Although the market is expected to move sideways over the short term with a downward bias as valuations across the board start to look a little thin, research house and fund manager Lincoln Indicators says it is not the time for investors to be selling quality stocks. In fact, long term investors should keep the faith that quality businesses will continue to grow as broader economic conditions develop and there are some 'hot stocks' expected to burn brightly in 2010.

Elio D'Amato, Chief Executive Officer of Lincoln, says "Lincoln does not have a crystal ball for numerical predictions. Rather we provide observations on the current climate and therefore how this sets us up for the future. Our long term perspective is well documented and hasn't changed, however over the short term we will see some interesting times."

A catalyst for a return to positive momentum is expected by the 2nd quarter 2010. "We expect the global economic picture to improve which should flow on to the outlooks of Australian listed companies. The likelihood of this occurring is somewhat contingent on a strong interim reporting season in February, which we feel will occur. The greater risks however lie in cyclical companies, the type that Lincoln tend to avoid in favour of those with robust fundamentals in good times and bad", said Mr D'Amato.

"There could be some bumpiness along the way which may result in short term volatility, with the recent Dubai World debt moratorium a prime example of this. Domestically, it is likely that homeowners will be able to absorb further interest rate hikes, at least to the 5.5% p.a. level, which we expect the cash rate to rise to over time."

With regard to the emission trading scheme (ETS), despite its recent defeat in the Senate, eventually an ETS-like strategy will be implemented and while it will lead to an increase in electricity costs, it will also create a boost to green industries and activities. As the rest of the rich world moves to adopt similar policies, Australia's ETS is more or less inevitable and is not expected to have the catastrophic effects on industry that some doom-mongers have been suggesting.

Mr D'Amato said "Australia has a chance to be a world leader in this new global industry. Politics aside, being ahead of the curve, rather than chasing our tail, would be a good way to position ourselves as global economic leaders in the near future, and over the long term advisers in this growing field."

The RBA is likely to continue down the path of raising rates to 'normal levels'. This is something Lincoln interprets to be around the 5.5% - 6% level. This will likely see the Australian dollar reach parity with the US dollar, however this should not be too long an event as US manufacturing is expected to benefit from the lower US dollar and lead the economy back to a recovery of sorts. Inflation is expected to remain under control and that oil will rise in price gravitating to the US$90 level as the world's growth picks up pace. "Australian industries expected to outperform include oil, healthcare, agriculture, IT and telecommunications. World growth is not over, US growth is not over, nor is growth in Asia. These sectors are well positioned to ride that growth from present levels."

Lincoln has ranked its possible outperformers in 2010 in several categories:

The methodology used to rank companies is based on Lincoln's 'Nine Golden Rules'. Stocks are analysed against a series of key indicators, including financial health, management, share price value, liquidity, share price trend and market capitalisation. The stocks that perform strongly against each of these criteria are given a 'Star Stock' rating by Lincoln.

"Our selection criteria identify companies that have achieved the strongest growth in earnings, maintained strong financial health, expected to grow their business, and of course reward shareholders with share price performance and/or generous dividend payments," said Mr D'Amato.

Lincoln's 'hot stocks' in 2010

Best Small Cap Stock

Strike Oil Limited (STX)

STX is an Australian based oil and gas explorer and producer with operations in Australia and the United States. The company has performed strongly since reversing the declining EPS trend in FY08 due to the commencement of production at the Rayburn project and stronger oil prices. FY09 proved to be another good year despite the global financial crisis with the company already having an established production base and management responding well by re-prioritising its business strategies. STX added a significant new asset to its portfolio, the Southern Cooper Coal Seam Gas Project with the grant of PEL 96 in May 2009.

The outlook for STX is positive. The company recently reported that it has ramped up production to full capacity as the Henry Hub spot price for gas has increased some 150 per cent from the lows of US$1.85/MMBtu in mid September 2009 to over US$4.50/MMBtu in October 2009 and the Nymex futures price at approximately US$6.00/MMBtu for January 2010 indicating significantly higher prices to come. 2010 will be an interesting year for the company, with the recent signing of the Eaglewood Joint Venture in the US Gulf Coast. As a result, the company expects to participate in up to 10 wells in the US for 2010.

