large-capitalization core equities · financials 7.2% 8.2% 27.9% -16.4% -10.5% 23.4% health care...

P R I V A T E C L I E N T R E S E A R C H January 2005

G U I D E D P O R T F O L I OL A R G E - C A P I T A L I Z A T I O N C O R E E Q U I T I E S

Terry D. SandvenDirectorPrivate Client [email protected] 303-5527

Craig W. Johnson, CFAVice PresidentPrivate Client [email protected] 303-6428

Jason W. Lind, CFAVice PresidentPrivate Client [email protected] 303-6487

Jack T. Hartwig, CFAAssistant Vice PresidentPrivate Client [email protected] 303-0425

Year-End Review & New Year Outlook

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M A R K E T A N D S E C T O R P E R F O R M A N C E

Exhibit 1

Price ReturnsClose Q4

Index 12/31/04 2004 2004 2003 2002 2001 2000S&P 500 1,211.92 8.7% 9.0% 26.4% -23.4% -13.0% -10.1%S&P Barra Growth 582.04 8.1% 4.7% 23.9% -24.5% -13.5% -22.5%S&P Barra Value 625.54 9.3% 13.3% 29.0% -22.5% -13.2% 4.2%Dow Jones Industrials 10,783.01 7.0% 3.1% 25.3% -16.8% -7.1% -6.2%Nasdaq Composite 2,175.44 14.7% 8.6% 50.0% -31.5% -21.1% -39.3%Russell 2000 651.57 13.7% 17.0% 45.4% -21.6% 1.0% -4.2%MSCI EAFE 1,515.48 15.0% 17.6% 35.3% -17.5% -22.6% -15.2%Lehman U.S. Aggregate Bond 1108.7 1.0% 4.3% 4.1% 10.3% 8.4% 11.6%

S&P 500 SectorConsumer Discretionary 13.1% 12.1% 36.1% -24.4% 2.0% -20.7%Consumer Staples 7.4% 6.0% 9.2% -6.3% -8.3% 14.5%Energy 4.2% 28.8% 22.4% -13.3% -12.3% 13.2%Financials 7.2% 8.2% 27.9% -16.4% -10.5% 23.4%Health Care 4.8% 0.2% 13.3% -20.0% -12.9% 35.5%Industrials 9.5% 16.0% 29.7% -27.6% -7.0% 4.5%Information Technology 13.4% 2.1% 46.6% -37.6% -26.0% -41.0%Materials 8.0% 10.8% 34.8% -7.7% 1.0% -17.7%Telecommunication Services 7.4% 16.0% 3.3% -35.9% -13.7% -39.7%Utilities 11.1% 19.6% 21.1% -33.0% -32.5% 51.7%

The Large-Capitalization Core Equities Guided Portfolio is an equity portfolio of U.S.-basedcompanies. The portfolio is managed to fit within the large domestic stocks asset class ofour asset allocation process; the objective is to achieve competitive large-capitalizationperformance while assuming a reasonable level of risk.

2 | Private Client Research Piper Jaffray

January 2005

Investment Approach 1 Gather Ideas—Attractive investment opportunities are identified by assessing andleveraging the insights from Piper Jaffray equity analysts, research correspondentsand our own independent research.

2 Top Down Sector Focus—Economic, market and industry trends are assessed.Primary consideration is given to overall macroeconomic factors—valuation ofindustry sectors, market cycles and innovations.

3 Bottom Up Stock Selection—Emphasis is directed to individual companies expectedto outperform given macroeconomic factors. Management, products, balancesheet, cash flows, valuation, competitive position and relative EPS growth areamong items considered.

4 Portfolio Construction—Approximately 30 companies, diversified across multiplesectors and industries, are typically selected. A combination of growth and valuedisciplines is employed. Factors warranting change include valuation, change insector allocation, failure to meet expected growth rates, and fundamentaldeterioration. Secondary consideration is given to technical analysis.

Portfolio ManagementTeam

Terry D. SandvenDirector, Private Client Research

• 15 Years of Investment Experience• BA, Concordia College, Moorhead• MA, University of Wisconsin-Milwaukee• MBA, University of Minnesota

Jack T. Hartwig, CFAQuantitative Analyst

• 4 Years of Investment Experience• BS, University of Wisconsin-Eau Claire

Craig W. Johnson, CFAResearch Analyst

• 9 Years of Investment Experience• BA, Drake University• MBA, Drake University

Jason W. Lind, CFAResearch Analyst

• 7 Years of Investment Experience• BA, St. Olaf College

Piper Jaffray Private Client Research | 3

January 2005

Our outlook for 2005 isgenerally favorable. Weremain, however, mindful ofthe challenges looming onthe horizon for late 2005and 2006, namely, a slowerrate of earnings growth,higher short-term interestrates and globalimbalances. This arguablyimplies market volatility; it

Actual and estimated earnings are on an operating basis.*Year-over-yearSource: First Call Corporation estimates

E A R N I N G S P R O J E C T I O N S

Exhibit 2

Close Earnings Earnings12/31/04 2004E P/E 2005E P/E

S&P 500 1211.92 $65.84 18.4 x $69.64 17.4 x

S&P 500 Earnings Growth* 18.8% 5.8%

The Large-Cap Core Equities Guided Portfolio ended 2004 up 7.0% (including dividends)versus 10.9% for the S&P 500 and 8.3% for the Lipper Large-Cap Core Index.

• Year In Review—All things considered, the Portfolio performed modestly below expectations,primarily due to our consumer discretionary and consumer staples exposure andunderweight among energy and utilities sectors. Energy, industrials, telecommunicationservices and utilities were the best performing sectors in the year; health care, informationtechnology and consumer staples lagged.

