Water is a sector we consider as a “Must-Have” in most long-term investment portfolios.  We have even gone as far as saying that H2O is one of the key and critical investment sectors for futurists, who often look out a decade or more when evaluating trends.

Investing in water used to be much easier, but now companies like General Electric Co. (NYSE: GE) and 3M Co. (NYSE: MMM) have helped to consolidate the filtration segment of the water-trade.  Both of those are attractive investments from time to time, but both are far too broad to invest in just because they have water exposure that will drive growth in the future.  The top water stock for 2011 from 24/7 Wall St. was American Water Works Company, Inc. (NYSE: AWK) and that remains a favorite today.  Shares were trading around $25.30 when that award was issued versus about $29.00 now.  We continue to love this company and we admire its recent dividend hike.

Our goal is not just to update our own price target in American Water Works Company, Inc. (NYSE: AWK).  We believe that can continue on higher and we now think that $35.00 is feasible.  It just raised its dividend and we expect another dividend hike in a year and then again after that.  Still, the goal is to now identify those water investments which offer both growth and safety ahead as the stock market and economy are facing mixed outlooks.

Since we started covering the sector broadly, a lot has changed. Conversely, much remains the same as well and that is a good thing.  The 2012 election cycle is not far away, the economy is in a soft-patch, Greece is a real threat that could to topple Europe, Japan is trying to get out of the red in its GDP again, and both China and India are trying to slow their economies to fight inflation.  We want to review our “investable water universe” and single out some of our own single ‘best idea’ water investing strategies based on today’s valuations and trends of today that can have a significant upside ahead.

Some reports have been out about actual water scarcity here in America.  Securing potable water reserves in the future will be a challenge for many nations and this is where the term “The International Water Wars” comes from.  The water sector has given large rewards in some cases, and been very painful in other cases.

We are reviewing the following today: American Water Works Company, Inc. (NYSE: AWK); Watts Water Technologies, Inc. (NYSE: WTS); Instituform Technologies Inc.  (NYSE: INSU); Tetra Tech Inc. (NASDAQ: TTEK); and Calgon Carbon Corporation (NYSE: CCC).  On the international scene, there is Veolia Environmental S. A. (NYSE: VE) as well as Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) as the international emerging wild cards.  To show just how risky this can be in foreign lands, there is Duoyuan Global Water Inc. (NYSE: DGW) that has been crushed with the batch of reverse-merger companies out of China and which has been halted for some time.  For more diversified picks via ETFs, there are also the PowerShares Water Resources (NYSE: PHO) and the PowerShares Global Water (NYSE: PIO) to consider.

Looking through water investments is often a price-sensitive effort and investors rarely get to buy their favorite water stocks at big discounts.  In utilities, our review for the top pick in 2011 focused on Aqua America Inc. (NYSE: WTR), American Water Works Company, Inc. (NYSE: AWK), American States Water Company (NYSE: AWR) and California Water Service Group (NYSE: CWT).  We also went through the valuations and the outlook for Layne Christensen Company (NASDAQ: LAYN), Tetra Tech Inc. (NASDAQ: TTEK), and Watts Water Technologies, Inc. (NYSE: WTS).  In the land of ETFs, there are the PowerShares Water Resources (NYSE: PHO) and the PowerShares Global Water (NYSE: PIO) depending upon your geographic focus.

There is a clear winner for 2011 and we followed it up with a “runner-up selection” as to which water stock is the best pick for investors in 2011.  We have a basic table below for performance metrics and have added color with support for our top water pick for 2011.

For starters, many reports have been out about water’s scarcity and that securing potable water reserves in the future will be a challenge for many nations for the decades ahead.  This is where the term “The International Water Wars” comes from.  Making a blanket investment in water has so far been a difficult trend.  The sector has given large rewards in some cases, and been very painful in other cases.

We are reviewing American Water Works Company, Inc. (NYSE: AWK), Badger Meter, Inc. (NYSE: BMI), Tetra Tech Inc. (NASDAQ: TTEK), Watts Water Technologies,  Inc. (NYSE: WTS) and Veolia Environnement S.A. (NYSE: VE).  For more diversified picks via ETFs, there are also the PowerShares Water Resources (NYSE: PHO) and the PowerShares Global Water (NYSE: PIO) to consider.  Lastly there are two BRIC stocks that will require a judgment of your own, but those are Duoyuan Global Water Inc. (NYSE: DGW) and Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) as the international emerging wild cards.

There are some key risks ahead in water that make investing in water not as sound as investing in other futurist asset classes. For starters, many ‘water companies’ grew because they were building new large infrastructure projects for all of those new housing communities that were built from the 1990′s to 2007.  That business is gone for now, and many feel that it may be years before that business comes back in any meaningful way.  Another huge risk is that water is unfortunately not immune to the economy, even if you die after a few days without water.  Local, state, and even national governments around the world have to be able to pay for water investments via taxes, and we know how budgets are under pressure on all angles top to bottom.  Another risk is protection and seizure, where local government may declare that water is a public asset and we have already seen many local and regional instances where the exporting or transporting of water away has been blocked.  You have also likely heard where local communities are trying to prevent water companies from taking the local water and selling it elsewhere.  Another consideration is that there is a movement against bottled water today despite the notion that local tap water is often contaminated, tastes bad, and is believed to contain trace elements of pharmaceutical products.

