You Can't Rely Only on These Stocks

Whenever there's a lot of uncertainty in the economy, there's a great temptation to retreat to the safest names you can think of for your portfolio. Over the long run, however, it's likely that you're going to need more than just solid, steady large-cap stocks to reach your financial goals.

Safety, of a sort
No one really knows which direction the stock market is headed right now. After a huge rally that has gone well beyond even most investors' wildest dreams of avarice, plenty of skeptics are poised for some event to break the euphoria and send stocks plummeting once more. You can see how skittish investors are by looking at the reaction to Friday's fraud charges against Goldman Sachs; a piece of news that was directed at a single stock threw the entire market for a loop.

Yet it's telling where investors sought refuge from falling stock prices. Among the few gainers were some extremely well-known stocks in other sectors. Coca-Cola (NYSE: KO  ) , for instance, rose more than 1%, and Verizon (NYSE: VZ  ) eked out a small gain. Why did these stocks buck the market? It's simple: A Wall Street lawsuit has nothing to do with how Coke is turning its huge brand recognition into sales, even in poor areas of China. Goldman's fate won't have any impact on Verizon's rapidly evolving smartphone strategy. Rather than falling prey to prevailing market opinion, those stalwarts stood on their own merits and did what you'd expect them to do in a crisis: They stood their ground.

That kind of security is incredibly comforting during tough times. But it comes at a price.

Giving up growth
The problem with many large-cap companies is that they've already seen the vast majority of their growth. They may well still be reasonable investments for certain types of investors. Especially when a particular business generates a good deal of free cash flow, income-seeking investors can be extremely happy owning shares of mature companies that pay out their profits to shareholders via dividends.

But many investors don't have enough money to be able to afford to rest on their laurels and live off dividend payments. Instead, they need companies that will grow aggressively over time, delivering capital appreciation to help you build a big enough nest egg that you can retire on your own terms.

Unfortunately, many big companies aren't going to deliver much in the growth department. Here are some prime examples:

Stock

Dividend Yield

Estimated 5-Year Future Earnings Growth

Merck (NYSE: MRK  )

4.2%

3.8%

Pfizer (NYSE: PFE  )

4.3%

2.4%

Consolidated Edison (NYSE: ED  )

5.3%

3.3%

Verizon

6.4%

4.9%

CenturyTel (NYSE: CTL  )

8%

0.3%

Source: Yahoo Finance.

You can't deny that the dividends that these stocks throw off are impressive. But stagnant earnings growth -- even among analyst estimates that are usually biased upward -- raises concerns. Merck and Pfizer both rely on pipelines of drugs to replace sales of blockbuster sellers after their patents expire, and it's uncertain where they'll find new drugs to replace lost revenue. Verizon and CenturyTel have turned decades of infrastructure investment into big dividend payments, but they face increasing competition in broadband services, and bread-and-butter revenue generators like landlines may soon end up looking like the 21st century's equivalent of the buggy-whip maker. And ConEd, like many utilities, is subject to the whim of regulators -- which doesn't exactly put a business in the driver's seat to determine its own destiny.

Think small
In contrast, small-cap stocks have a three-part recipe for success. They have a lot more room to run with strong ideas. They're small enough to go unnoticed by many professional analysts on Wall Street, giving you a bigger reward for your work. And historically, they've outperformed large-cap stocks as a class -- and the best performers among them have the capacity for truly amazing gains.

Take JA Solar (Nasdaq: JASO  ) , for instance. The maker of solar cells has suffered along with the rest of the solar industry in recent years as prices fell to unsustainably low levels. Recently, though, the company guided estimates higher for shipments during the quarter -- and if alternative energy continues to grow in popularity, JA Solar could be among the beneficiaries. In addition, its relatively small market cap of $900 million means it still has room to run -- in fact, most analysts expect 16% growth per year over the next half decade.

When markets are crashing, big-cap stocks look like the place to be. But over the long run, you probably can't afford to rely solely on blue-chip names. Expand your horizon to consider small-cap stocks, and you'll put yourself in a much better position to get where you want to go.

Find the most promising stocks with less effort. Fool contributor Rex Moore can show you seven more signs of a winner.

Fool contributor Dan Caplinger often goes for the smaller choice. He doesn't own shares of the companies mentioned in this article. Coca-Cola and Pfizer are Motley Fool Inside Value picks. Coca-Cola is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters today, free for 30 days. For the answers you need, rely on the Fool's disclosure policy.


Read/Post Comments (2) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2010, at 1:13 PM, MarkinSanDiego wrote:

    Let's see, Con Ed at over 5% dividend (and has increased it each of the 10 years I have owned) with a paultry 3% growth, equals 8% a year in my book. . .yes, the stock has been pretty flat over the last 5 years, but then again FLAT is GREAT!!! in those 5 years I have received better than 25% dividend return, and didn't get a heart attack during the recent financial meltdown - ditto Southern, Progress Energy, etc. . . .let's face it, utilities may be boring, but I LOVE boring . . I am retired and writing this from Switzerland where I spend a few month each year. . .bravo ED!

  • Report this Comment On April 20, 2010, at 5:10 PM, Fairhopeguy wrote:

    JASO - for the life of me gets piled on everyday with high volume relative to it's peers, yet for the most part of the day, lags it's peers in performance.

    I have run the numbers on JA Solar more than a few times, and I have read every article on the street written about JA Solar, I have listened to every conference call, and I have followed every investment conference where they spoke about the performance of thier company. I don't think their an analyst on the planet that is more tuned into that company than I am, and from what I have read, seen and heard I can attest that JA Solar is at least $3/shr under valued at it's current level.

    If they J A Solar just hit's the output that they guided to during the last conference call, and prior any of the raised guidance, with the operating margins reported in the last qtr, they will do at least a dollar a share for the calendar year 2010. Throw in the raised guidance, and the possibility that they were acquiring shares in the qtr, and you have a VERY under valued stock.

    If they report over a buck in earnings for all of 2010, and we apply a P.E. of 20 to the stock, it's a $20 stock by year end, currently trading at $6.00..

    I think they will blow those numbers out of the water, seeing that I have included the NEW BUSINESS, they spoke of at the Jefferies Conference, or the fact that they are able to produce output efficiencies of 18.5% by mid year at full production capacity with off the shelf equipment they already possess, while using less wafer than before, all while maintaining a breakage percentage of around 1%. This means they can increase output while reducing cost and maintaining margins and ASP's.

    Everything I just reported can be verified in the last earnings report, The presentation at the Jefferies Investment conference, attended by JASO, and the most recent report of thier raised guidance revelation.

    JASO is getting a raw deal on wall street at the moment, or it is just way off everyone's radar screen, Either way, it's way under valued as of today's close..

    Bank on that..

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