• Best/Worst Performers—Target, Exxon Mobil, St. Jude Medical, Caterpillar, GeneralElectric, Dell, Dow Chemical and Verizon Communications led performance, each posting2004 performance in excess of 20%; Cisco, Coca-Cola, Eli Lilly, Intel, Pfizer, and Viacomlagged, each posting negative returns of 15% or greater.

U . S . T R E A S U R Y Y I E L D C U R V E

Exhibit 3

0

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3Mo 6Mo 2Yr 5Yr 10Yr 30Yr3Mo 6Mo 2Yr 5Yr 10Yr 30Yr3Mo 6Mo 2Yr 5Yr 10Yr 30Yr3Mo 6Mo 2Yr 5Yr 10Yr 30Yr

1 Year Ago3 Months Ago1 Week Ago21-Jan-05

places a premium on security selection.

• Earnings And Interest Rates—As reflected in Exhibit 2, estimated earnings growth in2005 over the 2004 level is currently 5.8%, significantly below 2004 over 2003 levels.

• Yield Curve—With the Fed moving short-term rates higher, the conventional wisdom isthat inflation and overall economic activity must be accelerating. That conclusion seems

Source: FactSet Research Systems Inc.

premature. For manycompanies, valuationlevels are more closelytied to the 10-yearTreasury yield, which isnot moving, as reflected inExhibit 3.

• Global Imbalances—To adegree, the worldeconomy seems out ofbalance. U.S. budget andtrade deficits are atunsustainably high levels;similarly, U.S. savingslevels are at unsustainably

low levels. The U.S. savings rates are at 60-year lows. Eventually market forces willlikely restore the balance between spending and savings levels.

• Portfolio Changes—Recent changes have been made resulting in more market-neutralsector exposure, reduced exposure to companies with lower growth profiles andincreased exposure to companies with improved earnings visibility.


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January 2005

Description: Comcast is the leading U.S. cable television operator with approximately 40million homes passed and 21.5 million basic cable subscribers. The company also owns asmall group of content assets including, for example, E! Entertainment Television.

Valuation: Our price target of $36 is based on a 10 multiple on estimated 2005 cash flowof $3.60 per share, a level we feel conservatively discounts competition and pricingconcerns.

Catalysts:• Continued solid uptake trends for key growth services such as digital video (including

HDTV, digital video recorders and video on demand) and high-speed data.• Free cash flow could benefit from a moderation in capital expenditures over coming

years.• Customer retention rates benefit from multi-service packages.• Comcast's rollout of Internet phone service is planned to be completed by year-end

2006.

Risks and Concerns:• Volatile subscriber and adoption rates in any given quarter, pricing trends, competitive

landscape

Comcast Corp. Price: $33.56 Price Target: $36

C O N S U M E R D I S C R E T I O N A R Y

Industry Themes—The consumer-related sector and subindustries typically perform wellduring periods of economic expansion, strong consumer confidence and employmentgrowth.• Holiday sales performance was mixed, with high-end retailers generally outperforming

the lower end. Post-holiday sales are likely to "make or break" first quarter earnings formany retailers, resulting in increased near-term volatility.

• Stock performance for media companies has improved recently, likely driven byattractive valuations and share buyback announcements.

• Oil and gas prices present a headwind to consumer spending.


January 2005

Description: Viacom is a diversified entertainment company with operations in varioussegments, including cable networks, network television and entertainment.

Valuation: Media stocks are traditionally valued on a cash flow basis. Street consensusestimates VIAB to post cash flow per share of $3.62 in 2004 and $3.92 in 2005; applyinga multiple of 11 times, toward the low end of its historical valuation range, yields our $44price target.

Catalysts:• Viacom recently announced an $8 billion share repurchase program, which represents

approximately 13% of shares outstanding at current prices.• Divestiture of Blockbuster is now completed, which should improve Viacom's growth

rate.• Weakness in its radio division (approximately 10% of revenues) is being addressed by a

plan to selectively divest assets in this division.• Valuation, which is at the low end of historical levels, should gain traction as its 2005

growth outlook gains visibility.

Risks and Concerns:• Uncertainty surrounding advertising outlook, pricing, market share

Viacom Inc. Price: $38.85 Price Target: $44

Description: Target Corporation is a general merchandise retailer in the U.S. comprisingupscale Target discount stores.

Valuation: Our $59 price target is based on a 22 multiple of estimated fiscal 2005 earnings,a modest premium to its five-year average given divestitures of slower-growing departmentstores.

Catalysts:• Target's comparable-store sales gains have outpaced its closest peer over recent quarters;

we view this as sustainable based on Target's customer base.• Margin concerns have arisen from consumer shopping patterns over this past holiday;

we consider the recent pullback a buying opportunity for long-term investors.• Target has completed approximately one-third of its $3 billion share repurchase

program and expects to finish it by around year-end 2006.• Piper Jaffray's EPS estimate for fiscal January 2006 is $0.10 above Street consensus and

represents 26% growth versus estimated prior-year levels.

Risks and Concerns:• Exposure to bad debt expense, a downturn in the overall economic environment

Target Corporation Price: $50.20 Price Target: $59


January 2005

Description: The Coca-Cola Company manufactures, distributes and markets nonalcoholicbeverages in markets across the world.

Valuation: Our $47 price target is based on a modest discount to average relative valuation,or 23 times estimated 2005 EPS.

Catalysts:• KO's new CEO has effectively lowered the bar for 2005 expectations, and any element

of sequential operating improvement should benefit KO shares, in our opinion.• A key area of focus for new management will be the balancing act between pricing and

volume growth; improved execution on this front could serve to improve earningsconsistency versus recent years.

• The weak dollar should disproportionately benefit KO, as it is one of the few U.S.-basedcompanies that derives more than half of total sales from international operations.

• An improved product mix in the higher-growth, non-carbonated category could improveoverall growth.

