Bargain Blue Chips


Bargain Blue Chips

With these five well-run companies on sale, this is your chance to buy at the right price.

The recent stock-market unpleasantness offers a useful reminder that the highest fliers often take the biggest tumbles when conditions turn inhospitable. A related lesson is that one secret to success when buying stocks is that you should avoid overpaying -- and knowing how much is too much is an art in itself. But we're confident we've unearthed five terrific blue chips that even a miserly buyer would agree are priced right and could be perfectly at home in your portfolio.

Furnishing homes

A seller of everything from bedspreads to espresso makers, Bed Bath & Beyond (BBBY) still has plenty of room to expand. Its earnings rise each year, and it recently reported strong sales gains at existing stores. Yet BB&B has gone from being an expensive stock to being marked down like last year's towels. The ratio of its price-earnings multiple to its earnings growth rate, known as the PEG ratio, is little more than 1. That's well below its historical average.

There are no concerns about the attractiveness of the stores' style or the company's ability to hold down costs and maintain profit margins. The housing slowdown is not an issue: Home furnishings always need to be updated and replaced. Even if you won't be buying a new place for a while (and even if you never do), you'll still need bath and kitchen stuff.

Cardinal sins

Questionable acquisitions, ill-advised challenges to entrenched competitors, accounting issues that got it in hot water with regulators -- Cardinal Health (CAH) has seen its share of problems in this decade. But now the man who built Cardinal from scratch to annual sales of $80 billion 30 years later has stepped down. Other senior executives have also departed. Now, under Kerry Clark, a former Procter & Gamble manager who took over as Cardinal's chief executive in 2006, the distributor of drugs and other health-care products is regaining its focus.


Evidence of a new-and-improved Cardinal abounds. The company recently shed its pharmaceutical technologies and services business, a patchwork of units, for $3 billion. Cardinal pledges to spend the proceeds on buying back its own stock -- more than 10% of its market value at today's $72 price. The company also raised dividends 50% last year. Clark says that Cardinal will concentrate on logistics and hospital safety, leaving drug development and manufacturing alone. The sharper focus bodes well for Cardinal because health-related companies that excel in one specialty rather than spreading themselves too thin are generally more successful.

New chemistry

Chemical manufacturers require huge investments, and their commodity-like products sell for prices that have trouble keeping up with the rising cost of natural gas and other hydrocarbons. So Wall Street tends to ignore these companies and assign low values to their stocks.

In that light, Dow Chemical's feat of producing a total return about equal to that of the overall market the past four years is encouraging. The stock (DOW) remains cheap because Dow is in transformation from a producer of basic chemicals to a maker of specialty products sold in new overseas markets.

Dow has a long list of upcoming international joint ventures in specialty areas, and in the U.S., it's working hard on research into edible oils and fibers. Its plan is to shift its long-term earnings profile away from commodity chemicals and the ups and downs of natural gas. If it succeeds, its return on capital should perk up and send the stock higher.


Big Blue in limbo

The reborn IBM (IBM) has evolved from a stodgy manufacturer of large computers to a consulting and software powerhouse. But IBM hasn't gotten credit for its transformation. Says Yvonne Bishop, who co-manages Summit Everest fund: "There's been a lot of opportunity to get in and out of it. I've made money." That's right -- you've had to trade Big Blue to prosper from it in this decade.

So why own it now? Franklin Mutual Shares fund manager Peter Langerman, who is buying the stock, calls IBM's status a perfect example of limbo between growth and value, which means it's ignored by pros who appreciate the merits of the business but can't fit the stock into their buying methods and pricing disciplines. As the stock hovers between $85 and $95 even as profits keep rising, IBM looks more and more like a bargain-bin special.

In case of disaster

Langerman and Michael Maloney, of Skyline Special Equities, agree that there are investment opportunities in insurance. Maloney particularly likes reinsurers. These are companies that protect primary insurance companies from catastrophic losses. Hurricane Katrina and other disasters cost reinsurers big bucks in 2005, just as 9/11 did in 2001.

But 2006 was light on insured catastrophes the world over. Should the years ahead bring a normal, and not an extraordinary, run of disasters, casualty stocks will do well. XL Capital (XL) has a wide-ranging reinsurance business and a smaller direct-insurance presence. It trades for 1.3 to 1.4 times its book value, which is moderate. If the loss experience stays favorable, premium growth and investment income will pad its book value to more than $60 and give this long-neglected stock, recently $71, a jolt to the $80s.


Key numbers: Five stocks that don't get enough respect

Of those listed below, only shares of Dow Chemical have topped the 58% total return of Standard & Poor's 500-stock index since the last bear market ended in October 2002. All five are attractively priced and have solid prospects.

Bed Bath & Beyond BBBY $40 $11.4 $2.39# 17 13.1%
Cardinal Health CAH 72 30.0 4.19& 17 4.5
Dow Chemical DOW 43 41.2 4.00 11 65.4
IBM IBM 93 140.4 6.72 14 18.2
XL Capital XL 71 12.8 8.92 8 -7.1

*Based on estimated earnings. **From October 9, 2002, to March 12, 2007. #For the fiscal year ending February 2008. &For the fiscal year ending June 2008. Sources: Morningstar, Thomson, Yahoo.