Simple and Solid, New Stocks
Emerge as Market's Leaders
By E.S. BROWNING
Staff Reporter of THE WALL STREET JOURNAL
The stock market looks awful. But maybe people are looking in the wrong place.
Despite big declines in the most visible market gauges during the past two years -- including a 70%
plunge since early 2000 for the Nasdaq composite -- a huge chunk of the stock market is doing just fine.
Nearly half of the stocks on the New York Stock Exchange and the Nasdaq Stock Market have gained
ground since late March 2000, according to a study by
Birinyi Associates, a research and money-management firm in Westport, Conn. The rising stocks are up a median 53% over that period of more than two years, while the decliners have fallen a median 66%, Birinyi found.
Many of the stocks that have been holding up surprisingly well were scorned or ignored during the bull market. As these new market leaders quietly emerge from the
wreckage of the bust, they offer a potential lifeline for
investors who have been burned while waiting for International Business Machines Corp., General Electric
Co. or Cisco Systems Inc. to turn around.
"You've got to get a fresh new line of soldiers in there," says John Meara, president of money-management firm Argent Capital Management in St. Louis.
The new leaders -- stocks with the strongest gains since the market turned down -- come from a
number of categories. But they have one thing in common: Almost all of them avoided getting caught up
in the excesses of the late 1990s. They generally are smaller and less complex than the old leaders, and
they trade at a lower price, compared with their earnings. In recent months, some foreign markets also
have begun looking like winners, performing better than the U.S. market and causing investors to shift
money overseas.
The performance of this new group obviously hasn't
turned around the major indicators, such as the Dow
Jones Industrial Average or the Nasdaq Composite Index.
Both of those are dominated by bigger, better-known U.S.
stocks, whose declines statistically outweigh the gains of
the generally smaller companies that are doing well. In
addition, more people own the big popular stocks that
have been suffering than own the smaller, more obscure
stocks that have been gaining.
The shift to a new breed of winners is the latest example
of a longstanding historical trend. When one group of
stocks declines, it doesn't tend to bounce back and take
over leadership again. A different group tends to emerge
in that role.
In the 1970s, oil stocks dominated. By the 1980s, that
group was fizzling, replaced by fast-growing
consumer-product multinationals such as Coca-Cola Co.
and McDonald's Corp. The 1990s saw tech stocks taking
the lead, producing one of history's biggest stock bubbles.
So far this year, the big gainers cross a wide range of
groups, including home builders, health-care providers,
steel companies, clothing makers and restaurants.
Nearly 300 stocks have more than doubled in price in the
past 12 or 13 months. For example, robust consumer
demand has helped auto-parts retailer AutoZone Inc. post
strong sales growth. Michaels Stores, which sells
home-decorating items, has soared on the back of strong
home sales. Owens-Illinois Inc., which makes glass and
plastic containers, has benefited from strong profit gains,
although it and other economically sensitive stocks have
pulled back a bit recently amid fears of an economic
slowdown.
Some analysts think of the current winners as just a
transitional group of refuge stocks, whose steady
corporate performance amid the post-bubble turmoil drew
enough investment to turn them into gainers. These
analysts think that once the market gets through the
turmoil, a more tightly defined new group of leaders will
emerge. Among the candidates: health-care stocks
benefiting from the aging of America; financial or
consumer-related stocks gaining from prosperity and lower inflation; or perhaps a dark
horse, such as natural-resource stocks, which might repeat the strong performance of oil stocks in the 1970s.
Market leaders can retain their dominance for as long as a decade or as little as a few months. Whatever group emerges in the years to
come, many analysts warn that the huge, double-digit gains of the 1990s may not repeat themselves, as even the leaders put in more modest
gains.
Here are the new rules for a new set of leaders:
Simple and boring is better.
During the boom, the sought-after companies were high-tech concerns that used the latest financial engineering and were involved in new
industries and businesses. Today, "cutting-edge" and "complex" are bad words. Wallboard is good. Consider wallboard-maker Centex
Construction Products Inc., which is up nearly 50% in the past two years despite a recent pullback amid concerns that the housing
business could be cooling off. Simple accounting is especially desirable.