Best Micro Cap Stock

North Queensland Metals Limited (NQM)

NQM is a micro cap gold producer which may be suitable for investors with a healthy appetite for risk. The company's main focus is the Pajingo Gold Mine joint venture (60% interest) project in Queensland but is exposed to a number of exploratory projects as well including Dotswood, Baal Gammon (Copper) and Twin Hills. The company experienced strong growth (150% EPS growth) in the last year due to combination of a ramp up in production and strong gold prices.

NQM's performance is expected to continue to improve as production and revenue improves to capacity over the next two years. The company is pursuing a 'brownfields' growth strategy focusing on existing and former mines, generally considered a low risk strategy. NQM has paid its maiden interim and final dividend this year, totaling 1.8 cents per share and expect to continue paying dividends going forward. This payout is supported by strong cashflows from the company's Pajingo operations, the company's strong cash balance and lack of debt on its balance sheet. However, the rising Australian dollar and historically defensive nature of gold exposure could be a headwind for the company going forward as the economy lifts itself from the financial crisis.

Best Income Stock

Telstra Corporation Limited (TLS), 8.21 per cent fully franked dividend yield

TLS is Australia's dominant telecommunications company and despite warnings of a structural separation to underwrite the government's National Broadband Network, this is a financially 'Strong' company that pays high dividends. TLS reported earnings growth of 10.5 per cent for the year to June and annualised return on assets of 14.16 per cent. With an adjusted annual pre-tax profit of $5.66 billion on revenues of $25.61 billion, there was plenty of cash flow available to build the business and pay out yet another healthy 14 cent dividend (after an interim dividend in December, also of 14 cents). Dividends are forecast to total 29.10 cents per share in the year to June 2010 and 31 cents per share in 2011. Importantly for income investors, TLS dividends are fully franked.

With regard to the government's proposed structural separation of TLS's wholesale and retail arms, the only viable solution for all parties (assuming the legislation is approved), is for the company's voluntary structural separation. Fortunately, the assets divested would be from the stagnant side of the business, whilst the company retains its growth divisions. We also believe that the market value of the sum of its parts may be greater than the price of the whole (at current prices) and given the flexibility promised by the government in a structural separation.

Best Engineering Stock

Monadelphous Limited (MND)

MND is an engineering group providing services to the resources, energy and infrastructure sectors. While it trades at a price to earnings premium to its industry peers, annualised return on assets of 27.9 per cent and earnings per share growth of 43 per cent per annum over the past four years justifies current valuations. MND is one of a handful of companies in its sector which maintained strong profit growth during the last financial year, hence retaining its 'Strong' Financial Health.

MND has paid a satisfactory fully-franked dividend over the years and this is set to continue with a forecast dividend of 75 cents per share in the year to June 2010 and 75.9 cents per share in 2011. MND also expects full-year revenue to come to similar levels as last year's $1.12 billion, on which MND reported a profit of $104.15 million before tax. Underlying this confidence is a high level of tendering activity from a broadening revenue base, MND said at its recent AGM. Over $400 million in new contracts have been secured since June 2009, including a $60 million three-year contract for facilities management services at the Gorgon liquefied natural gas project off the coast of Western Australia.

Best Retail Stock

Wotif.com Holdings Limited (WTF)

WTF is a leading provider of online accommodation booking services which has grown since listing in June 2006 to a $1.3 billion capitalisation company. WTF continues to exhibit 'Strong' Financial Health with an annualised return on assets of 29.1 per cent for the year to June 2009 and earnings per share growth of 20.73 cents per share in the period. Annual EPS growth has averaged 36.62 per cent over the past three years. With profits of $62.19 million on revenues of $118.82 million in the year to June, the margins at WTF are considerable. Dividends are forecast to grow to a total of 20.7 cents per share in 2010 and 24.8 cents per share in 2011.

