Reliable stocks for unreliable times

By Michael Brush

Is it safe to have money anywhere in the market? You bet. When investors panic about bad loan problems sapping the economy's strength -- something happening right now -- stocks with the best financial strength are a great place for your money.

Over the past 12 years, there have been seven credit-related market hiccups. Each time, it was the stocks with the best financials that outperformed the rest of the market, according to Credit Suisse (CS, news, msgs) analyst Pankaj Patel.

What qualifies as a financially sound stock? Patel looks for companies that generate real cash earnings and have little debt. I'd throw in qualities such as consistently high dividend payouts, high profit margins and insider buying.

In the coming months, stocks with these qualities will be the havens that investors buy as fear chases them from riskier bets. It makes sense to buy these now and let other investors drive them up when the credit-market worries worsen.

The ugliness isn't done

And I do mean "when." I think we can expect more bad news because for too many years, too many low-quality borrowers had too much access to easy credit.

"Now you are seeing lenders of all stripes realizing there is such a thing as risk and that they should be paid a premium for it, or perhaps they should avoid it," says George Putnam, the editor of the Turnaround Letter.

This has the pendulum in the credit markets swinging the other way, toward extreme caution. And no one knows where it will stop. Putnam, a close observer of the credit markets, says he can't see the end of the bad news, which tells me other investors have extreme levels of uncertainty. That means the havens will attract buyers for some time to come.

Here's a look at a few of the best bets:

Insiders lead the way

Patel, of Credit Suisse, came up with 66 "safer haven" stocks from his brokerage's coverage list -- companies that have a strong balance sheet and strong free cash flow. That's an unwieldy number of stocks, so I'll cherry-pick two where insiders recently bought shares, suggesting their stocks are safe.

The first is Best Buy (BBY, news, msgs), which has produced $2 billion in operating cash flow in the past 12 months and has $2.8 billion in cash and relatively little debt. In the recent share-price weakness, Chief Executive Robert Willett bought $496,000 worth of stock at an average price of $43.86, according to InsiderScore.com.

While rival Circuit City (CC, news, msgs) has been closing stores and another competitor, Tweeter Home Entertainment, has turned to bankruptcy, Best Buy's leading market share is at an all-time high, in part due to high customer-satisfaction rankings, points out Morningstar (MORN, news, msgs) analyst Brady Lemos. It's an example of how financial strength and market leadership helps a company gain market share during hard times that trouble competitors. Lemos has a five-star rating on Best Buy, Morningstar's highest rating.

Next, I'd suggest Johnson Controls (JCI, news, msgs), an auto-parts and building-supplies company that has generated $1.1 billion in operating cash flow in the past 12 months. Credit Suisse analyst Chris Ceraso believes strong demand for climate-control systems used in commercial buildings will drive healthy revenue growth over the next three years. Though the home-building sector has been weak, commercial building has remained strong. A director bought $2.4 million worth of the stock for about $120 a share in late July.

Dividends still matter

In times like these, it makes sense to go with stocks that pay solid dividends for two reasons, says the Turnaround Letter's Putnam. First, the dividends mean you get "paid to wait" for a market turnaround. The dividends are also a sign that a company has consistent earnings power. Just don't go with stocks that have a dividend yield much higher than 5%. That's a red flag that a company may be in trouble because its stock price has sunk so low that its dividend appears too good to be true.

For help finding the most reliable dividend payers, I turned to Kelley Wright of Investment Quality Trends (and a player in our Strategy Lab stock-picking game). He looks for solid companies that appear cheap -- though not as cheap as the shaky ones I've just mentioned -- because their dividend yields are at or near all-time highs. That's another way of saying their stocks seem inexpensive because they have been beaten down to all-time lows, relative to their dividends.

Continued: Screening out the weaker companies

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