WASHINGTON – If you want a grim statistic on America’s economic health, look at capacity utilization. A measure of the usage of the nation’s factories, mines and utilities, capacity utilization has dropped 10% since April 2000 and now sits at a 20-year low of 72%..

Despite the slack capacity numbers, some businesses have been ramping up over the past few years by increasing their capital investment and steadily adding to property, plant and equipment. It’s a risky bet, to be sure, but it may well look smart when the economy improves.

Example: American Woodmark, a manufacturer of kitchen cabinets with $499 million in revenue. For the latest 12 months, American Woodmark’s capital spending stands at $45 million, up from $23 million for the comparable period a year ago. On a five-year annualized basis, the company’s capital expenditures have risen 54%. The money has gone to projects such expanding assembly and finishing capacity at plants in five states.

Yet even with the capital-investment drive, American Woodmark has managed to keep its free cash flow (net income less capital expenditures plus depreciation) in positive territory. As its capital expenses fall, that free cash flow will likely get a boost, giving the company the flexibility to repurchase shares or pay down its modest $19 million in long-term debt.

So far, American Woodmark’s expansion has had mixed results. Profits have climbed from $4 million in fiscal 1996 to $32.2 million for the firm’s fiscal year ended April 2002. But year-over-year quarterly net margins have slipped from 6.2% to 4.9%. Shares have dipped accordingly–the stock trades 30% off its 52-week high.

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“We’re going to hit Dow 40,000 by 2016,” says money manager David Elias without blinking. It is not the first time he’s said it, either. Dow 40,000 was the theme and in the titles of his two books published in 1999 and 2000.Reviewers said they were a signal of a stock market about to go pop.

This time Elias’ call is all the more gutsy, flying in the face of greatly diminished expectations for stocks. The prediction is also more of a reach statistically. To get to 40,000 by December 2016 from where we are now, the Dow would have to sustain an annualized price gain of 13%. Starting from December 1999’s 11,400 level, it would have had to trot along at only 7.7%. To get a sense of how wildly bullish 13% is, note that over the past 100 years the index has climbed at a 5% rate.

And now we are contending with terrorism, volatile oil prices, high levels of corporate, government and personal debt, and a sluggish world economy. Mere mud on the hooves of history to Elias: “Over the last century we’ve had depression, recessions, the World Wars, all sorts of conflicts and tragedies,” he says, “and yet look at the long-term trend of the stock market. It’s up.”

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WASHINGTON – When war broke out in Iraq, we spoke with David Cooley, manager of J&W Seligman’s Global and International Growth equity funds. At the time, he liked prospects for Israeli stocks, particularly generic-drug maker Teva Pharmaceuticals.

Since that conversation, Teva shares have jumped 15% while Israel’s benchmark TA-100 index has increased 14%. From a 52-week low set in February, the index is up 29%. “Buying in front of a big geopolitical event is a scary ticket to write,” Cooley says, “but it’s often the right one to send to the trading floor.”

Cooley’s contrarian tactics don’t just apply to emerging economies or regions addled by conflict. In the wake of Gulf War II, he gives us a pick from none other than the Federal Republic of Germany.

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Stocks of companies doing business in medical equipment and supplies are often described as “defensive” or a “safe haven.” Truth is, they’re not all that safe.

“You can be a long-term investor in this business,” says analyst Ryan Rauch of Boston investment bank Adams Harkness & Hill. “You just have to be able to stomach volatility.”

One example is Inamed, a Santa Barbara, Calif.-based maker of products for cosmetic procedures, such as saline-filled breast implants, collagen implants for wrinkles and silicone bands used to reduce the stomach capacity of obesity sufferers.

Like many of its peers in the medical equipment business, Inamed stands to benefit from a demographic tailwind as millions of baby boomers head toward their golden years. In 2002, Inamed’s facial aesthetics sales grew 10%, to $74 million.

Moreover, Inamed’s business extends well beyond the U.S. and Canada. In fact, the company pulls in one-third of its revenue from outside North America. Should the dollar continue its recent weakening trend, Inamed’s results will get a boost.

Not surprisingly, expectations for the company’s financial future run high. Analysts reporting to Thomson First Call think the firm will enjoy an annualized earnings growth rate of 17% over the next three to five years.

So what’s wrong with the “safe haven” argument? In a sense, medical supply companies may suffer from their own success. Since 1998, health care equipment stocks in the S&P 500 have risen 39%, versus a 19% drop for the entire index. With those results, however, come rich valuations and high hopes. At the first sign of something amiss, these stocks often get dumped.