We expect WTF to continue to perform strongly and have valued the company at $6.44 per share, above trading prices. Contributing to this valuation is forecast EPS growth of 22.53 per cent in the coming year and then 17.32 per cent in 2011. WTF expects to grow its business in Asia after increasing the number of accommodation room nights sold in the region by 100% in FY2009. Notably continued strength in the Australian dollar should also encourage overseas vacations which will further support WTF's prospects.

Best Financial Stock

Westpac Banking Corporation (WBC)

In our view, of the big four Australian banks, WBC has reliable earnings growth and a wealth of synergies with the integration of St George Bank still yet to come on-stream. EPS growth has been forecast at 43.67 per cent in the year to September 2010 and 21.86 per cent in 2011. EPS growth declined by 37.38 per cent in FY2009, but annualised return on equity was strong at 16.67 per cent. With adjusted pre-tax profits of $6.1 billion on revenues of $13.3 billion in the past year, WBC is also highly profitable and dividends continue to be very attractive, forecast at 128 cents per share in the coming year, fully-franked of course.

In addition to the St George integration, customer deposit growth of 17 per cent and Australian mortgage growth of 17 per cent. Along with Commonwealth Bank of Australia (CBA), WBC shares almost 50 per cent of the mortgage market, measured by value, and that dominance continues to solidify. Funding costs are expected to increase as competition for customers intensifies and as wholesale funding shows few signs of dropping to pre-GFC levels. On the upside, improving economic confidence and an easing threat of recession should help grow business.

Best Health Care Stock

CSL Limited (CSL)

CSL is a Lincoln Star Stock and global leader in the bioplasma market. CSL also manufactures vaccines and other prescription pharmaceuticals for the global market. Its most newsworthy vaccine this year has no doubt been Panvax for H1N1, better known as swine flu, and CSL is the only commercial manufacturer of influenza vaccines in the southern hemisphere.

CSL is a very financially healthy company, with a 22.83 per cent return on assets in FY2009 and earnings per share growth of 24.53 per cent, no mean feat in the wake of the GFC. Adjusted pre-tax profits rose to $1.34 billion on increased revenues of $4.97 billion. Dividends also rose in the year to 30 cents (interim) and 40 cents (June). Next year, dividends are expected to total 73 cents per share and then 82.6 cents the year after. Perhaps surprisingly, CSL trades at a price to earnings ratio slightly below that of its peers and significantly lower than its historical levels due to unfavourable exchange rates and concerns about legal proceedings in regards to price fixing (which we feel is unlikely to succeed). As such, we assess that at present levels the company may represent a value opportunity for long term growth.

Best IT Stock

Reckon Limited (RKN)

RKN develops, distributes and provides after-sales technical support for users of its accounting software products in Australia, New Zealand and the UK. The company's brands include QuickBooks, Quicken, ReckonElite and APS. RKN continued to perform well posting 23.81% EPS growth in the last interim period. The company weathered the challenging retail environment by pursuing its strategies of building on organic growth, expanding product and service offerings to existing clients and growing by acquisition.

The outlook for RKN is positive with management expecting 50% revenue growth for FY09 which would cement the company's position as a leader in practice management, accounting and financial management software and services. This will be underpinned by continued organic growth and contributions from the Corporate Services and BillBack businesses. Looking forward, opportunities for the company still abound as the company leverages off full product suites, enterprise and online offerings. RKN will continue rolling out integrated compliance and secretarial offerings and bedding down the recently announced United States joint venture of BillBack LLC with nQueue Inc.

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Lincoln's latest Health of the Market report provides investors with independent, timely analysis of the Financial Health of all 1,800 plus Australian listed companies. For a full copy of the report please visit http://www.lincolnindicators.com.au/Articles/HealthOfTheMarket or call 1300 676 332.