Keeping the Faith With Ailing Stocks
By James K. Glassman
Sunday, January 31, 1999; Page H01
The objective of stock-picking, wrote Warren Buffett in one
of his annual reports, is "to purchase, at a rational price, a part
interest in an easily understandable business whose earnings
are virtually certain to be materially higher five, 10 and 20
years from now."
That, anyway, is how Buffett himself, chairman of Berkshire
Hathaway Inc. and America's most successful investor, does
it. "If you aren't willing to own a stock for 10 years," he
wrote, "don't even think about owning it for 10 minutes."
With such a distant horizon, you can afford to look for
companies that might be temporarily in trouble, with their
prices depressed. Given time, these firms can bounce back
and start producing big profits -- which translate into higher
prices and dividends.
But how can you tell whether a languishing business will
revive?
You can't. But history shows that a company with a great
brand name, a great corporate culture and great products will
tend to find a way. Small investors can't possibly figure out
precisely how such a company will solve its problems, but
they can make an educated guess that it will.
Two years ago, I dubbed the strategy grounded in this concept
"faith-based investing." It should not be confused with
throwing darts at the financial pages or just going with a
hunch. To succeed, faith-based investing requires the right
companies.
Right now, faith-based investors are looking closely at Boeing
Co. (symbol: BA) and Moto Inc. (MOT), two classic
examples of wonderful firms trying to surmount serious
troubles.
Their advocates can look to the experience of International
Business Machines Corp. (IBM) for comfort. No one could
possibly have known when Louis V. Gerstner Jr. was hired as
chief executive in 1993 that he could bring the firm back from
morbidity. But an investor would have noted that IBM met
the faith-based criteria:
Price beaten down on bad news, balance sheet still strong,
revenue still climbing, product lines varied, track record long
and impressive, brand name untarnished.
Eventually, the faith-based investor supposed, IBM would
find a leader who could turn the company around. And
Gerstner did the trick. The stock has risen from $22 (adjusted
to splits) to $183.25 on Friday.
A faith-based stock I cited two years ago was AT&T Corp.
(T), which was having severe management problems and
difficulties finding a new strategy in a changing
telecommunications world.
At the time, Robert Torray, manager of the Torray Fund
(1-800-443-3036), told me, "It's an excellent company. It's a
great brand name, with good finances." It was also cheap, and
Torray made it his largest holding. In the past two years,
AT&T has returned 136 percent, including reinvested
dividends.
Two other faith-based stocks, identified at the time, were
Apple Computer Inc. (AAPL) and McDonald's Corp. (MCD).
Apple hit a low of $14 at the end of 1997 and is now at
$41.18 3/4, the result of new management headed by founder
Steve Jobs and a terrific new product, the iMac. Apple did not
meet all the faith-based standards -- for one thing, sales had
fallen by more than one-third in two years and, for another,
the company was relatively new -- but it had a fabulous brand
name.
McDonald's is a more traditional faith-based stock.
Competition and saturation were hurting the company, and the
economic crisis in Asia -- a top region for fast-food growth --
didn't help. Share prices struggled to stay even in 1997,
finishing the year at $45. Then, in 1998, the outlook turned
brighter, and the stock soared to $76.
But understand that true faith-based stocks are not what
Buffett calls "cigar butts" -- that is, downtrodden companies
with dim prospects that still have a few more profitable puffs
left in them. (It's possible that Apple fits this description, but,
as a die-hard user for 15 years, I hope not.)
Instead, faith-based investing works only with what Buffett
calls "wonderful businesses" that have simply suffered
setbacks.
Faith-based stocks today? The most obvious is Boeing, which
has had serious problems digesting its acquisition of rival
McDonnell Douglas Corp. Production lines have clogged;
competition from Airbus Industrie, the European consortium,
has intensified; and the slowdown in Asia has trimmed
backlogs.
"We have been too arrogant, too distracted or too
self-satisfied," Boeing President Harry Stonecipher said last
fall. Still, Boeing retains a strong balance sheet, and sales rose
by nearly one-fourth last year.
But the near future looks poor. Boeing stock peaked on July
25, 1997, at $58.87 1/2. On Friday, it closed at $34.68 3/4 --
a decline of more than 40 percent.
Boeing remains, however, the largest aerospace company on
the planet, with the best brand name on the world's most
expensive exports. It has long-term contracts to provide planes
to American, Continental and Delta airlines, among many
others; it's the prime contractor for the space station; and it's
launching satellites and building military jets and helicopters.
The 23 analysts polled by Zack's Investment Management
estimate, on average, that Boeing's earnings for 1999 will be
$1.77. That's a P/E of 19, or well below average for a
large-cap stock. But Value Line expects sales and profits to
drop in 2000.
Few investment houses have a decent word to say about
Boeing, but that may be a bullish sign. Big money is best
made when the professionals hate a good company. The
question with Boeing is whether you want to become a
partner in a venerable business on trust. Is this a company that
will be making a lot more money 10 years from now?
David Fenstermaker of Raymond James & Associates in
Washington points to three other stocks with faith-based
characteristics:
* Motorola, whose "turnaround," a James analyst believes, is
"firmly in place," is continually developing new products and
never knows where its next big winner will come from -- a
good strategy for these times. It has gone from concentrating
on car radios to semiconductors to cellular phones and now to
a global satellite-based telecom network. Motorola has
bounced back impressively from below $40 in September to
$72.25 on Friday, but it still trades below its price of four
years ago.
* Walt Disney Co. (DIS) hasn't slumped as much as one
would like for a hard-core faith-based stock, but it remains
more than 20 percent below its high. Earnings have fallen for
the past three quarters, and Asia has been a drag. But Disney
-- which owns the ABC broadcasting network, theme parks,
television stations and most of ESPN cable, as well as its
movie and animation interests -- is easily the world's strongest
family-entertainment franchise. Richard Bilotti at Morgan
Stanley Dean Witter just boosted the stock to a "strong buy"
on Wednesday, but most analysts remain sour.
* Monsanto Co. (MTC) has sold off its chemicals business
over the past few years to become a "life sciences" company,
concentrating on genetics. It owns such brands as sugar
substitute NutraSweet and fat substitute Simplesse, as well as
DeKalb, the second-biggest U.S. seed producer. A failed
merger last year with American Home Products Corp.
crippled Monsanto stock, and it now trades 27 percent below
its August high. Like Disney, Monsanto could be a premature
faith-based company; it may have to suffer some more.
Unfortunately, at a time when investors are favoring
large-caps with strong histories of growth, finding good
faith-based stocks is not easy. Companies in cyclical
industries, such as Tidewater Inc. (TDW), which services oil
drillers, don't really qualify.
Nor, I suppose, does Citigroup Inc. (C), which was formed
last year with the merger of Citicorp and Travelers Group.
Doubts remain whether this behemoth can be managed
effectively, but the firm is really a new company, so we can't
fall back on history.
What about companies that have endured legal setbacks? Two
obvious candidates are Philip Morris Cos. (MO), purveyor of
tobacco and packaged goods, and Owens Corning (OWC), the
fiber glass maker, which has overhanging asbestos liabilities.
And Buffett's own Berkshire Hathaway (BRKA), whose
shares have tumbled more than 20 percent since June: Does it
make the grade?
None of these is a pure play, but, beyond Boeing and
Motorola, they may be the best available. More profitable
targets may just have to wait. In the meantime, keep searching
-- and keep the faith, baby.
Glassman's e-mail address is jkglassman@aol.com; he
welcomes comments but cannot answer all queries.
© Copyright 1999 The Washington Post Company
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