7 High-Quality Stocks for 7 Lean Years

For us hope-to-be-elite investors, it pays to check in with what the already-elite investors are doing and saying. In fact, we all could have made a lot of money over the past decade had we listened to Jeremy Grantham, the chairman of asset manager GMO.

In 2000, he looked out 10 years and predicted the S&P 500 would underperform cash and that emerging markets would be some of the best places to put money to work. He wasn't just prescient; he was spot-on.

That kind of macro precision, to go along with an enviable investment track record, makes Grantham someone we should all follow more closely. That's why I took a keen interest in Grantham's recent quarterly letter, where he outlined his predictions for the next decade.

The news is pretty sobering.

Calling it his "Seven Lean Years" thesis, Grantham predicts below-average economic growth, anemic corporate profit margins, and other severe obstacles for the stock market. Over the next seven years, Grantham predicts, U.S. stocks as a group will deliver annualized real returns between 1.1% and 2.9%. That's less than you might get putting your money in a CD.

To stock investors like us, that's downright gloomy.

The silver lining
Ah, but then we arrive at the silver lining -- the saving grace, as Grantham calls it. The stock market as a whole might turn out to be a loser, but that won't be the case for "high-quality" U.S. stocks. Grantham thinks elite stocks are poised to return as much as 10% a year or better.

Grantham doesn't detail what he means by a high-quality stock, but I think it's safe to assume he's talking about large companies that have strong balance sheets, sustainable competitive advantages, stable or growing profit margins, and opportunities for growth, even in the face of economic challenges.

7 stocks that might make Grantham's cut
In my pursuit for high-quality U.S. names, I looked for the following criteria:

• Large-cap stock: At least $20 billion in market size.
• High profitability: An average operating margin of 15% or higher over the past five years.
• Strong balance sheet: A debt-to-equity ratio of less than 50%.
• A dividend: Not necessarily for yield, but as a measure of financial strength.

Here's what I found:

Source: Capital IQ (a division of Standard and Poor's), as of July 27, 2010.

First, consider the diversity of the names here:

• Carnival: A major cruise liner and vacation company that should see a turnaround in travel bookings once the economy turns the corner.
• Johnson & Johnson: The most dominant consumer health care company in the world has been around for more than 100 years and pays a solid dividend.
• Microsoft: Needs no introduction, but new online, mobile, and entertainment services initiatives should help offset waning growth in its dominant Windows and Office divisions.
• Southern Copper: A major miner and producer of copper and other metals with valuable assets in Central and South America.
• Thomson Reuters: After the acquisition of Reuters in 2008, Thomson now holds a formidable moat in the market for information and analytics.
• Travelers: Now free from under Citigroup's umbrella, this storied insurance company has been writing policies for more than 150 years.
• Walt Disney: So much more than just your average media company, Disney is a brand that extends into almost every corner of the entertainment marketplace.

Now, I'm not suggesting you could simply buy these seven stocks, kick back, and expect to collect 10%-plus annual returns for the next seven years. But I think this small list is a nice start on a Grantham-style portfolio -- one that should, if you believe Grantham, outperform big time over the next seven years.

Any thoughts on the stocks in my Grantham portfolio? Have a few high-quality U.S. stocks to throw into the hat? Share them in the comments section below.