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Blue Chips on the Bargain Rack

Written By Brian Hicks

Posted August 28, 2011

Thanks to Fed Chairman Ben Bernanke, the nation’s savers can spend another two years roaming the desert.

By promising to keep his zero interest rate policy (ZIRP) in place until 2013, Bernanke proved once again that he is a saver’s worst nightmare. Instead of offering people some manna from heaven, he kicked them where it counts.

Essentially, the Fed told those with a nest egg to protect that they need to look elsewhere if they have any hopes ever of capturing some yield again.

(In Ben’s world, the idea of money in the bank earning a reasonable interest rate is a dangerous thing.)

Unfortunately, that leaves investors who also need a measure of safety very few desirable options outside of U.S. Treasuries, whose yields have also been driven into the dirt (as evidenced by the paltry 2.15% yield on ten-year notes).

Factoring in an official inflation rate of 3.63%, that makes dividend-paying stocks the next best option for investors actually looking to grow their savings.

In today’s tumultuous markets, the good news is that dividend-paying blue chip stocks have actually gone on sale…

But as the herd hits the panic button, the good companies often get taken down with the bad.

The Safety of Blue Chips

At this point, nibbling on blue chips stocks is the investment strategy that makes the most sense for investors seeking decent yields along with a measure of long-term safety.

The reasons for this are pretty simple…

Blue chip stocks are the best of the best, and financial stocks aside, they are going to be with us for a long, long time. The name “blue chip” itself comes from the world of poker, in which the color blue signifies the chips of highest value.

If you’re able to build up a stack of these during a downturn, you will likely wake up at some point in the future well ahead of the rest of the players.

So what should bargain hunters be looking for these days as they troll for the winners amidst the fire sale?

In general, investors should be looking for companies that all have — at a minimum — the following six characteristics (i.e. the things that make them blue chip stocks in the first place). They are:

  • A nationally recognized, well-established company
  • Companies that sell high-quality, widely accepted products and services
  • Companies that are known to weather economic downturns
  • Companies that can operate profitably under adverse economic conditions
  • Companies with a long record of stable and reliable growth
  • Companies with a solid and consistent dividend history

Three Stocks for the Long Haul

As a general rule of thumb, a fair P/E ratio for an average blue chip stock can be derived by subtracting the inflation rate from a base of 18. To apply this rule, subtract the latest inflation rate of 4 percent from 18 to arrive at a target P/E of 14X earnings.

With that in mind, here are three brand names that have made it to the bargain rack:

  • DuPont Co. (NYSE: DD): A diversified chemical giant, DuPont is a global enterprise with operations in 90 countries. The company has consistently been paying dividends since 1904 with a payout ratio of 46%. DD pays a 3.6% yield. The forward P/E is just 9.85.
  • General Mills Inc. (NYSE: GIS): Founded in 1928, General Mills has a P/E of 13.64 and pays a dividend of 3.30%. Current earnings estimates have risen from $2.61 in 2011 to $2.83 in 2012. At 14X earnings, GIS has a relatively safe 10% upside from here — along with the promise of long-term future price appreciation. With a roll call of famous brands in the stable, GIS is going to be with us for a long time.
  • Molson Coors Brewing Company (NYSE: TAP): The fifth largest brewer in the world, TAP was formed in early 2005 with the combination of Adolph Coors Co. and Molson, Inc. The company has a PEG ratio of 1.04 , a P/E of 11.36, and is trading below book value. Aside from making my favorite beverage, TAP pays a 3.0% dividend.

Keep in mind, of course, that these are investments — not trades.

After all, there is a big difference between the two, and now is the time to decide which style really fits your needs. Just be careful not to be trampled by the herd as you head in the other direction.

By the way, there have been 25 declines of 10% or more since 1962. Only nine of them turned into bear markets. In the other 16 instances, the losses were halted between 10% and 20% before the market began to move higher again… Just some food for thought.

You can find a few of the week’s best investment ideas in the Wealth Daily and Energy and Capital articles below.

Your bargain-hunting analyst,

steve sig

Steve Christ
Editor, Wealth Daily

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