Two Growth Stocks to Sparkle in 2008

We're bullish on the prospects for share price appreciation for  Siemens (SI) and  ABB Ltd. (ABB) in 2008. Despite stellar returns in 2007 (37% for Siemens and 43% for ABB), we think that strong earnings growth will lead to superior stock price gains in 2008 for both companies. Our research shows a strong positive correlation between individual stock performance and earnings growth in the large-cap diversified industrial space. For the period 2001 to the present, we reviewed annual earnings changes and stock price movements for the six largest global diversified industrial companies:  3M (MMM), ABB,  General Electric (GE),  Honeywell (HON), Siemens, and  United Technologies (UTX). We call this group our Big Six global industrials. Consistent with basic market intuition, we found that in five of the seven years analyzed, the industrial company that turned in the best stock price performance in a given year also had the highest growth in that earnings.

An equal-weighted portfolio composed of our Big Six global industrial companies bested the performance of the MSCI World Index between the start of 2001 and Dec. 17, 2007, generating a return of 61% compared with the 30% return of the MSCI World Index--but that's not the end of the story. Our analysis indicates that stock price movements are highly correlated with annual earnings growth in the large-cap diversified industrial category. In a hypothetical portfolio in which we bought the stock that turned in the highest earnings growth for a given year--purchasing it at the beginning of the year and selling it at the end of the year--we were able to generate an eye-popping paper gain of more than 590% for the seven-year period.

We think the results of our study are compelling and comport with basic investing principles. Over time, a stock's price tends to move with a company's earnings. When earnings increase, valuations tend to go up as well. While we recognize that stock prices tend to move ahead of earnings, we think our research indicates that stock prices in the large-cap industrial sector do not fully reflect all of the earnings growth potential prior to the year in which it is recognized. As a result, an investing strategy that isolates the large-cap industrial company with the best earnings prospects prior to the start of its fiscal year should outperform a portfolio strategy, which equally weights each of the stocks in the group.

"Global Big Six"* Diversified Industrials Earnings Champs 2001-2007
Category	2007*	2006	2005	2004	2003	2002	2001
Year's Earnings Champ	ABB	ABB	ABB	Siemens	3M	3M	United Tech
Champ's Earnings Growth ( % )	62	62	125	34	17	14	12
Earnings Champ's Annual Return ( % )	43	72	101	0	41	-21	-18
Earnings Champ's Cumulative Total Return ( % )	590	382	180	39	39	-1	-18
MSCI World Index Return ( % )	9	18	8	13	31	-21	-18
MSCI World Index Cumulative Return ( % )	29	21	3	-4	-15	-35	-18
* "Global Big Six" diversified industrials firms include 3M, ABB, General Electric, Honeywell, Siemens, and United Tech. ** Year-to-date return through 12-17-07

Our back-tested portfolio requires advanced knowledge of which companies will generate the highest earnings growth, but we're confident in our ability to identify those companies with the best earnings prospects as we move into the new year. Based on our bottom-up analysis of the outlook for the global drive industrial sector, we determined that among the six largest global diversified industrial companies, ABB and Siemens have the best prospects for earnings growth in 2008. We think that Siemens, based in Munich, Germany, will top the field with a 20% earnings pickup, and we think that ABB, based in Zurich, Switzerland, and Stockholm, Sweden, will run a close second and turn in an impressive 19% earnings increase. Both companies are well-positioned to serve the rapidly industrializing emerging markets. We discuss each company's earnings outlook in detail below.

Siemens 2008 Outlook
9% Sales Growth
20% Earnings Growth
In 2007 Siemens made significant strategic changes to its business. Siemens sold its automotive components business for 11.6 billion euros and merged its telecom equipment business into a joint venture with  Nokia (NOK). Both businesses were underperformers, and we think that by trimming these problem segments from the fold, management will be free to focus on improving the profitability of Siemens' core remaining businesses. We expect Siemens' new CEO Peter Loscher to focus management's attention on cost-cutting actions and efficient manufacturing practices to boost operating margins. In addition, Siemens is expanding in core business segments with higher-than-average operating margins, such as in medical products. In 2007, Siemens acquired medical diagnostic equipment maker Dade-Behring. Before it was acquired, Dade was generating operating margins in the high teens, well above the 7.4% consolidated operating margins Siemens reported in fiscal 2007. Due to the impact of portfolio actions and the benefits of efficiency gains, we think that Siemens will be able to boost operating margins by roughly 150 basis points to 9% in 2008.

The outlook for Siemens' top-line growth is also very promising. Siemens' largest business segments are its fastest growing. Powerful global secular trends are driving growth in its largest segments at two to three times global gross domestic product growth. In power generation and power transmission sales, growth is being fueled by substantial demand from emerging-markets customers. We think power-generation-related sales will increase 20% in 2008. Automation and drives should increase sales by about 10%, due to broad investment in manufacturing in eastern Europe, as well as from emerging-markets economies. Siemens' expanded medical products unit should be able to generate high-single-digit sales growth. Combined, the power generation, power transmission, automation, and medical products segments constitute about 50% of Siemens sales. Overall, we project that Siemens will be able to increase its top line by 9% in 2008, comprising 8% organic growth and at least 1% growth in sales from acquisitions. We think that the combination of sales growth and operating margin improvement will drive earnings growth by about 20% in 2008, tops in the diversified industrial group. We expect share price appreciation to match the earnings gains. Our fair value estimate on Siemens ADRs is $190 per share.

ABB Ltd. 2008 Outlook
15% Sales Growth
19% Earnings Growth
ABB Ltd. is riding the crest of the industrial buildout wave in emerging markets. The company can be viewed as broadly serving two enormous markets: power generation and industrial automation. ABB is a market leader in each category and is benefiting from the growth of rapidly industrializing countries in Asia, including China and India. ABB also controls the largest installed base of industrial automation systems in Europe and leads the industry in landing new business for automation systems in Asia. Year-to-date total sales are up 25% compared to last year, and we expect robust sales growth to continue in 2008. As of September 2007, the company's book-to-bill ratio for the year was 1.24.

We project another record year for ABB sales, though sales growth will likely be slightly below the stunning levels of 2007. We project that ABB's continuing operations will generate top-line growth of 16% in 2008, reporting total sales of $33.5 billion. In addition, we project that ABB will generate about 80 basis points of operating margin improvement in 2008, due to the effects of favorable operating leverage and the impact of cost control efforts. We think these factors combined will result in earnings growth of about 19% in 2008. Based on past performance in the large-cap industrial sector, we think that ABB's shares will generate a share price return well above average for the diversified industrial group in 2008. Our fair value estimate for ABB ADRs is $36 per share.