The market's more richly valued than you think, writes Jack Hough in Barron's, as Q4 S&P 500 (SPY) earnings are expected to rise 10.5% on just a 0.6% increase in revenue. "Where's that margin growth going to come from," asks S&P's Howard Silverblatt. "Most of us aren't exactly napping on the job as it is."
Avoid sectors particularly prone to estimates cuts like consumer discretionary (XLY) and telecom (IYZ), suggests Hough, but favor safer groups like tech (XLK, though Cisco last week calls "safe" into question) and health care (XLV).
A stock screen scoring companies by free cash yield as well as ability to still boost margins yields 5 top picks:
Danaher (DHR) - it trades at what seems like a pricey 18x earnings, but just 15x projected free cash.
Lear (LEA) at 10x earnings is growing faster than the auto market as a whole as it picks up market share and electrical content in cars is rising.
The screen also yielded 3 to avoid:
Tiffany (TIF) at 20x earnings is pricing in faster earnings growth in 2014. Praxair (PX) expectations are for a near-doubling in earnings growth to 13%. Lennar (LEN) with 32% projected earnings growth remains pricey even as the housing recovery appears to be slowing.