CURRENT DOMESTIC STOCK PICKS IN WATER

American Water Works Company, Inc. (NYSE: AWK) is our single best pure-play in water for the U.S. investor of our investing universe.  This was one of our top defensive stock picks and it recently bumped up its dividend.  American Water is the largest public water and waste water utility in the U.S. and it serves about 16 million people spread across 35 states and two Canadian provinces.  This is not what investors would consider a home run stock, but it is also one that doesn’t strike investors out.

An implied dividend yield now of 3.8% is also a solid reward considering the investment climate for bonds and that many utility investments have mixed histories.  This one offers water investors, defensive investors, and income investors the same outcome.  At $23.15, its 52-week range is $18.91 to $23.77.  No bottled water here; think tap water, showers, sprinkler water, toilet water, and water for industries.  Investors hate paying at the 52-week highs, so any sizable pullback here should be used as a buying opportunity.

Watts Industries (WTS) Downgraded after poor earnings. Falls to $27.91 from 52-week high of $46.71.

Time Warner Cable (TWC) Cable loses exclusive franchise in apartment complexes. Drops to $27.55 from 52-week high of $44.

Merge Technologies (MRGE) Company says it will restate some earlier financial results. Shares drop to $1.84 from 52-week high of $8.16.

Lca-Vision (LCAV) Two downgrades on poor earnings outlook. Falls to $16.90 from 52-week high of $50.69.

Douglas A. McIntyre

The new cover story for the May 2007 Smart Money Magazine is an interesting one as "The Ten Stocks For The Next Ten Years" and is one that will carry some interest from small cap and growth-oriented investors for those seeking secular trends.  This was posted online earlier this week, but this is the sort of issue that you usually want to look at a few days after the dust settles and over the first weekend that the magazine is actually on the stands.  Many will have seen this online or will have seen some of it this morning on CNBC or elsewhere, but most readers of the hard copy will probably be reviewing this 10/10 list over this weekend.

The screening criteria used by Smart Money was not a focus on the classic P/E ratios or book value, and the names are an interesting mix of companies.  Many of these are well known and have been around for some time, and some are rather obscure names that the public doesn’t follow that closely. The screen put a greater emphasis on price/sales ratios; its looked for a classic small-cap range from $300 million to $2 billion in market value; a history of rising sales of at least 10% a year over the past five years. That screen produced 150 names that they chose 10 stocks from.

We wanted to see how these have fared recently since the list is a veryinteresting mix of small-cap companies.  Some of these have made itonto our own buyout screens at some point and some only appear ingrowth screening, although most are really growth companies that may beexperiencing secular trends as far as the research points.  Oddlyenough, none of these are in sectors that are mindblowing or true futurist-tech. Maybe the K-I-S-S rule applies: "Keep It Simple, Stupid."  None of these are related to computers per se (and only one is anInternet play), none are energy companies, none are pure-plays onalternative energy, and most are in areas that do appear to have growth(otherwise they wouldn’t be on the list).  None of these are upcoming brand retail plays so to speak.  Some of these have only comepublic recently, so trying to use a longer-term trading trend analysisisn’t possible on some.

OK, so here is there list:

Atlas Air Worldwide (AAWW-NASDAQ):long-haul air freight; stock close to all-time highs since being publicover the last 18 months; company has a growth plan in place and hasorders for more Boeing jumbo jets in the hopper.

Brightpoint (CELL-NASDAQ):cell phone distributor that installs proper software to make phonescompatible with each provider; stock has been around forever andtrading toward lower-end of a one-year trading range, but upconsiderably over the last 5-years.

Harris Interactive (HPOL-NASDAQ):interactive research and polling; uses more than 6 million participantsonline; stock has been in $5.00 to $6.50 trading band over the lastyear.

OSI Systems (OSIS-NASDAQ):medical scanning and a homeland defense play for cargo screening;trading above what was the highest points of a 5-year trading range of$15.00 to $24.00.

Powerwave Tech (PWAV-NASDAQ):makes the amplifiers, antennas and other equipment that enable wirelessphones and handheld devices to transmit and receive voice and data;over the last year this one fell from $15.00 to $5.00 beforestabilizing; very sporadic earnings history expected to lose money thisyear and not make money annually until 2008.

Sirona Dental Systems (SIRO-NASDAQ):designs, manufactures and sells dental chairs, treatment workstationsand instruments; public less than one-year.  Caring for teeth probablyisn’t a fad, even if there is no sex appeal to the story.

Tetra Tech (TTEK-NASDAQ):consulting firm specializing in water-resource management andenvironmental cleanups; stock is at the higher-end of a $15.00 to$20.00 trading range seen over the last 20 months.  Classic water stock.

United Natural Foods (UNFI-NASDAQ):largest national distributor of organic and natural foods in the US;stock is toward the lower-end of a 2-year trading range because ofconsolidation of Whole Foods and Wild Oats into one company.

Viasys Healthcare (VAS-NYSE):a cluster of high-technology medical-equipment and diagnostic companiesthat focus on respiratory care and neuro diagnostics that came publicin 2001; very close to all-time highs.

Watts Water Tech (WTS-NYSE):supplies water-control, purification, safety and flow devices; stockhas been around for more than 15-years, traded up significantly byalmost 300% in the last 5+ years.  Classic water stock.

No matter how you cut it, this is a pretty interesting mix.  It is oddthat none of these are in alternative energy and none of them are in"care for the aging" per se.  Any list of this magnitude is going to behighly subjective, so this critique is not meant as any criticism.  Itactually points out some great names that would have otherwise fallenthrough the cracks.

Jon C. Ogg
April 13, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.