Risks and Concerns:• CEO succession plan creating some departure concerns, competitive end markets,

international uncertainties, long-term margin outlook

The Coca-Cola Company Price: $41.25 Price Target: $47

C O N S U M E R S T A P L E S

Industry Themes—Stocks of consumer staples companies are typically considereddefensive, often regarded as a safe haven in periods of economic uncertainty.• Staples companies are operating in a highly competitive environment with generally

limited pricing power. As such, earnings consistency is often a function of innovationand operating efficiencies.

• Weakness in the dollar continues to provide a sales and earnings boost to companieswith international operations.

• Companies are having a difficult time balancing promotional spending and pricingincentives (which spur volume growth) with related margin pressure.


January 2005

Description: Wal-Mart is the world's largest retailer based on revenues. Operations includeWal-Mart stores, Sam's Club and international stores.

Valuation: Our WMT price target of $59 is based on the low end of historical valuation (22times) applied to estimated fiscal January 2006 EPS.

Catalysts:• Any improvement in sales trends, given the pullback in WMT shares, should support

higher price levels, in our opinion.• Lower oil/gas prices would disproportionately help disposable income levels for core

WMT customers.• Continued opportunity for margin improvement (further pressure on suppliers for lower

prices) adds visibility to earnings growth despite volatility in recent sales trends.• Street consensus estimates are for 18% and 14% earnings growth in fiscal January 2005

and 2006, respectively.

Risks and Concerns:• Dependence on margin improvement as a key component to earnings growth,

competitive threats, law of large numbers, more-limited U.S. growth opportunities

Wal-Mart Stores Inc. Price: $54.49 Price Target: $59

Description: PG is a leading global consumer goods company. Its products fall into fivecategories: fabric and home care, beauty care, baby and family care, health care, andsnacks and beverages.

Valuation: We've set a $64 price target based on 22 times fiscal June 2006 Street consensusearnings of $2.88 per share. The multiple is in line with its ten-year average.

Catalysts:• International exposure and innovation across business lines should continue to drive

consistent double-digit earnings growth for PG over the coming years, in our opinion.• Valuation stands slightly below ten-year historic averages, which could allow the shares

to appreciate at least in line with earnings growth.• Currency translation should benefit from the weak dollar.• Above-average earnings visibility should be rewarded in an overall volatile market, in

our opinion.

Risks and Concerns: Competitive activity, pricing, consumer trends, currency exchangerates

Procter & Gamble Co. Price: $55.99 Price Target: $64


January 2005

E N E R G Y

Industry Themes—Energy companies are generally benefiting from high realized oil andnatural gas prices. Continuing fears of supply disruptions in the Middle East and arecovering global economy have resulted in high physical premium and oil prices not seensince the early 1980s. Given OPEC's commitment to cool down oil prices, we believe U.S.commercial petroleum inventories will likely grow in 2005.• Higher finding and developing costs, increased reliance on advanced recovery techniques

and limited unused production capacity should result in a favorable capital spendingcycle for oilfield services and equipment companies.

• Integrated oil companies' consensus earnings estimates are forecasted to decline in 2005,as oil prices may not remain at current levels.

Description: BHI is a leading provider of oil and gas exploration, and productionequipment and services.

Valuation: We derive our $52 price target by applying a multiple of 28 to consensus 2005estimated earnings, a modest premium to its historical average of 25.

Catalysts:• Given the strong global demand surge for oil, unused production capacity has fallen to

historically low levels, creating a favorable investment backdrop for oilfield service andequipment companies.

• The consensus fiscal 2005 earnings estimate for BHI has increased 5.6% since mid-October and now implies 23% earnings growth in 2005. Visibility on 2005 earningsremains high as pricing power among oilfield service companies is improving.

Risks and Concerns:• Magnitude and timing of capital spending, worldwide drilling activity, exposure to the

Gulf of Mexico, volatility of commodity prices

Baker Hughes, Inc. Price:$42.58 Price Target: $52

Description: XOM is the world's largest publicly owned integrated oil company.

Valuation: We derive our $57 price target by placing a P/E multiple of 17 on the consensus2005 earnings per share estimate, a discount to the ten-year average multiple of 18.

Catalysts:• An improving global economy coupled with a limited amount of spare production

capacity is underpinning the current price of oil and natural gas and correspondinglyXOM's earnings estimates.

• High realized oil and natural gas prices are driving 2005 earnings estimates higher.Should oil prices be sustained, estimates may prove conservative.

• XOM's production growth rate is anticipated to reach 3% annually beginning in 2006,as new development projects in Canada, the Middle East and Russia come on line.

Risks and Concerns:• Political tension in major oil producing regions, commodity volatility, refining margins,

success at replacing its reserves through drilling

Exxon Mobil Corp. Price: $51.50 Price Target: $57


January 2005

F I N A N C I A L S

Industry Themes—Financial stocks have generally outperformed the broader market overthe past several years. Prospects of a higher interest rate environment in 2005 maydampen investors' enthusiasm for financial stocks, leading to an environment favoringstock selection versus sector investing.• In an improving economy commercial-oriented banks are generally favored over

consumer-oriented banks, as the environment tends to be more favorable for businessloans.

• Merger activity will likely continue to drive competitive efficiencies in today's less-regulated banking environment.

• Recent tax law changes and financial institutions' generally low dividend payout ratiosare widely expected to result in a ratcheting up of dividends in the sector over the nextseveral years.

Description: AIG is one of the world's leading insurance organizations, providing an arrayof property-casualty, life insurance, and retirement savings products.

Valuation: We arrive at our $75 price target by applying a price-to-earnings multiple of 14to consensus 2005 estimated earnings. This assumed multiple represents a modestdiscount to the ten-year historical average multiple of 17.

Catalysts:• We believe resolution of the ongoing New York Attorney General's investigation

represents an important catalyst for AIG shares as it would remove a large degree ofuncertainty from their story.

