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PepsiCo (NYSE: PEP  )
This great company could be a good addition to any portfolio. Of course, it has the whole battle-for-Olympus thing going on with Coca-Cola (NYSE: KO  ) for dominance in the fizzy beverage world, but it also has a giant snack-food arm that has provided significant growth. However, the company's quality hasn't escaped many investors, and the stock's current valuation suggests pretty middle-of-the-road returns ahead. For investors playing defense, that could be just fine, but it's not enough to make PepsiCo my next buy.

Home Depot (NYSE: HD  )
It's easy to be a Home Depot hater. Maybe a little too easy. The economy is sluggish, the housing market is still pretty much in shambles, and chief competitor Lowe's (NYSE: LOW  ) has made up significant ground on it in recent years. However, the company's CEO Frank Blake has been at the helm for a little more than four years now, and I think he's moving the company in a good direction. And with few investors particularly bullish on a home-improvement retailer during a prolonged housing slump, the stock also has a pretty attractive valuation. That said, retailing is a tough business, and I'm not sure I'm sold on the durability of Home Depot's competitive advantage.

Exelon (NYSE: EXC  )
There's a lot to like about Exelon, and high on the list is the stock's 5% dividend yield. The power company also has a very significant amount of nuclear generation assets. Though nuclear took a hit on the PR front this year after the disaster in Japan, most reasonable people still consider it a very viable solution for lower-emission energy generation. But as I noted in my write-up, I'm not crazy about the offer that the company made for Constellation Energy, so that knocked the stock down on my list.

Aflac (NYSE: AFL  )
It was very tough for me to not put Aflac in the top spot. I think there's the potential for very significant returns from the stock going forward. I like the dividend, I like the management, I like the business, and even without Gilbert Gottfried (or maybe especially without Gottfried?), I like the duck. Above all, I like the future potential. There are some big question marks for the health care systems in both the U.S. and Japan, which could mean more business for a supplemental insurance provider like Aflac. So why didn't it get the top spot? Because I liked another stock just a bit more.

ArcelorMittal (NYSE: MT  )
How did ArcelorMittal make it all the way to the top of my list? In four simple words: It's ... so ... darn ... cheap. As I noted last month, its price-to-earnings ratio based on average 10-year earnings -- a measure that value investor Ben Graham was a fan of -- was a mere 7.3. A commenter on one of my articles also pointed out that the stock trades at just a hair above half of the company's reported book value. But it's not just a "this is really cheap" thesis. This is also a really great company and a global leader in the steel business. Better still, it was built, is run, and is 41% owned by Lakshmi Mittal, a fellow who I think is a very savvy steel man (not to be confused with Iron Man). Finally, I should also point out that my personal portfolio is light on materials companies, so ArcelorMittal also got a boost because it would increase my portfolio's diversification.

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Thanks to some timely tailoring, shares of Gap (GPS) jumped 27% on Nov. 21 even as the retailer's sales fell 8%.

The reason for the favorable reaction was another round of successful cost-cutting at Gap, which boosted profits despite the reluctance of consumers to spend at Gap, Banana Republic, and Old Navy stores.

Across the economy, corporate executives are looking to follow a similar strategy. As a potentially nasty recession sets in and revenues drop, firms are forced to cut their way toward higher profits.

Some analysts predict the Gap can continue boosting profits next year even as revenues decline. But eventually, many analysts say, Gap must find a way to draw more shoppers' dollars—not just cut costs through inventory controls, shrinking real estate holdings, or other measures.

A Short-Term Strategy

"While expense management has been impressive, we continue to wonder how sustainable earnings growth is longer-term with deteriorating sales and given a bleaker economic outlook in '09," wrote Banc of America (BAC) analyst Dana Cohen. (BofA handles banking services for Gap.)

Many other firms are taking similar cost-cutting steps, which often involve large rounds of layoffs. Dell (DELL) was also able to increase profits last quarter despite falling sales. The computer maker said it has cut 11,000 jobs in the past year.

"It's a necessary strategy, but it's a short-term strategy," says Dan Genter, chief executive and chief investment officer at RNC Genter. After a certain point, you're no longer cutting fat from your budget, he says—you're cutting bone.

For some firms, cost-cutting can be a healthy process that repositions them for future growth. Greg Estes, portfolio manager at Intrepid Capital Management, cites Starbucks (SBUX), which is shutting down less profitable coffee shops after "growing too fast" for several years. "If and when a positive environment returns, they'll be in a better position [with] better margins and a better portfolio of stores," says Estes, whose funds own Starbucks stock.

However, Estes says that, with some exceptions, it's generally very difficult to cut costs significantly for more than four quarters. After a while, though you may be widening profit margins, you're shrinking the entire firm.

When Are Cuts Permanent?

The financial sector is the most glaring example of these sorts of permanent cost cuts. Faced with a financial crisis and a tough economy, financial firms are slashing costs, shrinking expenses and perks, and laying off hundreds of thousands of workers—sometime alongside mergers with weaker rivals, sometimes not.

For example, Citigroup (C), the recipient of a federal government bailout Nov. 24, "may end up being a shadow of what it was," Genter says. Citi, like other financial firms, faces the problem of leverage, he says. Because it built its business on borrowed money, its contraction is more striking and more permanent when that leverage goes away.

In corporate board rooms, there is a raging debate on how much and how quickly to cut as the economy slows down. If you believe the recession will be over by mid-2009, you may want to hold onto valuable employees and keep facilities open so you can profit from the recovery.