"We have diligently tried to scrub our portfolios of anything with creative accounting or financial engineering," says Tim Morris, chief
investment officer of New York money-management firm Bessemer Trust.
Mr. Meara of Argent Capital decided several months ago to check out energy supplier AES Corp. as a possible investment. AES stock had
lost half its value, due partly to the company's exposure to troubled foreign energy markets.
Thinking it might be a bargain, Mr. Meara traveled to AES's headquarters in Arlington, Va., to interview company executives.
"I couldn't figure it out," the money manager says of AES's business and financial structure. "I just said there are too many moving parts. ...
If you can't explain it to a five-year-old in five minutes, it's not worth taking the extra risk for it."
When Mr. Meara made his trip, AES was trading at about $35 a share, down from a high of about $70. Today, despite a sharp rebound last
week, it fetches less than $5, partly as a result of the hammering that energy companies have received in the wake of Enron Corp.'s
collapse. An AES spokesman declined to comment.
Today, Mr. Meara's holdings are focused on simpler names such as manufacturers Ingersoll-Rand Co., Eaton Corp. and Illinois Tool Works
Inc., railroad company Norfolk Southern Corp. and food-maker ConAgra Foods Inc.
"Our clients are pretty nervous," he says. "We tell them that we aren't gunslingers."
Bruce Simon, chief investment officer at Philadelphia money-management group Glenmede Trust, says he has sold technology stocks such
as Sun Microsystems Inc. and Solectron Corp. from most of his clients' portfolios. He has replaced them with names such as United Parcel
Service Inc., managed-care group Wellpoint Health Networks Inc. and specialty-gas maker Air Products & Chemicals Inc.
Small is better than big.
One of the best places to be during the late 1990s was in supersize stocks, companies such as Cisco, Sun Microsystems and AOL Time
Warner Inc. that dominated their markets and were diversified enough to offer investors several ways to win.
Now, with many big companies having trouble boosting sales, dealing with excess inventory and adjusting their accounting to the new
post-Enron conservatism, investors are looking to companies that didn't get caught up in the earlier euphoria. Small and midsize stocks,
which often out-gained big stocks during the 1970s and 1980s, once again are performing better than big ones.
Especially popular are small and midsize stocks in mundane businesses. Today they look both inexpensive and easy to understand.
Of the nearly 300 stocks that have doubled in price during the past year, all but 17 have market values below $1 billion, according to
Baseline, which tracks stock prices. "The average-Joe company is doing better than the big man on campus," says Jon Brorson, director of
stocks at Northern Funds, a money-management arm of Northern Trust in Chicago. "The big-cap, predominantly technology names still are
too high and still are overpriced. It is the little nerd that is probably coming into its own."
Small companies whose stock prices have more than doubled in the past year include Friendly Ice Cream Corp., with a total market value of
only about $50 million, Jo-Ann Stores Inc., with a market value of $500 million, and Johnson Outdoors Inc., with a market value of less
than $200 million.
One drawback of smaller stocks is that detailed information about them can be less available than it is at big, heavily scrutinized companies
such as Microsoft Corp. or Intel Corp. That makes it more difficult for investors to anticipate developments, increasing the risk of a
company's suddenly blowing up from inexplicable causes. Over the past two years, some big companies such as Tyco International Ltd.
and, to a lesser degree, even GE and IBM have suffered from sharp stock declines, which has made some investors shrug off the risk of
small companies.
One way to get around the risk of small stocks -- including the concern that after two years of strength, they may be due for a setback -- is
by buying broad groups and indexes of them. That way it's possible that any stumbles in a few will be offset by gains in the rest.
Even some investors who still prefer large stocks are leaning toward the smaller members of that group. Merrill Lynch's U.S. investment
strategist Richard Bernstein likes to tell clients that they should be focusing not on the 50 biggest and most famous companies in the
Standard & Poor's 500-stock index, which were the big winners in the 1990s, but on what he calls "the non-nifty 450." Those stocks have
done better recently, and he thinks they will continue to do better. They often are less expensive than the mega-stocks, and they also are
less likely to have been caught up in the excesses.
In the 1990s, many investors focused their investments mainly on the biggest stocks in the S&P 500. Now, as those investors pull some
money out, it is those same big stocks that they are selling.