• China represents a significant growth opportunity, and AIG management anticipatesChina will represent 8% of total life-insurance premiums in five years, up from 2%today.

• A stable pricing environment, coupled with the company's access to low-cost funds,should allow AIG to generate consistent low-double-digit earnings growth over the nextseveral years.

Risks and Concerns:• Management succession, inflation and interest-rate sensitivity, sustainability of the

current pricing cycle, goverment investigation of the insurance industry

American International Group Inc. Price: $67.70 Price Target: $75


January 2005

Description: Goldman Sachs is a premier global investment bank and securities firmproviding advisory, trading and financial services primarily to institutions and high-net-worth individuals.

Valuation: Given uncertainty surrounding capital markets activity, the multiple investorshave been willing to assign to the shares has contracted sharply and is currently 12 timesfiscal 2005 estimated earnings. We arrive at our $120 price target by applying a multipleof 14 to consensus 2005 estimated earnings, a multiple roughly in line with the five-yearaverage of 15.

Catalysts:• Prospects for a stronger macro environment could lead to improved capital markets

activity over the next several quarters, easing investors' negative sentiment towardbrokerage stocks and leading to possible modest multiple expansion.

• Goldman's participation in several recently announced M&A deals should providevisibility to fiscal 2005 earnings.

Risks and Concerns:• Capital market condition, global economic backdrop, competition from banks,

proprietary trading and principal risk, wide range of earnings estimates

Goldman Sachs Group Inc. Price: $105.00 Price Target: $120

Description: Citigroup is a diversified financial services company with more than $1 trillionin total assets.

Valuation: At current levels, we believe C offers investors close to a 30% total returnopportunity to our $60 price target when including the 3.3% current dividend yield. Ourprice target is based on applying a multiple of 14 to 2005 estimated earnings. Theassumed multiple is within the historical valuation range of 7-20 times.

Catalysts:• Attractive valuation as the shares trade at less than 11 times estimated 2005 earnings

and at a 66% relative market multiple.• Consensus earnings estimates imply 7.7% earnings growth in 2005 and 8.1% growth in

2006. We believe an improving economy and a recovery in capital markets activitiesprovide visibility to these estimates.

• Citibank's product and geographical diversification should partially insulate thecompany's net margin from a flattening yield curve.

• Improving credit quality trends

Risks And Concerns:• Interest sensitivity, exchange rate exposure, commodity market volatility, emerging

market risk, integration risk, increased regulatory scrutiny, litigation risk

Citigroup Inc. Price: $48.17 Price Target: $60


January 2005

Description: MBNA is one of the largest issuers of bank and affinity credit cards in the U.S.

Valuation: Given MBNA's leadership position in affinity branded credit cards, we believethe shares deserve a multiple roughly in line with their ten-year average of 14. We arriveat our $34 price objective by applying a multiple of 13 to estimated 2006 earnings.

Catalysts:• Higher levels of credit card use and improving employment trends should lead to

improved credit quality and better visibility on 2005 estimated earnings.• Expectations for loan growth to accelerate to 10% in 2005, up from 8% in 2004, are

based in part on a slowdown in cash-out mortgage refinancing activity and a favorableoutlook for consumer spending.

• In our opinion, investors' expectations have been reset following weak employmentresults, creating what we believe to be an attractive buying opportunity.

Risks and Concerns:• Rising credit losses, low growth of credit card debt, interest margin compression, new

competition

MBNA Corp. Price: $27.37 Price Target: $34

Description: Morgan Stanley is among the nations largest securities firms. The companyalso owns the Discover credit card.

Valuation: Our $63 price target is based on a P/E multiple of 14 applied to the consensus2005 earnings estimate. This assumed multiple represents a slight premium to thehistorical ten-year average forward multiple of 13. We believe this premium is justified bythe company's strong competitive position and modestly improving investor confidence.

Catalysts:• Prospects for a stronger macro environment could lead to improved investment banking

activity over the next several quarters.• Increased capital markets activity could ease negative sentiment toward brokerage

stocks, potentially narrowing the shares' 18% valuation gap from its ten-year historicalaverage multiple of 13.

• Mostly better results from Discover Credit Services could result in modest upside tofiscal 2005 earnings estimates.

Risks and Concerns:• Capital markets condition, proprietary trading and principal risk, aircraft leases,

consumer credit card quality, global economic growth

Morgan Stanley Price: $56.45 Price Target: $63


January 2005

H E A L T H C A R E

Industry Themes—Supportive macro factors such as demographics and increasedutilization of preventative medicine have become secondary to company-specific products,pipeline and competitive outlooks.• Earnings growth outlooks within large-cap pharmaceuticals appear muted over coming

years based on competitive pressures, patent challenges and expirations, and politicaluncertainties.

• Device companies have generally strong growth outlooks, driven by low penetrationrates and high barriers to competitive entrants; valuations are toward the upper end ofhistorical ranges.

• A new wave of patent expirations and a number of ongoing or upcoming patentchallenges create opportunities within the generic drug industry; pricing concerns havepushed valuations to historically low levels.

Description: AMGN is a leader in developing and marketing biotechnology products. Thecompany possesses three $1.5-billion-plus product franchises, with specialties in the cancer,kidney failure and arthritis markets.

Valuation: Our $69 price target is based on a 1.3 P/E-to-growth rate on 2005 estimatedearnings. This represents a slight discount to a peer-group average of 1.4.

Catalysts:• Clarity surrounding Medicare reimbursement changes and effect of prescribing patterns

for AMGN products is needed. The company expects to address this issue with investorson January 27, 2005.

• Amgen recently gained FDA approval for Kepivance, a drug to treat mouth sores inpatients undergoing chemotherapy. Future labeling expansion could increase the salesopportunity for this drug.

