It's Time to Buy These 3 Megacap Stocks

Adam Fischbaum's picture

Friday, September 30, 2011 - 9:00am

by Adam Fischbaum

If you're an occasional visitor to the dog track or the horse track, then you're probably familiar with the trifecta. The thing about a trifecta is you must pick which horses or dogs will win first, second and third, in exact order. So your chance of being hit by a falling satellite is probably better -- a "sure win" is rare, if it even exists at all. But every now and then, the universe presents us with something fairly close to a "sure win."

Uncertainty about the outcome of Europe's debt crisis, whether the U.S. economy is truly slowing down from a quarter speed, and the anemic economic recovery have all created a market volatility that brings back unpleasant memories of late 2008 and early 2009. But there's always unnoticed opportunities that develop during such times of financial turbulence. And right now, the ever irrational and fearful "Mr. Market" has created a large-cap trifecta -- the closest thing to a "lock" investment I've seen lately.

With low price-to-earnings (P/E) ratios and above-average dividend yields, these three stocks make a lot of sense right now. But you've got to summon up a little strength to step up to place your bet successfully. Let me explain...

Year-to-date, the S&P 500 Index has returned only about -6.5%, which isn't too bad considering it was off more than 15% for the same time period in 2008. However, measuring from its most recent high of 1,356 in July of this year, the index is now down a little more than 13%. That's pretty healthy in anyone's book. Plenty of stocks have been beaten up this summer, especially financial stocks. But the current valuations of three mega-cap names have caught my attention. These stocks offer healthy balance sheets; strong, time-tested franchises; single-digit P/Es; attractive yields and price discounts of up to 40%. I'm talking about International Paper (NYSE: IP), Dow Chemical (NYSE: DOW) and E.I. DuPont de Nemours (NYSE: DD).

1. International Paper
The name says it all: the world's leading producer and distributor of printing papers and packaging products. After a rough 2008, things have perked up at International Paper. The quarterly dividend has more than doubled since the end of last year, rising from $0.125 per share to $0.263 cents a share, now sitting at a 4.3% yield. Sales in 2010 grew 7.8% to $25.17 billion compared with 2009. As the world continues to go paperless, this wasn't bad. 

2. Dow Chemical
Making everything from dry-cleaning solvent to the Scrubbing Bubbles, Dow holds the spot as the nation's largest chemical company. After a tough slog in 2009 (when revenue fell 22% to $44.87 billion from $57.5 billion in 2008), the company has turned nicely, paying down nearly $4 billion in debt and raising the quarterly dividend, -- which had been slashed when things got tough -- 66% from $0.15 to $0.25, bumping the annual yield to 4.2%. Things look good going forward. Dow is sitting on $6.8 billion in cash while emerging markets currently count for 30% of sales. [My colleague Lisa Springer recently wrote more about Dow in this article.]

3. E.I. du Pont de Nemours and Co.
I'm really glad everyone shortens the name to DuPont. I'm also glad the numbers for Dupont are trending nicely. Second-quarter revenue was up 21% year-over-year to $10.4 billion. Shares pay a nice 4% dividend, and the $6.8 billion the company has in cash makes for a nice cushion. As the second-largest U.S. chemicals manufacturer, its agricultural products (fertilizer, herbicides, etc.) generate 24% of all sales. It's important to remember that the world is getting bigger and there is going to be more mouths to feed, so rest assured DuPont will be there when it happens. [Read Lisa Springer's recent article on this growing-population megatrend here.]

Risks to consider: While these three companies are extremely diversified, they are all classified as cyclical industries. Half of the experts and most of the public are convinced the U.S. economy will slow down in the near future (although it's debatable how swiftly it's moving). In addition, the evidence of the European economies grinding to a halt is overwhelming. Therefore, the upside of cyclical stocks may be somewhat muted, thanks to the effect slowing demand will have on earnings. Don't be surprised if analysts revise earnings estimates downward.

Action to take -->
Market pessimism has definitely re-priced these three stocks. International Paper trades at a forward P/E of about 8 and at $24.28 per share, the stock is nearly 35% below its 52-week high. Dow's numbers are nearly identical at $23.76 a share and a forward P/E of 8.3. The discount to the 52-week high is even more attractive at almost 43%. Dupont trades at the highest premium of the group, with a forward P/E of 10. At $40.89 a share, the stock sits at a 28% discount to its 52-week high. All three are some of the strongest of the blue-chip names on the market. Even with tepid single-digit equity returns, 4%-plus dividends will switch on the beauty of compounding. Buy 'em, stick 'em in a corner and get paid while you wait for better days.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.