Cheap stocks are back.
In the boom, investors didn't worry much about a stock's price. If it traded at 100 times its projected earnings, that didn't matter -- as long
as it was thought to be a stock of the future. Dozens of stocks traded at lofty triple-digit multiples of their earnings.
Today, that fascination is gone: The stocks doing the best are "value" stocks, those that are trading at a relatively low price compared with
earnings.
Since the market's peak in March 2000, the stocks that have risen trade at a median price of only 18 times their earnings for the previous 12
months, according to Birinyi Associates. That compares with 23 times earnings for stocks that have fallen since March 2000.
The reason: In an effort to get away from the discredited boom mentality, investors are pulling money away from the darlings of the 1990s,
the stocks whose prices ran up the fastest. They are putting it in stocks that weren't involved in the boom, whose prices tended to remain
more moderate.
Auto-parts maker American Axle & Manufacturing Holdings Inc., for instance, has a price-to-earnings ratio of 10. Owens-Illinois trades at
about 11 and home-builder Ryland Group Inc. at about 10. All these stocks have more than doubled in value in the past 12 or 13 months.
"In 2000, I had very smart people that I knew in the industry saying, 'forget valuation,' " says Mr. Meara of Argent Capital. "Well, forget
that. Valuations matter. Now everybody is looking at valuation, and they don't have any confidence in anybody's ability to execute."
In a similar shift, after scorning dividends for years, in favor of fast-growing tech companies that pay no dividends, investors once again
are starting to put money into companies such as tobacco maker Philip Morris Cos., which pays 4% of its stock price in dividends each
year.
Foreign is good.
Like small stocks, foreign stocks in the later 1990s became almost irrelevant to many investors, who noted then that the U.S. was virtually
the only major country with a booming economy amid a global slowdown.
For years before that, however, foreign stocks frequently did better than big U.S. stocks. Now foreign stocks are back. Tokyo's Nikkei
index is up 15% since February. The Korea Fund, a barometer of the South Korean stock market, has doubled since September.
As a result, some U.S. investors are shifting money abroad again. And some foreign investors, who had been pouring money into big U.S.
stocks in the late 1990s, now have begun to bring money back to their home markets -- or to other non-U.S. markets -- to the detriment of
the U.S. stock market. Foreign markets didn't boom the way the U.S. market did, and some investors think that now is their turn.
And even after the recent gains, "we find that international stocks look as cheap as, or cheaper than, U.S. stocks," says Mr. Simon of
Glenmede.
The S&P 500, for example, currently trades at around 2.8 times its companies' book value, or the value at which their assets are carried on
their balance sheets. The big foreign stocks in the widely used index of major foreign markets compiled by Morgan Stanley trade at about
2.1 times book value. That makes them appear substantially cheaper, despite the gains foreign markets already have made and despite the
drop in U.S. stock prices, Glenmede calculates.
Mr. Peters of PanAgora says his firm likes foreign banks, such as National Australian Bank, Royal Bank of Canada and Canadian Import
Bank. He also likes auto-parts company Valeo SA of France, Japan's Toshiba Corp. and Franco-Spanish tobacco company Altadis SA.
If the stock slide worsens, for example, or if investor skepticism surrounding accounting and corporate scandals spirals, even the
up-and-comers could be caught in the downturn.
But the fact that these kinds of companies have gone up as the indexes have crumbled is capturing the attention of some investors, who
now are forced to unlearn many of the rules of the bull market.
Tom Connolly, manager of the Twins Public House bar in midtown Manhattan, lost a bundle on stocks such as Yahoo Inc. and AOL. He no longer talks to clients about Internet stocks, but Mr. Connolly, 49 years old, hasn't stopped investing. Among his new picks: TeamStaff Inc., a small New Jersey provider of back-office payroll and temporary-staffing services, just the kind of company he would have shunned two years ago. TeamStaff's stock has made little progress since Mr. Connolly bought it, but at least it hasn't fallen through the floor.
"Right now I am just trying to take it easy," the bar manager says. "I want something I can watch each day where there won't be a lot of maneuvers, something where there isn't going to be some surprise coming out of nowhere that makes it crash to the bottom." |