• AMGN's 2005 estimated P/E-to-earnings growth multiple of 1.1 screens attractiveversus a peer-group average of around 1.4.

Risks and Concerns:• Patent litigation, Medicare reimbursement rates, clinical uncertainties, competitive

landscape

Amgen Inc. Price: $64.16 Price Target: $69


January 2005

Description: Medtronic is a leading medical technology company that specializes in diverseareas such as cardiovascular, spinal and neurological therapies.

Valuation: Over the past ten years, MDT's median P/E relative to the S&P 500 has been1.8, with a high of 2.6 and a low of 1.0. The shares currently trade at a 1.4 relativemultiple, and our price objective of $56 uses a 1.5 relative multiple on estimated calendar2005 earnings.

Catalysts:• Further visibility into its drug-coated stent program—which has been under scrutiny

post a data set released last spring that showed higher-than-expected vessel renarrowingover 12 months.

• Potential acceleration in market growth for implantable defibrillators based on clinicaldata and improved insurance reimbursement.

• Renewed operating leverage in the income statement increases visibility for earningsgrowth.

Risks and Concerns:• Rapid product cycles, lack of operating leverage, market share volatility associated with

its many market-leadership positions

Medtronic, Inc. Price: $51.09 Price Target: $56

Description: BSX specializes in development of minimally invasive medical devices for usein interventional medicine.

Valuation: Our price target was recently reduced to $43 and is based on a 19 multiple ofestimated 2005 earnings. Visibility for earnings growth in 2006 and beyond is likelyneeded to move the multiple closer to its peer group average of 25 times.

Catalysts:• Timing and competitive uncertainties continue to prevail for the next duo of expected

entrants into the drug-coated stent market. This benefits BSX given its current marketshare leadership.

• BSX plans to host an important analyst meeting on February 1, which should detail itspipeline progress and earnings growth outlook for 2005.

• A share buyback is authorized for up to approximately 14% of share float.• A next-generation drug-eluting stent platform is launching in 18 international countries

and is expected in Europe later this year.

Risks and Concerns:• Pipeline uncertainty, level of investment spending, Medinol stent litigation, competitive

products/pricing and timelines

Boston Scientific Corporation Price: $33.53 Price Target: $43


January 2005

Description: Teva is a leading generic drug manufacturer, with headquarters in Israel.

Valuation: Our price target of $33 is based on a modest discount to its ten-year averageforward valuation, or 20 times Street consensus estimated EPS of $1.62 in 2005.

Catalysts:• We believe an investment theme surrounding generic drug manufacturers will reemerge

in 2005 based on another wave of major branded patent expirations beginning in 2006.• Teva has 120 new drug applications with the FDA and potential 180-day exclusivity on

25 of these filings (representing U.S. branded sales of around $20 billion).• Valuation has drifted down close to historic lows based on industry pricing concerns.• Any surprise patent victory could spark a rally for generic drug manufacturers.

Risks and Concerns:• Volatility surrounding industry and company-specific patent litigation outcomes, pricing

dynamics in generic products, clinical/competitive risks in its branded pharmaceuticaldivision

Teva Pharmaceutical Industries Price: $27.85 Price Target: $33

Description: Pfizer is a leading pharmaceutical company with broad product andtherapeutic category exposure.

Valuation: Our $32 price target is based on a modest discount to its peer group averageapplied to 2005 estimated EPS.

Catalysts:• An analyst meeting is planned for April 5 wherein Pfizer management is expected to

offer 2005 earnings guidance as well as a three-year growth outlook. Current consensusis for 1% earnings growth in 2005 and around 5%-6% over the coming years.

• Continued positive developments for Pfizer's deep pipeline should support modestacceleration in earnings growth during the 2006-2008 period.

• Pfizer trades at a 25% P/E discount to its peer group on 2005 estimates, a level webelieve over-compensates for company-specific risk factors.

Risks and Concerns:• Patent challenges, clinical risks, competitive outlook, lack of leverage to any one pipeline

product given a revenue base of over $50 billion, Cox-II uncertainty

Pfizer Inc. Price: $25.30 Price Target: $32


January 2005

Description: Caterpillar is a leader in construction and mining equipment, diesel andnatural gas engines, and industrial gas turbines.

Valuation: Our $102 price target is based on a P/E multiple slightly above its ten-yearaverage, or 14 times the Street consensus EPS estimate for 2005.

Catalysts:• CAT could post improved operating margins over coming quarters as it implements

pricing power and better manages operating costs.• Street earnings estimates for 2005 continue to drift higher, with a current consensus

estimate of 27% earnings growth versus the estimated 2004 level.• Ongoing strength in commodity prices drives a solid backdrop for spending initiatives by

Caterpillar customers.• Order rates have continued strong over past months, which improves near-term sales

visibility for CAT.

Risks and Concerns:• Operationally managing surging demand, wide deviation in Street earnings estimates,

varying assumptions for peak earnings year

Caterpillar Inc. Price: $92.53 Price Target: $102

I N D U S T R I A L S

Industry Themes—Industrial companies typically perform well during periods of economicexpansion and as earnings growth accelerates from depressed levels.• Order trends have, in general, stabilized at solid levels over past quarters.• Cost control efforts of past years present the opportunity for solid earnings leverage to

accelerating sales growth.• Dividend yields are generally underpinned by solid free cash flow yields. Companies

with solid balance sheets could look to raise payout ratios.

Description: MMM is a diversified technology company with a global presence in areassuch as health care, safety and security services and electronics. 3M benefits fromintercompany cooperation in research, manufacturing and marketing of products.

Valuation: Our MMM price target of $93 is based on a five-year average P/E multiple of 22applied to the Street consensus EPS estimate of $4.17 for 2005.