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Sometimes it pays to search troubled regions for investment ideas. Last year, for example, with Israel suffering through suicide bombings and a deteriorating political situation, we suggested a few Israeli technology firms (FORBES, July 22, 2002). At last check that portfolio was up 33%, versus the S&P 500’s 10% decline.

“I think you do need to be a contrarian on the geopolitics to a certain extent,” says Christopher D. Alderson, head of emerging-market equities with T. Rowe Price. Alderson notes how Turkey’s reluctance to contribute to the U.S. military effort, which led to the country’s failure to win an aid package, has hurt its financial markets. As such, Alderson says, some Turkish stocks, like NYSE-listed Turkcell Iletisim Hizmetleri, have begun to look attractive. Driven down by concerns about the finances of a big shareholder, Turkcell has a price-to-sales multiple of 1.4.

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A little over a year ago Duke Energy declared it had finished its “best year ever,” despite Enron’s collapse and the other problems afflicting the energy business at the time. It reported revenue of $60 billion, by that measure making it the 13th-largest U.S. corporation.

But the “best year ever” didn’t look so great the following June, when a task force at the Financial Accounting Standards Board reached a new consensus on how to account for energy trading. Reversing a position taken in 1998, it decreed that energy trades should be recorded on a net, not a gross, basis. In other words, if a company trades an energy futures contract for $100,000 and makes a $2,000 spread on the trade, it should recognize as revenue only the $2,000.

Whoosh. Duke Energy restated its revenues going back to 1997. With 2002 sales of $15 billion, the company ranks 115th on this year’s Forbes Sales 500. The stock has fallen from $37 to $13 over the past year.

A lot of puffery has been going into the top line. According to the Huron Consulting Group, a Chicago firm focused on corporate finance and restructuring, revenue recognition problems were behind 85 of the 381 accounting restatements of public companies in 2002. Typical mischief: recording a sale without accounting for the fact that the buyer has the right to return the goods, or, worse, hasn’t even taken title to them; counting revenue from deals with unfulfilled obligations (such as future consulting services).

In February the Securities & Exchange Commission filed fraud charges against eight past and present employees of Qwest Communications. The SEC says that, among other things, Qwest cooked up false internal documents to justify treating a $34 million equipment sale as something that could be booked in its June 2001 quarter. Qwest has overstated revenues in other ways, for example, by swapping fiber-optic capacity with other telecom companies. As of the latest tally the company had restated its 2001 revenues downward by $1.3 billion, or 7%.

From July 1997 to July 2002 the SEC launched 227 investigations of suspected financial misreporting, 126 of them relating to revenue recognition. Improper timing of sales is the biggest offense–borrowing from the next quarter in a desperate effort to make the analysts happy for this quarter. The SEC also found 80 cases of utterly fictitious revenues and 21 cases of improperly valued revenue, such as the right-of-return cases mentioned earlier.

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Since March 11th, the Nasdaq Composite index has rallied 12%. Whether the move signals a new bull market or just a war bounce is anyone’s guess. But the fact remains that the index is 72% cheaper than it was at the turn of the century. Although it could drop further, now seems as good a time as any for patient and careful investors to shop this market.

Here’s one idea: Cuno. The Meriden, Conn.-based company makes filtration technology for gases and liquids. Nearly half of the company’s sales come from products used for purifying drinking water for residential and commercial customers.

Over the past three years, Cuno’s revenue has increased by a modest 5% per year. But the company’s results should benefit from the growing demand for clean water in both developed and emerging economies. In the latter area, the statistics are particularly sobering. By the World Bank’s tally, 1.1 billion people lack access to safe water. As a result, 3.5 million children die each year from waterborne diseases.

Cuno seems well poised to tap into efforts to fix these and other water-related problems. Business outside the U.S accounts for 42% of the company’s revenue. In all, Cuno had $258 million in sales for its most recently reported fiscal year, ended October 2002. Analysts reporting to Thomson First Call expect that number to climb to $281 million this October and $295 million in 2004.

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With the broader market bouncing around at 1997 levels, Tony Rosenthal, who helps oversee a $2 billion portfolio at New York’s TimesSquare Capital Management, sees opportunities in mid-cap stocks, or those with market values between $1.5 billion and $10 billion.

