LA Times article. MRVC reference in middle
latimes.com
Tuesday, August 18, 1998
Street Strategies
Buying on Dips: First, Be Selective
Remember, There's No Sure Way to Gauge Where the Bottom Is
By WALTER HAMILTON
In the bull market of the 1990s, no strategy has worked better than
buying stocks on dips. Everybody knows that.
But here's something nobody knows: when a market slide will become so
severe that stocks keep going down and early bargain hunters get badly
burned.
It's far too soon, of course, to sound the death knell for a tactic that's
worked like a charm since 1990. Indeed, the current market pullback could
very well turn out to be just another great buying opportunity.
Some investors apparently thought so Monday as they pushed some
blue-chip stocks up sharply, lifting the Dow Jones industrial average 149.85
points, or 1.8%, to 8,574.85.
"The money we're putting into [stocks] today is going to look like good
investments in six or 12 months," said Lanny Sachnowitz, manager of the
AIM Charter mutual fund.
* * *
Nevertheless, individual investors should be cautious. Blue- chip shares
have fallen for four straight weeks, and the Standard & Poor's 500-stock
index still is off about 9% from its July 17 all-time high.
Smaller stocks have been sinking since April. Especially in their case, the
buy-on-the-dip mentality has been absent this time.
Obviously there is no sure way to gauge when a stock has stopped going
down--or if this market "correction" will turn into a full-fledged bear market,
the first since 1990.
Still, there are some broad rules investors should follow when sifting
through the market's debris for good buys.
* Be very selective: The first rule of bargain hunting is straightforward:
Don't buy a stock just because it's fallen in price.
After the Dow Jones industrial average plunged 554 points Oct. 27 amid
worries over the Asian economic crisis, individual investors led the charge
the next day, as the Dow rebounded 337 points.
The market gyrated for a couple of months, then launched into another
powerful surge in mid-January.
Anyone lucky enough to catch Microsoft at its Oct. 27 close ($64.38)
has gained 67%, with the stock now at $107.31.
But anyone rushing into the Korea Fund that day, when it closed at
$8.94 a share, is looking at a 32% loss, as the price has continued to slide
to $6 now.
"A common mistake individual investors make is they look at a list of
stocks that are down a lot and say, 'These are cheap. I'm going to go in and
buy them and they'll go back up,' " said David Corkins, manager of the
Janus Growth & Income fund.
"But very often, stocks are cheap for a reason."
In the case of any stock or fund tied closely to Asia, the fundamentals
had just begun to deteriorate last summer and fall. Few investors realized
how bad things would get--and how much cheaper the stocks would get.
A rule that always applies to stock-picking, but that is especially
important in a shaky market: Do your homework before buying what you
think are bargains.
"Do your best to understand what you're investing in," said Jim Margard,
a money manager at Rainier Investment Management in Seattle.
Corkins, for example, recently bought entertainment giant Time Warner(
) and computer networker Cisco Systems(). The
stocks got cheaper in the market pullback, which only increased their appeal
to Corkins because he is confident that the companies' fundamental business
prospects are strong.
* Long-term investors should look for companies that lead their
industries: If you're bargain-hunting not for a short-term trade but for an
investment that will pay off over several years, it's best to start with the
highest-quality industry leaders you can find--companies likely to survive any
industry-related or economy-related shocks that may still lie ahead.
In evaluating those stocks, use traditional valuation measurements as a
shopping guide--for example, stocks' price-to-earnings ratios.
* * *
For example, Scott Schermerhorn, manager of the Federated American
Leaders stock fund, just bought Boeing, the leading aircraft maker, and
Schlumberger, the oil-field services giant.
Both stocks have been hammered, as Boeing's earnings have weakened
in part because of production problems, and as Schlumberger's outlook has
dimmed with low oil prices.
Schermerhorn's reasoning in buying the stocks now: By his calculations,
they are the cheapest they've been in two decades when gauged against the
Standard & Poor's 500-stock index on several valuation measures.
Schlumberger is cheap relative to cash flow and earnings, Schermerhorn
said.
Boeing, meanwhile, is trading at a historically low valuation in terms of
price-to-book value, or the basic worth of the business.
"Do I know the time frame for when Boeing will come back?"
Schermerhorn asked. "Absolutely not. But do I think the worst of the news
is out? I can't think what's worse for Boeing."
Rainier's Margard, also a long-term investor, now likes Avon Products(
), Quaker Oats, US West and chemical firm B.F. Goodrich.
* If you're a short-term trader, understand what the market wants: At
any point, the market is dominated by certain trends. Right now, the market
most favors stocks with earnings reliability() and ample
liquidity.
That means many investors are afraid to buy stocks that have even a
small risk of disappointing Wall Street. It also means investors want stocks
that trade actively enough so that big institutions can quickly enter--and exit.
Both factors would seem to favor large stocks over small ones--the trend
since 1994 as well.
"In this market, if [a company] misses a number their stock is absolutely
devastated," said Marty Hurwitz, manager of the IDS Life Aggressive
Growth fund. "You need a reasonable prediction of earnings to minimize the
number of times that happens."
Hurwitz, hunting for companies with high reliability in their earnings or
cash-flow outlooks, now is favoring such issues as radio companies--names
like Chancellor Media (ticker symbol: AMFM) and Clear Channel
Communications() (CCU). Both have pulled back in the
market correction so far.