Catalysts:• Expected consistent 10%-plus earnings growth over coming years should drive upside in

3M shares.• We believe its five key corporate initiatives including, for example, Six Sigma and 3M

Acceleration, should benefit earnings consistency.• An analyst meeting is planned for mid-February, which should increase visibility on

pipeline sales drivers over coming years.• A solid balance sheet and free cash flow offers potential for a dividend hike.

Risks and Concerns:• International economic conditions, acquisition strategy, key management retention

3M Company Price: $82.02 Price Target: $93


January 2005

Description: Emerson is engaged in the design, manufacture and sale of a range ofelectronic and electromechanical products, systems and services.

Valuation: Given prospects for accelerating earnings growth, we arrive at our $71 priceobjective by placing a modest premium to average valuation on estimated 2005 earningsof $3.45 per share.

Catalysts:• Continued posting of solid order rates could cause revenue growth to outpace current

expectations.• Margins should expand as the cost base has been pared and revenue growth is

accelerating.• Enhanced visibility on fiscal September 2005 EPS growth prospects, which the Street

currently pegs at 16% versus 15% in 2004.• Recent news from peers supports a positive demand backdrop for Emerson's industrial

automation business.

Risks and Concerns:• Economy, end-market uncertainties, pricing

Emerson Electric Co. Price: $68.13 Price Target: $71

Description: GE is broadly diversified, with operations in areas such as power generation,medical technology, media and finance.

Valuation: Our price target of $40 is based on 22 times estimated 2005 EPS, which is in linewith its ten-year median multiple.

Catalysts:• A recent GE analyst meeting offered management's outlook for a solid growth recovery

in 2005; Street estimates are for 14% growth versus estimated 2004 results.• GE's CEO Jeff Immelt has completed what we view as a transition period at the

company over the past several years, including key asset acquisitions and divestitures, allof which should solidify prospective growth in 2005 and beyond.

• A solid balance sheet and generation of cash could support a major share buybackinitiative on the order of $15 billion over coming years.

Risks and Concerns:• Quality of earnings, complexity of company, corporate initiatives

General Electric Co. Price: $35.96 Price Target: $40


January 2005

I N F O R M A T I O N T E C H N O L O G Y

Industry Themes—Technology companies are anticipated to benefit from a weaker dollarand cash-flush corporate balance sheets in 2005. Consumer adoption of digital productsdrove solid second-half 2004 results for many companies, but higher interest rates maytemper future consumption. However, a potential pickup in corporate spending mayprove an offset.• Consumer adoption of digital home entertainment, broadband Internet access, wireless

networking, digital photography and gaming.• Penetration of PCs into emerging markets and stepped-up replacement of the corporate

installed base provide a healthy backdrop for the technology sector in 2005.• Option expensing may limit the sector's multiple expansion.

Description: Cisco Systems is the global leader in networking equipment, and its productsare the foundation of most enterprise networks and the Internet.

Valuation: Our price target of $22.50 is based on applying a multiple of 20 to calendar2006 earnings (less $2.62 in cash). This assumed multiple is in line with the ten-yearhistorical valuation range.

Catalysts:• Upgrading of older enterprise networks and the adoption of new technologies like voice

over Internet (VoIP) underpin consensus expectations for CSCO to achieve a mid-teensearnings growth rate over the next several years.

• CSCO's advanced technologies business is anticipated to exceed over 40% annualgrowth as adoption of home networking, wireless, security and VoIP solutions expandover the next year.

• Migration of telecommunication service providers to IP-based networks, increasedpenetration of broadband and fiber-to-the-premise (FTTP) builds represent significantlong-term growth drivers.

Risks and Concerns:• Deferral of enterprise and carrier spending plans, expensing of stock options, margin

compression, acquisition integration

Cisco Systems, Inc. Price: $18.74 Price Target: $22.50


January 2005

Description: Dell is the worldwide leader of build-to-order PCs. The company's otherproducts include servers, storage, printers and peripherals, and services.

Valuation: Our $44 price target is based on a P/E-to-growth multiple of 1.9 to a 15%longer-term growth rate applied to consensus fiscal 2006 estimated earnings. The assumedmultiple is in line with the historical ten-year multiple range.

Catalysts:• Expectations for low-double-digit PC unit growth coupled with a modest recovery in

enterprise spending in the U.S and a favorable mix shift toward mobile PCs fromdesktops supports management's objective of mid-teens earnings growth.

• Steepening component cost declines should allow for modest gross margin improvementand market share gains.

• Dell is leveraging its low-cost business model into new, higher-margin growth areas likestorage, servers and consumer electronics.

Risks and Concerns:• Erosion of low-cost advantage, deceleration in PC unit growth in 2005, flattening slope

of component price declines, IT spending trends among corporations, increasedinternational competition

Dell Inc. Price: $40.30 Price Target: $44

Description: Intel is the world's leading designer and manufacturer of microprocessors.The company has approximately 85% share of the microprocessor market.

Valuation: Given a challenging microprocessor roadmap in 2005, we would expect INTCshares to trade in line with their historical ten-year average of 20. We arrive at our $29price target by applying a P/E multiple of 20 on estimated 2006 earnings.

Catalysts:• Expectations for low-double-digit PC unit demand in 2005 and a favorable mix shift

toward mobile PCs lays the foundation for 15% longer-term earnings growth.• Gross margin is anticipated to sequentially improve through 2005 as fab utilization

levels rise, additional 300mm fabs come online, and 65nm production ramps.• Corporate and consumer adoption of wireless computing (WiFi and WiMAX) coupled

with Microsoft's next operating system (Longhorn) will likely drive the next productupgrade cycle.

Risks and Concerns:• PC end-market growth, diversification into wireless markets, sustainability of

microprocessor market share, gross margin improvement, consumers' satisfaction withlow-end processors

Intel Corporation Price: $22.94 Price Target: $29


January 2005

Description: Microsoft is a leading provider of software, services, and Internet technologiesfor both consumers and corporations.

