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Blue-Chip Blues

I like to look through lists of beaten down stocks for good bargains. Naturally, I donít expect to find a good value every time but there are often a few candidates that make the search worthwhile. During a recent search I was pleasantly surprised to spot several gleaming brand names languishing unloved in the bargain bin.

This time I started looking for U.S. stocks trading within 20% of their five-year lows. As you might imagine this initial list was quite long. To pare down the list I also demanded that bargain stocks earn at least a dime per share (both overall and from continuing operations). Why a dime per share? I wanted to avoid firms that, via a little accounting hockus pockus, magically managed to earn a few cents per share.

I screened for profitable stocks trading near their five-year lows on September 8 and compiled an impressive list of stocks.

The behemoth at the top of the list is Wal-Mart (WMT, $45.86) which coincidentally makes its profits by setting up innumerable bargain bins for its customers. Due to Wal-Martís stupendous size it seems unlikely to be able to continue to grow quickly. However, Wal-Martís stock is trading at a 33.5% discount to its five-year high and it has a price-to-earnings ratio of 18.1, which is only a slight premium to the market. Add in Wal-Martís modest debt levels and this is one quality stock that seems to have been unfairly discounted.

Next up is the battered and bruised Fannie Mae (FNM, $48.50) which has fallen 45.8% below its five-year high as it struggles with accounting restatements. In addition, investors have become worried that a real-estate collapse would damage Fannieís mortgage business. Add in a portfolio stuffed with complex derivatives and it takes nerves of steel to hold this one. On the upside, if the company avoids further trouble then its low-low price-to-earnings ratio of 6.3 will be reward enough.

Third on the list is mighty Coca-Cola (KO, $44,28), a long-time Warren Buffett favourite. Unfortunately for Warren the soft-drink giantís stock has declined 33.8% from its five-year high but Warrenís loss might be our gain. Although Coke has been a frighteningly expensive stock for many years, its current price-to-earnings ratio of 22.0 makes it a relative bargain Ė at least compared to its own recent history. Investors will also appreciate drinking in Cokeís 2.5% dividend yield, enjoy a decent expected growth rate of 8.1%, and feel fortified by its stable of brand-name sodas.

The fourth stock on my list has unfortunately attracted a swarm of hungry class-action lawyers and its shares trade 68.1% below its five-year high. Iím not talking about big tobacco but drug giant Merck & Co. (MRK, $29.19). The company ran into trouble after it was discovered that Vioxx, its blockbuster arthritis drug, had the nasty habit of increasing the risk of heart attacks and strokes in some patients. While estimated litigation-related costs appear to be gigantic, it hasnít stopped David Dreman, a noted value investor, from buying Merck shares by the bushel full. He should enjoy Merckís 5.2% dividend yield while waiting for better times.

The New York Times (NYT, $32.92) is the last big stock on my list. The Timeís stock has fallen 37.9% from its five-year highs amid fears that internet competition will overwhelm it. While many are calling for the demise of the newspaper business, I tend to disagree. After all, newspapers have survived the introduction of other new technologies (such as radio and TV) and their businesses have remained robust. Furthermore, The Times pays a nice dividend yield of 2.0% and trades at a below-market price-to-earnings ratio of 14.5. For new-era investors, it is instructive to compare the Timeís price-to-sales ratio of 1.4 with Googleís (GOOG, $295.39) price-to-sales ratio of 18.4. In this case, I rather suspect that the tried and true will turn out to be a better investment than the hip and new.

Just remember, if youíre looking to nibble at these down-and-out blue-chip stocks then dig deeper to be sure that they are good for your portfolio. Personally, Iíll keep this list close at hand just in case we see a little panicked selling in the fall.

Date: Oct 2005

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