* * *
Similarly, Jim Gribbell, manager of the Babson Growth Fund, has lately
added to companies he believes can notch low- to mid-double-digit annual
profit growth.
Among health-care companies, he's recently added to his holdings of
Pfizer(); Cardinal Health(), a
drug-distribution company; and Guidant, a medical products maker.
Overall, "We've been much more active [buying] the past week than we
have been the past two months," Gribbell said.
As for liquidity, Margard has only bought stocks lately whose average
daily trading volume is $2 million or more. On a $20 stock, that would
require that a minimum of 100,000 shares trade daily.
Liquidity isn't a direct concern for small investors. They can always sell a
few hundred shares. But if bad news hits, it's likely that institutional investors
will sell their shares long before small investors know of the news. So all else
being equal, a stock trading a relatively small number of shares will be hurt
worse than another stock.
* Be careful about buying the leaders of the last market advance: When a
correction hits, investors' natural inclination is to lunge at the stocks that led
the last phase of the bull market.
It seems logical enough. Problem is, the leaders of one bull run usually
aren't the leaders of the next. This dynamic is especially pronounced in
smaller stocks.
Why does leadership often change between market runs? Investors may
discover flaws in a stock that they didn't see before. Maybe a stock's
industry group has fallen out of favor. Or it simply could be that fickle
investors have moved on to the next hot stock, or group.
Whatever the reason, the hot stock often grows cold.
* * *
Consider MRV Communications(), a
Chatsworth-based computer networking company.
MRV was a top performer in early 1996, soaring from less than $8.50 at
the start of the year to more than $40 five months later. MRV then slumped
with a market pullback in mid-1996.
But as the Russell 2,000 small-stock index began to recover in mid-July
of that year, and eventually surpassed its old high, MRV's stock failed to
keep up. It did not make another strong run until the summer of 1997--by
which time many investors' patience may have worn out.
Other erstwhile high-fliers with similar patterns include Iomega and
Corrections Corp. of America.
* Look for strength: It might seem counterintuitive in a correction, but
even when looking to buy dips you should target strongly performing
stocks--especially if your orientation is more toward trading than long-term
investing.
In basic terms, look for stocks that fall by a smaller percentage than the
market on bad days and rise more than the market on good days.
Such strength is important for two reasons: First, these stocks are likely
to hold up better in a protracted downturn.
Second, and more important, this tactic is especially effective at
identifying the stocks that may lead the next phase of the bull market. The
reason is simple. When the market turns, the stocks investors want most are
likely to move up first.
When the market is mired in a correction, many big investors hone their
wish lists. When the market finally turns around, the strongest stocks move
up earliest as investors quickly pump money into them.
"You want to focus on the stocks that will recover the strongest and that
will lead the way," Corkins said.
To use this strategy properly, you must pay attention to the market so
that you recognize when it is turning higher.
* * *
Typically, a key sign that stocks are turning up comes when the market
moves up strongly for several days on heavy volume. When that occurs,
keep a close eye on the stocks that lead. They might be the best performers
going forward.
* Don't be afraid to sell if a "bargain" goes bad: One of the most
common mistakes individual investors make is hanging on to losers, hoping
they'll somehow turn around and make it back to the points at which they
bought them. That's a dumb strategy in good markets, but it can be
disastrous for bottom-fishers picking over a dicey market.
When investors buy on dips, they're hoping that a stock has stopped
falling. But they're implicitly taking the chance that the descent has further to
go.
The risk is that a stock is headed for a far deeper loss than an investor
realizes. And that just one sizable loss can decimate a portfolio.
So if a stock falls 8% from the price at which you bought it, many
experts say it's best to sell. Under no circumstances should you tolerate a
loss of more than 10%.
In some cases, you'll end up selling on the low and watching in frustration
as the stock moves back up. But you've also preserved your capital that can
be put toward other stocks.
Of course, long-term investors may argue that if they find value in a
stock--and it gets cheaper--they should simply buy more. That can work if
you have a truly long-term horizon, but it requires steel nerves--and a lot of
capital.
* * *
Cheap Enough Yet?
How a sampling of big-name stocks' prices have fallen from their
52-week highs, and the stocks' price-to-earnings ratios based on estimated
1998 earnings per share.
52-week Monday Percentage '98
Stock high close drop P/E
Avon Products $89.00 $80.88 --9% 27
Time Warner 100.00 89.63 --10 --
US West 58.00 52.00 --10 18
Pfizer 121.75 104.63 --14 50
Walt Disney 42.75 32.19 --25 33
Hewlett-Packard 82.38 55.25 --33 19
DuPont 84.44 55.06 --35 16
Boeing 58.19 36.94 --37 29
B.F. Goodrich 56.00 35.44 --37 12
Schlumberger 94.44 51.75 --45 18
S&P 500 1,186.75 1,083.67 --9 23
Note: P/Es based on analyst estimates tracked by Zacks Investment
Research.
Source: Times research
Copyright 1998 Los Angeles Times. All Rights Reserved
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Tuesday, August 18, 1998
Street Strategies
Buying on Dips: First, Be Selective
Remember, There's No Sure Way to Gauge Where the Bottom Is
By WALTER HAMILTON
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