Valuation: We derive our $33 price target by applying a multiple of 24 to estimated fiscalJune 2006 earnings. This assumed multiple represents a modest discount to the ten-yearhistorical average multiple of 28. We look for the shares' valuation multiple to expand asvisibility on the company's next operating system (Longhorn) improves.

Catalysts:• Street forecasts for low-double-digit worldwide PC unit growth provides support for

mid-single-digit earnings growth in calendar 2005.• The company generates nearly $2 billion in free cash flow per quarter. A recently

stepped-up share buyback program coupled with a modest dividend increase suggestsmanagement remains committed to returning excess cash to shareholders.

Risks and Concerns:• Cyclical nature of PC buying trends, PC growth rate in 2005, U.S. and European

regulatory and legal issues, open source software, pace of IT spending, competitivepressures

Microsoft Corporation Price: $26.32 Price Target: $33

Description: NOK is a leading provider of cellular infrastructure and phones.

Valuation: We believe there is room for NOK's valuation to expand as visibility on theWCDMA launch in Europe and the 2005 U.S. handset lineup improves. Our $20 pricetarget is based on a price-to-earnings multiple of 20 applied to 2005 estimated earnings(less $2.99 in cash), a multiple in line with its peer-group and ten-year historical averagemultiple.

Catalysts:• Expectations for 10% handset unit growth in 2005 in part support the consensus

estimate for Nokia to achieve mid-teens earnings growth over the same period.• The company intends to introduce 40 new phones during 2005. This, in addition to

modestly lower R&D spending, would likely lead to a modest recovery in operatingmargin.

• Faster uptake in WCDMA phones in Europe could prove 2005 earnings estimatesconservative.

Risks and Concerns:• Market share loss, sustainability of historical operating margin, carrier slowdown on

WCDMA infrastructure spending, inventory sell-through

Nokia Corporation Price: $15.05 Price Target: $20


January 2005

Description: SFA is a leading network equipment provider to the cable television industry.The company's product offering include interactive digital set-top boxes and high-speeddata modems.

Valuation: Our $40 price target is based on applying a 20 multiple to consensus fiscal 2006estimated earnings plus $8.25 per share in cash. The assumed multiple represents less thana one multiple premium to the ten-year historical average multiple.

Catalysts:• We believe consumer adoption of high-definition television (HDTV), digital video

recorders (DVR) and video-on-demand (VOD) is driving an upgrade cycle for SFA'sadvanced set-top boxes.

• We anticipate SFA to return a portion of its $1.3 billion in cash and equivalents back toshareholders through a significantly higher dividend or stepped-up share buyback.

• Solid cable operations bookings suggest set-top box revenues will likely grow by 15% infiscal 2005.

Risks and Concerns:• Customer concentration, new entrants in the set-top box market, potentially less-

favorable gross margin mix in coming quarters

Scientific-Atlanta Inc. Price: $31.35 Price Target: $40

Description: QCOM is a leading designer of CDMA-based wireless telecommunicationsproducts.

Valuation: Our $50 price target is based on a P/E multiple of 30 applied to estimated 2006earnings (less $4.00 in cash). We believe this assumed multiple to be reasonable givenQCOM's dominant patent portfolio and the improving visibility on 3G CDMA subscribergrowth rates.

Catalysts:• In our view, QCOM's dominant patent portfolio leaves the company well positioned to

benefit from a migration of more than one billion wireless GSM subscribers to CDMA-based technologies over the next decade.

• Sprint's acquisition of NXTL is widely anticipated to be a positive for QCOM asNXTL's current iDEN network will likely be migrated to a CDMA platform.

• We look for QCOM to post mid-teens earnings growth over the next several years asthe migration to CDMA and WCDMA accelerates.

Risks and Concerns:• Timing of WCDMA network launches in Europe, sell-through of CDMA phones,

inability to maintain royalty margins or protect intellectual property

QUALCOMM Incorporated Price: $42.62 Price Target: $50


January 2005

Industry Themes—Materials companies are generally seeing volume benefits from theeconomic recovery, which, in combination with cost savings and pricing power, areyielding solid earnings leverage.• Pricing power is a key driver for improved earnings within the materials sector.• Energy prices have continued to be volatile, mostly to the upside, creating upward

pressures to input costs.• Earnings growth outlooks for 2005 are generally solid, yet represent moderation from

estimated growth rates in 2004.

M A T E R I A L S

Description: Dow is a leading global science and technology company that providesinnovative chemical, plastic and agricultural products and services to many essentialconsumer markets.

Valuation: Our price target of $57 is based on a slight discount to the sector average P/Emultiple applied to Dow's Street consensus earnings estimate of $4.03 per share in 2005.

Catalysts:• Solid earnings growth is estimated at upwards of 55% in 2005 and its current dividend

yield of 2.7% ranks toward the top of the materials sector.• Pricing power is a function of high industry operating rates and limited supply additions

over past years.• Street earnings estimates for 2005 have risen substantially over past quarters and

support the recent move in DOW shares, in our opinion.

Risks and Concerns:• Asbestos lawsuits represent a liability, there is a wide range of 2005 earnings estimates,

peak earnings year uncertainty could continue to pressure valuation.

