From tomorrow's Heard on the Street column in WSJ:
March 16, 1999
Heard on the Street
For Some Bellwether Stocks,
Managers Will Pay Any Price
By ROBERT MCGOUGH
Staff Reporter of THE WALL STREET JOURNAL
There are some stocks you want to buy on the cheap. Then there are
bellwethers you just have to own at about any price.
That's the mantra these days of Erik
Gustafson and many others like him.
The co-manager of Stein Roe
Young Investor Fund threw in the
towel in November and bought
America Online when the stock was
at a peak. Mr. Gustafson had
resisted buying the stock for his $1
billion fund because it looked wildly
overpriced -- its price/earnings ratio
was "monstrous," he says.
A foolish move? Not by a long shot:
Since then, the fund's 300,000 shares (after adjusting for a split) have
doubled in value. Now, a relieved Mr. Gustafson is a convert to Internet
investing.
"To own a company like AOL, you had to throw out traditional measures
of valuing companies," he says. "We had to say we have to own what we
think is the dominant franchise in the Internet. It was a space that as a
money manager you simply have to be in."
The lure of owning the big,
market-leading stocks, such as
AOL, Dell Computer or Microsoft,
has become irresistible to money
managers. After all, despite the rise
in the market indices, most stocks
are wallowing or even declining in
price. Only by owning the market
leaders has it been possible for
money managers to earn their
bonuses by beating the Standard &
Poor's 500-stock index -- or their
competitors who already bought
those stocks.
All of which leads to a nugget of stock-market lore that says a bull market
ends not when everybody decides to sell, but when nobody is left to buy.
With the Dow Jones Industrial Average approaching the 10000 mark, it is
as good a time as any to ask: Are the buyers anywhere near being tapped
out?
Some statistics on ownership provide some tantalizing clues, showing that
the bandwagon for some market leaders has gotten pretty crowded.
Money managers have flooded into AOL in the past two years. On Dec.
31, 1998, a bit more than 19% of diversified U.S. stock mutual funds
reporting portfolios on that date owned AOL, according to Morningstar
Inc., a Chicago fund tracker. As recently as March 31, 1996, just 0.2% of
U.S. reporting stock funds owned AOL. (Funds report portfolios on
different dates, so each statistic is only a snapshot of the whole. But the
accompanying chart shows how clear the trend has been to jump on the
bandwagon.)
No doubt the ranks of funds owning AOL have surged this year, given that
the stock was added to the S&P 500 index on the first trading day of the
year.
Mutual funds aren't the entire market, of course, but other measures also
show soaring ownership of AOL. Investors owning more than $100 million
in U.S.-traded stocks must report their holdings quarterly in what is called
a 13f filing with the Securities and Exchange Commission. According to a
study of these filings by the Carson Group, a New York follower of
institutional investors, 27.2% of these large investors owned AOL at the
end of 1998, up from 9.8% at the end of 1996.
If anything, the bandwagon has gotten even more crowded for Dell. And
why not? It was the best-performing stock among 1,000 major U.S.
companies in the 10, five and three years through the end of 1998,
according to The Wall Street Journal's Shareholder Scoreboard. Fueling
that price rise was the surge in money managers buying the stock. More
than 33% of diversified U.S. stock funds reporting portfolios for Dec. 31
owned Dell, up from 1.3% at the end of 1993, according to Morningstar.
It isn't just gunslingers running growth-stock funds that are buying these
stocks. Among diversified stock funds reporting portfolios on Dec. 31, 18
designated "large-company value" funds owned Dell, according to
Morningstar. Value funds typically buy stocks that appear cheap
compared with earnings or assets. Dell, which carries a lofty P/E ratio of
82 times trailing earnings, and more than 58 times projected earnings, is
hardly what would be called a "value" stock. The stock also was owned
by at least two small-company growth funds, although Dell hasn't been
small for quite some time.
Can more big investors jump on the bandwagons of leading stocks such as
Dell and AOL? Possibly. Consider that on Dec. 31, 1998, 54% of big
investors owned IBM, according to 13f filings, and about 55% owned
Microsoft, roughly the proportion of funds owning those stocks in the past
two years.
But IBM's stock-market capitalization (number of shares times price) is
$169 billion, larger than either Dell ($110 billion) or AOL ($85 billion).
Microsoft's market cap is an enormous $402 billion. So more fund
managers have mandates allowing them to buy these stocks, and heavy
buying doesn't jar these shares with their bigger market caps.
What's the upper limit for ownership of a stock? Microsoft "is arguably the
most successful corporation in America," says OppenheimerFunds
manager Jay Tracey, suggesting that it is about "the maximum" in terms of
widespread ownership. Moreover, most stocks won't come near to the
widespread ownership of a stock such as Microsoft, he says: "Should we
expect America Online to become Microsoft?"
Of course, predictions made years ago that Dell or Microsoft would run
out of steam have proved dead wrong, and there still could be lots of life in
the market's leading stocks.
Mr. Gustafson, for one, thinks the argument that buyers will get tapped out
is off target. "Conceptually it sounds nice, but it hasn't happened," he says,
pointing to Microsoft as an example of a company that continues to do
well despite broad ownership.
How can he justify the high price of AOL, which sells for 388 times trailing
earnings, or 238 times projected earnings? Mr. Gustafson says major
communications or industrial revolutions, such as railroads in the 19th
century or radio in the early 20th century, brought valuations "that had not
been seen before."
Yes, the radio companies ultimately crashed in value, but "the Web has
grown faster than radio or TV ever did," he says. "Naysayers have missed
the fundamental shift in the U.S." to an information economy, which has
revitalized the U.S. in the past 15 years, he says.
Another buyer of AOL late last year was $820 million Pioneer Mid-Cap
Fund, and the stock has nearly quadrupled since then. Co-manager Steven
Carhart says the fund waited to buy until AOL began to turn a profit.
While it looks expensive by many measures, he estimates that the stock is
valued at $100 to $300 a share based on its fast-growing cash flow,
discounted at today's low long-term interest rates.
While AOL has now outgrown the midcap category -- its stock-market
value is now 50% larger than that of General Motors -- its size doesn't
mean that Pioneer Mid-Cap will automatically sell it, he says.
Mr. Carhart and co-manager Eric Weigel also don't buy the tapped-out
argument: "A lot more people want to own this stock," Mr. Weigel says.
"It's become a dominant franchise. It's almost like you have to own it."
Ian
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