Foliofn--Jim Glassman's "Gloom and Doom", 8/21/01...
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>>> james k. glassman
Gloom and Doom
August 21, 2001
My own leading stock-market indicator is a feeling of chill fear creeping up the back of my neck. That's what I felt on Aug. 17, when the Dow Jones Industrial Average fell 151 points and the Nasdaq fell another 63, and the news got gloomier and gloomier.
The world economy is worsening, stocks are falling, and the Wall Street Journal's online edition stated over the weekend, "There's Nothing on the Horizon to Lift Markets." Earlier came the astounding news that in the past year, the losses of all the companies whose stocks are listed on the tech-heavy Nasdaq Stock Market wiped out the earnings those companies had accumulated over the previous five years.*
Ford Motor Co. announced it was laying off 5,000 white-collar workers, U.S. demand was so weak that consumer prices fell more in July than in any month in 15 years, and Taiwan's economy collapsed into recession. Most European markets are down more than a fifth for the year, and, on Friday the stock of Deutsche Telekom, the German phone company, dropped another 5 percent; it's off more than 80 percent in 18 months.
There are lots of reasons to be worried about stocks, but
... the approaching panic that I have learned to monitor in my physiology is actually a contrarian indicator.
... It is often a sign that markets are about to turn, not down, but up, or at least that the gloom and doom are exaggerated.
... This phenomenon is based not on magic, but on logic.
... The market really can, as the expression goes, climb a wall of worry.
How can that be?
First, let's quickly dismiss the notion that the Wall Street Journal, or anyone else, can decide that there are no events on the horizon that will lift the market. Short-term movements of stock prices are utterly unknown and unknowable, as Burton Malkiel of Princeton showed 30 years ago in his classic book, A Random Walk Down Wall Street. So headlines like the one in the Journal are plain silly.
If investors are aware that some events - like a quarter-point cut in interest rates on Tuesday - are likely, then their expectations are reflected already in stock prices. Events that aren't expected are, by definition, surprises - so they aren't reflected in stock prices. Today's prices absorb everything investors know about companies right now. Tomorrow's prices can't be foreseen since tomorrow's events can't be foreseen. In other words - with a few exceptions - stocks tend to be correctly priced each day, based on the accumulated knowledge of investors. So, to state that a stock slide will continue is to express either ignorance or hubris. We just don't know about short-term movements. From today's perspective, they are random.
Second, recognize that the jet fuel for higher stock prices accumulates in times like these; all that's needed is something to touch it off.
... The fuel is cash.
... It is sitting around earning practically nothing - yields on two-year Treasury notes have dropped to 3.8 percent; on three-month bank certificates of deposit, to 2.9 percent.
... The ratio of taxable money-market fund assets to the value of all listed U.S. stocks has risen to 16 percent - close to the highest level in 20 years.
... Even an aggressive mutual fund like Janus Twenty now has one-quarter of its money in cash and bonds.
... Eventually, investors get tired of earning practically nothing, and pour their sequestered cash into the stock market.
When?
Again, no one knows, and, as a result,
... smart investors ignore the question of timing, just as they ignore another question they can't answer - the future of the economy.
... Instead, they concentrate on businesses.
Success in the stock market involves becoming a partner in a great business for a long time.
... Great businesses abound, and they are admitting partners at low prices.
... Of course, those prices could go lower, but this is a time, above all, for looking intently at the fundamentals of companies in which you want to become an owner.
Take Sealed Air Corp., a global manufactuer of protective packaging, including that polyeurethane wrapping with the little bubbles you love to pop. In 2000, Sealed Air's earnings rose 14 percent but profits are under siege with a slowing economy. Still, if you believe that this slowdown - like every other in the past 70 years - won't drag on and on, then Sealed Air is a very attractive company.
Samuel A. Mitchell and Christopher M. Niemczewski of Marshfield Associates, a Washington, D.C., money management firm with a leaning toward overlooked value stocks, recently explained to clients why they were accumulating Sealed Air: "Demand for protective packaging is driven by globalization, greater product sophistication, the rise of e-commerce, and the shift from rigid to flexible packaging. Food packaging [another Sealed Air line] will benefit from increasing living standards, the rise of supermarkets, food safety concerns, the emergence of Wal-Mart, and the shift to flexible packaging."*
Sealed Air is a kind of low-risk high-tech play. The company uses advanced technology to make better, cheaper packaging, and, as more people around the world buy from the Internet, businesses will need to pack and ship products for them. Sealed Air has the largest sales force and best distribution network in its sector, an excellent balance sheet and consistently rising sales.
