The Best Stocks of 2003

On the eve of the publication of our annualStocks 2004guide for the year ahead, Bill Mann takes a look at a couple of the great stock stories Fool writers tapped into in 2003 and how last year's returns stacked up against the major indexes. (Here's a hint: They blew the roof off the joint.)

The streak is over. After three consecutive years during which the major U.S. indexes dropped, the massive amounts of fiscal and monetary stimuli the federal government injected in the forms of tax cuts and interest rate cuts finally fired up the economy, sending the broader averages up substantially. Since the publication of Stocks 2003 on Nov. 26, 2002, the Dow Jones Industrial Average is up 12.3% and the broader S&P 500 has risen 15.2%, while the technology-heavy Nasdaq did best of all, up 34.8% thus far.

Our Stocks 2003 picks whipped 'em all, rising a combined 39%.

I will say here what I say each year: These gains for this amount of time mean almost exactly nothing. Business cycles do not generally run on neat little 365-day circuits. One of the features we added in Stocks 2003 was a "Time Frame" piece, to give our analysts the option of explaining whether the selection was simply based on value -- something that takes an indeterminate amount of time for the market to realize -- or on a catalyst that could at any moment drive the company's operating results higher.

One such event-driven selection from last year was Tom Jacobs' inspired pharmaceuticals pick. No, we're not talking Pfizer (NYSE: PFE  ) , Eli Lilly (NYSE: LLY  ) , GlaxoSmithKline (NYSE: GSK  ) , or even an Amgen (Nasdaq: AMGN  ) -- all of which saw solid share-price appreciation. I said inspired.

Tom identified Ligand Pharmaceuticals (Nasdaq: LGND  ) . Last year at this time, the market's opinion of Ligand was the next best thing to contemptuous. Tom disagreed, and determined that the company had a better chance of signing a marketing deal on favorable terms than the market foresaw. When the deal came in even better than Tom's best case, Ligand quickly went from being among the worst-performing selections of Stocks 2003 (it had dropped by nearly 40% over the first three months) to our best performer, tripling from its low. Ligand gained 143% since Tom's article came out last year.

How did Tom do it? Heck if I know -- I wouldn't know a ligand from a macrophage. Biotechs aren't my particular bag. But Tom spends many of his waking hours researching biotechnology companies, and when we asked him for a company he thought was a potential winner, it took him no time at all to come up with Ligand. The pick was effortless because the time he put into preparing for the pick was so extensive.

"Yes," you might say, "but biotechnology was hot this year. You could choose among any number of companies and have picked a winner." That's precisely what we mean about business not running on an annual cycle. Yes, Ligand had a tailwind this year, but Tom -- six months before the biotech bull ran -- couldn't have predicted that. What he did predict was that Ligand offered a favorable risk/reward. He was right, and he was rewarded.

What about companies that had no tailwind at all? Last year, one of my selections was WPP Group (Nasdaq: WPPGY  ) , one of the largest advertising/PR firms in the world. Advertising is mired in one of the nastiest slumps in history. If anything, WPP's industry put its stock up against a substantial headwind. In fact, my time frame discussion was clear about the fact that I had no idea when the ad market would improve, but that WPP's share price offered a substantial opportunity regardless of when it happened.

The ad market's still in a slump, but WPP's stock is up 34%. It could have just as easily been flat, but we didn't figure that the company would sink much below its $8 billion market cap at the time of selection. It had too many assets, too much brand power, and it still, even in the worst advertising market in decades, generated positive free cash flow.

And make no mistake about it, that's what we love here at the Fool -- positive (and growing) free cash flow that we can acquire at smaller multiples. When we can do that, we're much more sure that in the long run we're making great investment decisions, regardless of when (or, unfortunately, if) the market recognizes the value we perceive.

In some cases, this happened in spectacular fashion, as with Tom Jacobs' Ligand selection. In others, the answer is perhaps "not yet." Of 12 selections in Stocks 2003, only three trailed the performance of a strong S&P 500 for the year. That's a great record.

For Stocks 2004, we've once again come up with companies that are off the beaten path, some you've heard of and wrote off as investments long ago, others that are up-and-comers that we believe the market has yet to latch on to. They won't all take off like a Ligand -- that never, ever happens. We can't promise you the next Microsoft (Nasdaq: MSFT  ) . But our analysts have had their selections challenged and mounted vigorous defenses against a skeptical editorial committee. Some original selections were rejected. Those that remain we feel offer some extremely compelling investment ideas.

Stocks 2004 is released today. If you're interested in finding out what investments we think will race ahead of the pack in the year to come, you can find out right now. While the print version won't be mailed until Dec. 15, you'll receive an electronic version immediately. So why wait? Make an early New Year's resolution to beat the market with us at The Motley Fool.

Fool on!

Bill Mann
Editor, Stocks 2004

Of the companies mentioned in this article, Bill Mann owns Pfizer. The Motley Fool is investors writing for investors.


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