08/10 14:01 TALKING POINT--High Nifty Fifty valuations to stay
By Huw Jones
NEW YORK, Aug 10 (Reuters) - Benchmarking by fund managers, steady profits and cash fleeing Asia's woes will likely keep the valuations of the so-called Nifty Fifty stocks near record terrain despite setbacks like the Dow's 299-point plunge early last week.
Few on Wall Street are brave enough to ignore the money train headed for the biggest caps despite clouds hanging over corporate earnings, analysts said.
"Some of those companies we have still ranked a buy because we are ignoring the valuations and going with the trend in the market," said Sam Stovall, chief market strategist at Standard & Poor's.
The Nifty Fifty are the 50 largest companies most favored by institutions and which have a market capitalization of tens of billions of dollars. They change over time, but usually have higher than average P/Es because of their consistent earnings record.
"Benchmarking by institutions along with foreign investors are pretty much causing the very large caps to be and stay overvalued," Stovall said.
Nervousness about stocks have also kept investors plowing their cash into these big caps because they can be sold quickly if things turn worse because there is more volume traded in the shares.
BIG CAPS DEFYING GRAVITY?
Investors benchmark, or index, by investing in funds that track indices such as the S&P500 large cap index.
"If you were to use projected earnings and where we see interest rates going, we do find them to be very high and as time goes on, they will have to come down, both the prices and the earnings," Stovall said.
Favoring the big caps has distorted the market, with last month's record closes in the leading indices based on a few big stocks while the rest of the market languished, analysts said.
This divergence could make the market ripe for further volatility and set up some of the pricey big caps for a sharp fall, analysts said.
"In the near-term, this market has been inflated by extraordinary liquidity focused heavily on a relatively small group of world-class companies," said Bill Meehan, chief market analyst at Cantor Fitzgerald.
"Until those valuations are adjusted, the market will be vulnerable," Meehan said.
"It's the Nifty Fifty that pushed the market and P/Es (price/earnings ratios) to all time highs, and they will be probably taken apart at the end of the bull market," Meehan said.
The trailing 12-months P/E for the S&P500 index is 23.4, well above the traditional, with the forward 12-months P/E at 21.6, down from more than 23 earlier this year.
These are above the more traditionally levels of about 18.
Trailing 12-month P/Es for some Nifty Fifty favorites are even higher, with Coca-Cola Co. <KO.N> at 51, Gillette Co. <G.N> at 38, General Electric Co. <GE.N> at 33, Wal-Mart Stores <WMT.N> at 38, and Pfizer Inc. <PFE.N> at 54.
"We would not continue to buy Coke and Pfizer at these prices, but a company like PepsiCo Inc. <PEP.N>, that's an opportunity," said Alan Skrainka, chief market analyst at Edward Jones, adding that auto stocks are also overvalued.
"The market leaders will continue to lead, but you have to buy at a smart price. Don't just buy across the board," Skrainka said.
Investing in S&P500 index funds, however, makes it difficult to be selective among the big caps, with most of the money going automatically to companies most heavily weighted in the index, analysts said.
The S&P500 and the Dow Jones Industrial Average are up 12 percent and 8.7 percent respectively for the year, while the Russell 2000 small cap barometer is off 5.72 percent.
DO P/Es REALLY MATTER?
Some say P/Es are just one part of the picture.
CIBC Oppenheimer equity analyst Hany Gobreial said high P/Es will not fall in line with the broader market while inflation and interest rates are low, and profits are still growing, even at a reduced rate.
"As long as there is some profit growth, I don't think the P/Es are going to matter much," Gobreial said.
Anyone looking at just valuations is using the wrong market tool, said Guy Truicko, portfolio manager at Unity Management.
"I don't see how you can use P/Es as a method of choice. You should look at earnings momentum, who is growing revenues, and where are the earnings surprises," Truicko said.
Faith in Nifty Fifty earning power has been well placed so far this year.
In the first quarter, profits for the S&P500 index grew 3.8 percent over the prior year - the weakest in over six years, but for the top 50 companies in the index, profits grew 6.1 percent, and were flat for the bottom 250 companies, said First Call, an earnings tracking company.
With most S&P500 earnings reported for the second quarter, profits have grown 2.3 percent, but are up 6.5 percent for the top 50 companies in the index, and down 6 percent for the bottom 250, First Call said.
"In the short-term there is clearly better growth for these larger companies despite some of them being impacted by Asia," said Chuck Hill, First Call's director of research.
S&P500 earnings are forecast to grow 6.4 percent in the third quarter, and by 13.6 percent in the fourth, but more trimming is expected for both quarters, First Call said.
Even the Nifty Fifty are not immune to investor wrath when doubts are raised about their profits.
Dow component Procter & Gamble Co.'s <PG.N> stock has been battered since it said its first half fiscal 1999 will be difficult.
Shares in American Express Co. <AXP.N>, another Dow component, fell almost 7 percent last Thursday after the financial giant warned that Asia's pain was hurting some operations.
moneynet.com@NEWS-P2 |
