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5 Best Value Stocks for 2011

When I asked Tom Forester, manager of the Forester Value Fund, to come up with the "top five value stocks for 2011,"* I apologized for my choice of phrasing, explaining that hype is the lingua franca of the Internet. But he out-hyped me, vowing to name "five perfect stocks for 2011."

Time will tell just how close to perfection his picks are, and if you have some value stocks that you think are better, please mention them in the comment section below. In any event, Forester, whose fund (FVALX) gets the top rating, five stars, from Morningstar, offers an interesting list of companies that are hiding in plain sight - mostly household names whose neglect or avoidance by investors leaves them trading at bargain valuations. Three of the five companies have the added quirk of being stalwarts of the technology sector, not the sort of place where investors usually go to find value.

His first selection, Microsoft (MSFT), has grown cheap over the years in line with the ebbing of the software maker's reputation as an innovator, as noted in a recent post here.

"We haven't been able to buy Microsoft for years, 20 probably," Forester said. The reason he wants to is not just the low price-earnings ratio of about 10 times estimates of next year's earnings, but the success of recent iterations of its Windows and Office programs and such new products as the Xbox Kinect gaming system.

"Windows 7 has been a home run, and they've just redone the Office suite," he said. Comparing Windows 7 with its much maligned predecessor, he added: "Vista had a 15 percent penetration rate, Windows 7 already has close to a 25 percent penetration rate, and another 50 percent of companies" are expected to upgrade in the coming year.

As for Kinect, Forester noted that Microsoft has already sold about 3 million units, well above forecasts of sales in the first year ranging from 1 million to 3 million. Other bright spots at Microsoft include Bing, the search engine that is eroding the market share of Google (GOOG), and the Windows smart phone, which could appeal to the great mass of humanity that use the Windows operating system on their computers, even as it elicits smirks from the cool kids.

"Microsoft's [current] reputation was built in the days of Vista, when it bombed and nobody wanted the product," Forester said, "but now it's changing."

Hewlett-Packard's reputation has been tarnished by the antics of some of the bosses making their way through the executive suite's revolving door. The result is a PE ratio of about 7.5 times next year's earnings as investors continue to shun the stock (HPQ).

"They've found a way to shoot themselves in the foot from a management perspective in the last year or two, but they still have good lower-level managers," Forester said. "2011 could be the time to get away from that distraction."

Hewlett could get an assist from Microsoft, as the take-up of Windows 7 fuels a general increase in tech spending by businesses: "This is the right point for HP in a corporate upgrade cycle that probably has two or three years left. I think sales will be good for the next couple of years at least."

Going lower tech and higher viscosity, Forester recommends Chevron (CVX), which he admires for being the cheapest of the oil super-majors. Another point in its favor is that Chevron is more sensitive than its rivals to the price of oil because more of its business is related to production rather than activities like refining.

"Refining has been soft because people are driving less," Forester said. "Chevron has strong cash flow of $2 to $4 billion a year, so I would expect them to buy back some of their shares. They're the best of the energy group."

Surveying Main Street, Forester likes the CVS Caremark drugstore chain. With its stock (CVS) trading at roughly 11 times next year's earnings, investors seem to be ignoring CVS's valuable pharmacy benefit management business. Drugstore companies that have this operation "tend to sell for a premium," he said, "but you almost get it for free with CVS."

Forester expects his last choice, Best Buy (BBY), to benefit from strong holiday sales of gadgetry like iPads, Kinect Xboxes, phones and big-screen TVs. The chain may continue to get a boost, he said, from the demise of Circuit City, which went bust in 2009. Beyond having less competition to worry about with Circuit City out of the picture, Best Buy may be able to strike better deals with companies whose merchandise it sells.

*MoneyWatch believes that index funds, with their low expenses and history of strong returns, should form the core of an investment portfolio. Still, some investments perform better than others and so do some money managers. With that in mind, here is one in a series of posts running on Tuesdays through December offering top investors' top picks for 2011.

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