<<Feeling blue..I view point that I have been trying to follow since last couple of weeks...
Shares of blue chip companies are being pummelled. But they should not be written off, write Philip Coggan and Andrew Hill - 10 Mar 2000 20:39GMT
Are blue chips dead - or merely resting? The question is worth posing in a week in which Procter & Gamble, the US consumer products company that is one of the bluest of the traditional blue chips, saw its shares slide 31 per cent in a day after warning that its third quarter earnings would fall.
Blue chip shares are not supposed to do that. A blue chip is the kind of share that an investor can lock away in a drawer for 10 years, confident that the company's profits and dividends will have grown steadily over that period. In the 1970s, these were known as "one decision stocks".
But these days, it seems much harder for established companies to maintain the kind of steady record that justifies the blue chip tag. P&G's decline comes in the same quarter as the resignation of Douglas Ivester, Coca-Cola's chief executive, after a series of mishaps and a recent lacklustre share price performance. Gillette and Xerox, among other branded heavyweights in the US, have disappointed the US markets in recent months. In the UK, market stalwarts such as Marks and Spencer and J Sainsbury, the retailers, are looking tarnished.
The blue chip tag could even be a liability in the US, at least temporarily. According to Morning star, the mutual funds research group, all 53 of the funds with "blue chip" in their title have recorded negative returns so far this year. The Dow Jones Industrial Average, home to the US market's 30 heavyweight stocks, was down 13 per cent for the year as of Thursday evening.
Warren Buffett, the archetypal blue chip investor, will have a lot of explaining to do in his annual letter to shareholders of Berkshire Hathaway, his investment company, due to be posted on the company's web site on Saturday.
There are firm economic reasons why the blue chip is out of favour. Economic changes have made life much more difficult for some of the old established companies. In the 1970s and 1980s, rapid growth in nominal gross domestic product meant companies could almost guarantee double digit revenue increases every year. With that kind of following wind, it was pretty easy for managements to deliver consistent improvements in profits.
But since the start of the 1990s, inflation has dropped sharply and global economic growth has been, until recently, fairly sluggish. Consumers have been resistant to price rises. Many companies have found it hard to increase sales at anything above a snail's pace; increasing profits, therefore, has become a relentless grind of cost-cutting.
Other factors have also weighed in. "Globalisation and the power of the internet mean that the world is increasingly fast-changing and competitive. That puts pressure on established companies," says Richard Davidson, European strategist at Morgan Stanley Dean Witter.
Ironically, the US bull market gained momentum in the mid-1990s as investors bet on big brands - Coke and P&G among them - to take emerging markets by storm. But that process has taken longer than expected. Meanwhile, low inflation has meant that traditional blue chips have fallen out of stock market fashion.
The value of a share represents the sum of all future cashflows to investors, discounted to the present day. In a high inflation, high interest rate world, the effect is that profits many years in the future are worth little in present day terms; the discount rate applied to those profits is too high. That favours blue chips making profits today over growth companies promising profits in a few years' time.
But in a low inflation world, the promise of profits is worth a lot more. That has favoured the growth school over the old established stocks.
Also, the long bull market in stocks has made equity investors more aggressive. "Investors' appetite for risk has increased and blue chips have a lower risk profile," points out Mark Howdle, European strategist at Salomon Smith Barney.
Frederick Reynolds, president of a California-based fund management group that includes the $640m (œ405m) Reynolds Blue Chip Growth Fund, says: "Companies that dominate their industries are still blue chips. It's just that the industries aren't doing so well."
All this lies behind investors' recent preference for "new economy" over "old economy" stocks, a sector that includes most of the blue chips. The blue chips have been hit by a double whammy. Not only do investors like the higher growth prospects of the technology, media and telecommunications shares they believe technological change will eat into the profits of the old economy groups.
That was highlighted in the US this week when the Nasdaq composite index, which is heavily weighted towards technology stocks, burst through 5,000 for the first time. In the UK, meanwhile, long established groups such as Whitbread and Scottish & Newcastle dropped out of the FTSE 100 index to be replaced by newcomers such as Baltimore Technologies and Capita. One relegated company, Allied Domecq, had greater annual profits last year than all nine of the new entrants put together.
The new economy stocks certainly lack some of the characteristics of the old. "Blue chips, as conventionally defined, have a consistent dividend growth record but that does not apply to many tech stocks," says Michael Hughes, a director of Baring Asset Management. In the UK at least, that is a problem for the many investors who do require dividend income, such as pension funds and the elderly.
The second problem is that technological change is so swift one cannot be sure the big tech stocks of the past will still be around in 10 years' time. Perhaps Vodafone AirTouch Mannesmann, the first global mobile phone brand, will turn out to be one.
In the US, however, there is evidence that the definitions of blue chips are changing. Most would agree that Microsoft, for example, is a blue chip stock, yet it has never paid a dividend. David Blitzer, the Standard & Poor's economist who heads the committee that vets companies for inclusion in the S&P 500 index, says: "If there is sort of an average blue chip, it's clearly changed: the [S&P] 500 is one third technology stocks at the moment, which is as high as it has ever been." Nevertheless, the selection committee still fights shy of including companies, such as retailer Amazon.com, that have never turned a profit.
Jeremy Siegel, professor of finance at Wharton Business School, believes the more startling aspect of the US market is how high-growth stocks also have the highest market capitalisation. In the 1960s and early 1970s, members of the so-called "nifty fifty" growth stocks - including Coca-Cola, McDonald's and General Electric - made up perhaps one out of four of the top 20 companies by market capitalisation. Now, says Prof Siegel, the ratio is more like four out of five. Some of these, such as Cisco Systems - the networking company that some analysts believe could become the first trillion-dollar company - may already deserve to be called blue chips.
What seems clear, however, is that it will take more than a market hiccup or an interruption of steady growth to see off the old blue chips.
Some have already shown their durability. General Electric, the only Dow stock that was also a member when the index was formed at the end of the 19th century, is still one of the biggest quoted companies in the world. Other traditional blue chips, such as Ford and General Motors, are enlisting technology to shore up their experience and brand-names. And companies such as P&G and Coca-Cola still own valuable worldwide franchises.
Some of the biggest technology stocks have already earnt admission to the blue chip list and others undoubtedly will. But it is not hard to foresee circumstances - a bursting of the internet bubble, a global recession - in which the defensive qualities of the old-line blue chip companies might also seem attractive again. >>
--------------------------------------------------------------------------------
|