But is it cheap enough?
In 2002, if the economy gets back on track, the company should certainly earn more than $2 a share. The stock closed Friday at $40.33, down by about one-fourth from its 12-month high. If Sealed Air can boost its profits by 10 percent annually for the next 10 years, its earnings per share will rise to $5.19. So, at a price-to-earnings (P/E) ratio of between 20 and 25, the stock should then be priced around $120 - a nice tripling for the decade.
Another example of what's available in these scary times is Smart & Final, Inc., the largest U.S. warehouse grocery chain, with 225 stores, mainly on the West Coast and in Florida. Casino, S.A., the giant Paris-based retailer, owns 60 percent of the stock, and is traded on the New York Stock Exchange, with a total capitalization of only about $300 million. Earnings have risen sharply in recent years, and Value Line, which awards the stock its top ("1") rating, expects earnings to rise at an annual rate of 33 percent for the next five years. "Overall," writes analyst Mario Ferro, we look for steady bottom-line improvement to fuel strong price appreciation out to 2004-06."*
Unlike the rest of the market, Smart & Final has been rising recently - up more than 10 percent in the past two weeks to $11.75 - close to a high. But shares trade at a reasonable price-to-earnings ratio of 20, based on this year's projected earnings. The U.S. grocery business has consolidated and modernized (and benefited from new German, Dutch and French ownership), and, even if the economic slump continues, folks have to eat. As a warehouse chain, Smart & Final's sales and profits rose smartly in the last recession as shoppers became even more price-conscious. Every portfolio of 20 stocks or more ought to contain a retailer - and a good grocer makes good sense. Another fine chain is Albertson's.
Meanwhile, Dow Theory Forecasts, a mild-mannered newsletters that favors conservative, large-cap stocks, uncharacteristically gushes over Bristol-Myers Squibb, calling it a "drug giant on sale." Earnings have risen at an annual average of 18 percent over the past five years and they are up 12 percent for the first half of 2001, yet the stock has dropped from a high of $74.88 late in 2000 to $56.70 last Friday.
Investors appear concerned about "generic competition and a weak pipeline of drugs in late-stage trials," says Dow Theory. It's true that generics have hurt sales of the anti-anxiety drug BuSpar and cancer drug Taxol and that Bristol is hustling to get new remedies ready for market. But the good news is that the firm has an excellent line of diabetes treatments at a time when that disease is burgeoning; also, Bristol is wisely moving away from lower-margin beauty-care to concentrate on higher-margin pharmaceuticals. The company could be a takeover target, even at a market cap of $110 billion; it has an attractive dividend yield of about 2 percent; and the valuation seems modest, at a P/E of 26, for a company with low volatility and high earnings growth.*
I cite these three stocks not to urge you to rush out and buy them specifically - but to remind you that, in tough times, the basics of good investing are the same as in flush times.
... Your job, even as fear creeps up the back of your neck, is to buy businesses worth holding for at least five years - not to guess what's going to happen tomorrow or the day after.
... Or, if you don't want to spend your time doing research, then let experts find those great businesses for you.
... But don't be paralyzed by fear, and don't sell in a panic.
Sources: Wall Street Journal quotation on "horizon," www.wsj.com.
Marshfield Associates (21 Dupont Circle, NW, Washington, DC 20036; 202/828-6200), letter to clients, July 2001.
Value Line Investment Survey, Aug. 10, 2001, pp. 1524 and 1532.
Dow Theory Forecasts, Aug. 6, 2001, issue, p. 8.
The Fine Print
Any information or opinions concerning specific securities or general investing concepts are not those of FOLIOfn and are for general reference purposes only. None of the information or opinions in this column should be considered specific investment advice. Equity investing involves significant risk including the loss of your investment and investors are encouraged to consult their own financial advisers and/or other sources of information before making investment decisions. Past performance of a security, industry or sector is no guarantee of future results. James K. Glassman or FOLIOfn and any of their officers and employees may acquire, hold or sell a position in the securities mentioned in this column. <<< |
