healthy (and the housing market gets out of the sickbed).
Therefore, the opportunity to buyshares of banks like
Bank of America (
BAC
)
and
JP Morgan (
JPM
)
while they trade for less than 10 times 2012 profits looks quite
appealing. Trouble is, some investors are convinced that we haven't
seen the end of themortgage crisis. They also fear banks may be
subject to a great deal of litigation in 2011. So buying these bank
stocks carries the risk that yet more funds will need to be set
aside to cover liabilities. But it's important to stay focused on
the long-term.Shares could well take a hit from these passing
events, but the long-term outlook wouldn't be tarnished.
As a possiblecatalyst for the group, the end of the government's
TroubledAsset Relief Program (TARP) restrictions is leading to talk
of a reinstatement of dividends. When that happens, many large
banks could offer up 3% to 4%dividend yields. And if you look at
the current share prices in the context of what dividends may look
like in 2013 or 2014, you may be looking at yields that are twice
as high.
A fully-valued stock
Caterpillar's (
CAT
)
profit growth is expected to moderate in 2011 and take off again in
2012. That view anticipates a robust mining sector, a still-hot
Chineseeconomy and a rebound in major U.S. construction projects.
But are those factors really likely to play out? Recent economic
data out of China, coupled with the steady surge in oil prices
(which had been underway long before the Middle East erupted) could
start to blunt global economic momentum.
Of all the stocks in the table above, I have the least confidence
inearnings forecasts for Caterpillar. Moreover,shares already trade
for around 12 times 2012 profits, and historically speaking, that
multiple is usually closer to eight or nine in the context of
peakearnings . Even if Caterpillar sharply boosts profits again in
2013, and if you assume that 2013 is the peak, then
shares
are still fully valued.
The clear winner
There's one name in this group --
Alcoa (AA)
-- that continues to be underestimated by many investors. Shares of
the aluminum giant have shed about 3% since I
wrote about it
again in late January.
As I noted then, profits are expected to grow strongly in 2011 and
2012, according to consensus forecasts, but I think they'll keep
surging in 2013 and 2014. That's not because I think the global
economy
will be very hot by then. Instead, I think the industry dynamics
will keep shifting in Alcoa's favor. The company is the most
energy-efficient player in an energy-intensive industry, which
could be a key advantage if energy prices remain high. Moreover,
China has been throttling back output for a host of reasons, most
notably around energy and environmental concerns. That should help
Alcoa avoid the vicious pricing dynamics that hit in 2008 and 2009.
Action to Take -->
In addition to my bullish view on Alcoa, which I see rising up into
the low to mid-$20s by the time the cycle has played out, I can't
help but notice the appeal of bank stocks. They have emerged from
the crisis in strong shape, sport reasonable multiples and could be
looking at a half-decade of sustained profit growth. The
mortgage
crisis-related risks are real, but perhaps casting too large a pall
on this group.
-- David Sterman
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.