12 stocks that keep growing & growing & growing

Kiplinger's Personal Finance Magazine, May, 1998 by Steven T. Goldberg

Robert Millan was once a textbook example of how not to invest. He traded frequently, hopping from stock to stock, his picks based largely on which were rising the fastest. "I was buying and selling as quickly as I could," he recalls. And guess what? "I seemed to be losing more than I was winning." But Millan has mended his ways. In fact, he exemplifies how you should invest. He doesn't jump willy-nilly into a stock. First he does his homework--and once he's found a good stock, he holds on for the long pull.

This story lays out a low-cost, diversified investment plan that lets you own stock directly in growing businesses--rather than through mutual funds. We can't promise you a quick buck. Rather, it's a way to invest for the long term: to watch your stocks rise in value, to reinvest your dividends and to invest more money regularly--all that, and without being burdened with day-to-day investment decisions. Another bonus: While you'll be taxed on dividends, you will owe no taxes on your stocks' appreciation unless you sell shares. That's the way Warren Buffett got rich--by rarely selling a good business, even if its stock became overvalued--and it's how you can, too.

FINDING TERRIFIC COMPANIES

The vital first step is to assemble a list of diverse companies worthy of your long-term commitment. Research shows that owning stocks of about a dozen large companies in different industries gives you the full benefits of diversification. We started by using Morningstar StockTools software to screen U.S. stocks for essential attributes:

STEADY GROWTH. We looked for companies expected by a consensus of Wall Street analysts to increase earnings by at least an annualized 11% during the next five years.

PLENTY OF HEFT. Only stocks of companies with a market value (share price times number of shares outstanding) of more than $3 billion made the cut. Companies of that size hardly ever fall and don't usually falter for long. In addition, the economic climate of the '90s has been partial to large companies.

GOOD VALUE. We screened for stocks that are fairly priced relative to their earnings. The price-earnings ratios of all but two stocks (Avery Dennison and Paychex), based on expected earnings this year, are no higher than 1.6 times their estimated earnings-growth rates over the next five years (compared with 3 for Standard & Poor's 500-stock index). All except Paychex sell at no more than 25 times this year's estimated earnings, and four trade at P/Es of less than 20. (By comparison, the P/E ratio of the S&P 500, based on '98 earnings estimates, is 22.4.)

While numbers are important, we didn't select stocks simply because they look good on paper. Thirty stocks met our statistical standards. We then vetted them with a dozen top mutual fund managers. They explained which stocks they liked and which they didn't--and why. Brokerage research analysts who follow the stocks helped cull the list still further.

The dozen finalists for this investment plan include two financial-services companies, two business-services firms, two manufacturers, and one company each in oil services, defense, consumer staples, leisure, technology and consumer durables. They have what it takes to maintain increased sales and earnings. Some, such as Citicorp and Intel, are giants known to everyone. Others, such as Avery Dennison, Harley-Davidson and Newell, are smaller but are the leaders in their fields.

HOW TO HOLD DOWN YOUR COSTS

What makes this package so economical to buy and add to is the availability of dividend reinvestment plans (DRIPs). While it's nice to have your dividends reinvested in additional shares at no cost, the real benefit is that a DRIP allows you to buy more shares periodically, directly from the company and without paying commission to a broker. (With the stock market as pricey as it is these days, regularly investing small amounts in solid stocks makes even more sense than it usually does.) The result is an almost-no-cost investment plan.

Unfortunately, not all DRIPs measure up. In recent years many companies have imposed a grid of fees that make their plans look like profit centers. Some charge you to set up a DRIP Others charge you each time you invest money. Some assess annual fees, and some even charge to reinvest your dividends. For instance, Gillette charges its DRIP investors not only a brokerage fee of $2.50 to $5 plus 8 cents per share to buy shares, but also $1.25 plus 8 cents per share to reinvest dividends. You'll want to turn thumbs down on DRIPs that aren't investor-friendly. Fortunately, plenty of great companies also offer great DRIPs.

You don't have to be rich to invest through DRIPs, either. You can invest $100 in one stock one month; the next month, you can invest $100 in another stock. Before you know it, you'll have a sizable portfolio. But DRIPs are equally attractive for wealthy investors who don't want to waste money on commissions. You may, however, choose to use a discount broker, rather than track ten or 12 stocks individually. Either way, for tax purposes keep careful records each time you buy or sell shares.