“Mid-caps combine the best of both worlds,” says Rosenthal. Unlike large stocks, he explains, mid-caps can be relatively “undiscovered,” particularly as the big brokerage firms pare down their equity research operations. On the other hand, mid-caps are usually more liquid and less volatile than smaller capitalization issues, which often get crushed when a big holder bails out.

A growth investor, Rosenthal looks for companies he thinks will increase sales, earnings and free cash flow by at least 15% over the coming three years. He pays particular attention to free cash flow, which Forbes defines as net income plus depreciation minus capital expenditures. The metric gives a sense of a company’s ability to buy back stock, pay down debt, make acquisitions and plow cash back into the business.

Example: Moody’s, the New York publisher of opinions, ratings and research on issuers of bonds and other credit obligations. The company certainly has a good track record generating free cash flow; its free cash flow margin, or free cash as a percentage of revenue, stands at a very robust 29% for the past 12 months.

Moody’s shares are down 15% from a 52-week high of $52 set last August. Driving the decline are worries that an eventual rise in interest rates will slow down the issuance of new bonds, meaning less business for rating agencies like Moody’s, Fitch and Standard & Poor’s. Another fear: Financial reforms will weaken the strong market position that Moody’s has enjoyed.

Rosenthal says such concerns are real but overdone. Although he expects Moody’s business to soften, he predicts that the firm, of which Warren Buffett’s Berkshire Hathaway owns 15.5%, will continue to deliver healthy free cash flow in 2003.

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A valuation gap still exists between U.S. and non-U.S stocks. Relative to ten years ago, for example, the S&P 500 ‘s price has appreciated 92% versus 21% for Morgan Stanley Capital International’s EAFE index of stocks from developed economies in Europe, Australasia and the Far East.

Could that gap close? As the euro’s recent rise might suggest, there’s evidence of a growing appetite for non-U.S. financial assets. And it ‘s not hard to argue that U.S. stocks have plenty of room to fall. Based on reported earnings, the S&P 500 now has a trailing 12-month price-to-earnings ratio (P/E) of 29. In early 1995, as the last bull market began its climb, that ratio stood at 16. Hardcore bears say that even the multiple from 1995 looks too rich, arguing that down markets usually don’t grind to a halt until earnings multiples bottom out in the single digits.

The bears could always be wrong, but it still may be prudent to make a couple of bets on non-U.S. stocks. For U.S. investors, American Depositary Receipts (ADRs) are the easiest way to do so.

Listed on American exchanges, ADRs are certificates issued by U.S. banks acting as the depositary for shares in the non-U.S. companies. They provide American investors with the same economic benefits as regular shareholders, including dividends.

Example: Cadbury Schweppes. At a recent $23, ADRs for the London-based beverage and candy concern trade at just nine times trailing earnings per share. That looks very reasonable next to PepsiCo’s trailing multiple of 23. Coca-Cola sells for 24 times trailing profits. And compared to its U.S. rivals, Cadbury shares are also cheaper relative to book value and sales.

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From tulips to internet stocks, hot sectors have a long history of bringing misfortune to investors. But James Floyd, co-portfolio manager of the Leuthold Select Industries fund, hasn’t lost faith in a sector-based strategy.

“Our thesis is that the big moves are made by groups,” Floyd says. “If you get the groups right, it will be much easier to get the stocks right.”

Leuthold Weeden Capital Management, which has $250 million in assets under management, started its Select Industries fund in June 2000, just as the bear market was starting to bite. Since then Floyd and comanager Steven Leuthold have built the fund’s assets to $11 million. It has been rough sledding for the fund recently, and its return of -16% since inception seems nothing to brag about, except that a passive investment in the S&P 500 is off 35% over the same period.

Floyd’s selling pitch is quantitative analysis. He and Leuthold parse 2,000 stocks into 140 industry groups, which are then ranked according to 30 criteria. Most of the screening items are crunchily objective; they include such factors as earnings growth, cash flow (in the sense of net income plus depreciation), insider activity, relative strength, earnings estimate revisions and present versus historical valuations. But the pair add in some softer subjective scores, such as their assessment of economic or political risks affecting an industry.

The 30 criteria are then grouped into seven broad categories: value, growth, contrarian, technical, judgmental, long-term price momentum and insider activity. Industry groups scoring highest by these seven measures rise to the top of the fund’s shopping list. From there Floyd and Leuthold start prying out individual stocks using equally quantitative screens.

Full story (reg. required) at Forbes.com