The Dow Chemical Company Price: $49.97 Price Target: $57


January 2005

T H R E E Y E A R H I S T O R I C A L P R I C E C H A R T S

2002 2003 2004

45

50

556065707580

50 Day Moving Average 200 Day Moving Average

American International Group Inc. (AIG)Jan 18, 2002 - Jan 18, 2005 High: 80.00

Low: 42.92Last: 67.70

2002 2003 2004

30

35

4045505560657075


Amgen Inc. (AMGN)Jan 18, 2002 - Jan 18, 2005 High: 72.37

Low: 30.57Last: 64.16

2002 2003 2004

24

28

32

36

40

44


Baker Hughes Inc. (BHI)Jan 18, 2002 - Jan 18, 2005 High: 45.30

Low: 22.60Last: 42.58

2002 2003 2004

10

15

20

253035404550


Boston Scientific Corp. (BSX)Jan 18, 2002 - Jan 18, 2005 High: 46.10

Low: 10.24Last: 33.53

2002 2003 2004

25

30

35

40

455055


Citigroup Inc. (C)Jan 18, 2002 - Jan 18, 2005 High: 52.88

Low: 22.88Last: 48.17

2002 2003 2004

40

50

60

708090100


Caterpillar Inc. (CAT)Jan 18, 2002 - Jan 18, 2005 High: 98.72

Low: 33.75Last: 92.53

2002 2003 2004

19.2

22.4

25.6

28.832.035.238.4


Comcast Corp. (CMCSA)Jan 18, 2002 - Jan 18, 2005 High: 37.24

Low: 17.05Last: 33.56

2002 2003 2004

8

12

16

20

2428


Cisco Systems Inc. (CSCO)Jan 18, 2002 - Jan 18, 2005 High: 29.39

Low: 8.12Last: 18.74


January 2005

2002 2003 2004

24

28

32

36

40


Dell Inc. (DELL)Jan 18, 2002 - Jan 18, 2005 High: 42.57

Low: 21.90Last: 40.30

2002 2003 2004

25

30

35

40

4550


Dow Chemical Co. (DOW)Jan 18, 2002 - Jan 18, 2005 High: 51.34

Low: 23.66Last: 49.97

2002 2003 2004

45

50

55

60

65

70


Emerson Electric Co. (EMR)Jan 18, 2002 - Jan 18, 2005 High: 70.88

Low: 41.74Last: 68.13

2002 2003 2004

22.4

25.6

28.8

32.035.238.441.6


General Electric Co. (GE)Jan 18, 2002 - Jan 18, 2005 High: 41.84

Low: 21.30Last: 35.96

2002 2003 2004

60

70

80

90

100

110


Goldman Sachs Group Inc. (GS)Jan 18, 2002 - Jan 18, 2005 High: 110.88

Low: 58.57Last: 105.00

2002 2003 2004

16

20

24

283236


Intel Corp. (INTC)Jan 18, 2002 - Jan 18, 2005 High: 35.19

Low: 12.95Last: 22.94

2002 2003 2004

38.4

41.6

44.8

48.0

51.254.457.6


Coca-Cola Co. (KO)Jan 18, 2002 - Jan 18, 2005 High: 57.91

Low: 37.01Last: 41.25

2002 2003 2004

12

14

1618202224262830


MBNA Corp. (KRB)Jan 18, 2002 - Jan 18, 2005 High: 29.68

Low: 11.96Last: 27.37


January 2005

2002 2003 200432

36

40

44

48

52


Medtronic Inc. (MDT)Jan 18, 2002 - Jan 18, 2005 High: 53.70

Low: 32.50Last: 51.09

2002 2003 2004

50

55

60657075808590


3M Co. (MMM)Jan 18, 2002 - Jan 18, 2005 High: 90.29

Low: 50.00Last: 82.02

2002 2003 2004

22

24

26

2830323436


Microsoft Corp. (MSFT)Jan 18, 2002 - Jan 18, 2005 High: 35.00

Low: 20.70Last: 26.32

2002 2003 2004

30

35

40

4550556065


Morgan Stanley (MWD)Jan 18, 2002 - Jan 18, 2005 High: 62.83

Low: 28.80Last: 56.45

2002 2003 2004

12

14

16

18202224


Nokia Corp. (NOK)Jan 18, 2002 - Jan 18, 2005 High: 24.24

Low: 10.51Last: 15.05

2002 2003 2004

24

28

32

36

40


Pfizer Inc. (PFE)Jan 18, 2002 - Jan 18, 2005 High: 42.46

Low: 21.99Last: 25.30

2002 2003 2004

36

40

44

48

52

56


Procter & Gamble Co. (PG)Jan 18, 2002 - Jan 18, 2005 High: 57.40

Low: 37.04Last: 55.99

2002 2003 2004

15

20

2530354045


QUALCOMM Inc. (QCOM)Jan 18, 2002 - Jan 18, 2005 High: 44.99

Low: 11.60Last: 42.62


January 2005

Source: FactSet Research Systems Inc.

2002 2003 2004

10

15

20

25303540


Scientific-Atlanta Inc. (SFA)Jan 18, 2002 - Jan 18, 2005 High: 38.59

Low: 10.10Last: 31.35

2002 2003 2004

16

20

24

283236


Teva Pharmaceutical Industries Ltd. (TEVA)Jan 18, 2002 - Jan 18, 2005 High: 34.67

Low: 12.92Last: 27.85

2002 2003 2004

25

30

35

40

455055


Target Corp. (TGT)Jan 18, 2002 - Jan 18, 2005 High: 54.14

Low: 24.90Last: 50.20

2002 2003 2004

32

36

40

44

48


Viacom Inc. (VIA.B)Jan 18, 2002 - Jan 18, 2005 High: 51.89

Low: 29.75Last: 38.85

2002 2003 2004

44

48

52

56

60


Wal-Mart Stores Inc. (WMT)Jan 18, 2002 - Jan 18, 2005 High: 63.94

Low: 43.72Last: 54.49

2002 2003 2004

32

36

40

44

48


Exxon Mobil Corp. (XOM)Jan 18, 2002 - Jan 18, 2005 High: 52.05

Low: 29.75Last: 51.50


January 2005

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N O T E S

© 2005 Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota 55402-7020 05-0012

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