Whether it is a hungry young stockbroker, a colleague at the water cooler, or a friend at a cocktail party, apparently well-meaning people are going to urge that you make some abysmal investment choices in the coming year. They will tempt you with a chance to get in on the initial public offering of a coffee stock. Or maybe a new real estate investment trust that manages shopping malls. How about a new closed-end municipal bond fund?
How about none of the above? A big part of investing successfully next year will come from knowing what not to buy. If you're easily tempted by stock tips, you had best disconnect your phone lines and plug your ears in 1994. Wall Street will continue to bring out new issues, some of questionable quality, to meet the apparently insatiable public demand. As the bull market trudges on, it will become more and more difficult to find a quality stock that sells at a reasonable price. "You've always got to be more careful when you've had a bull market for a while than when you're coming out of a bear market," says Fred R. Kobrick, manager of MetLife-State Street Capital Appreciation Fund.
STAR GAZING. Like it or not, one won't be able to pick the losers of '94 simply by zeroing in on those specific sectors or industries that are out of favor at the moment. "At various times, things will get bombed out, then they get cheap," says Nola M. Falcone, portfolio manager of the Evergreen Total Return Fund, an equity-income fund. Consider revisiting companies you currently shun later in the year to see if the stock's valuations have improved, Falcone says, "even ones that are at silly price-to-earnings ratios right now."
But while there are no hard-and-fast rules, there are some general principles you should keep in mind when evaluating any investment next year.
First of all, don't be dazzled by this year's stars. "We would avoid the hot stocks of '93," says Douglas K. Rayborn, chairman of Rayborn & Co., an investment management firm in Delray Beach, Fla. "That is, computer- and telephone-related issues that have run up sharply and are selling at high P-Es with lots of expectations."
Kobrick warns of a continuing telecommunications "mania" and says it may be years before interactive media plays, such as Qualcomm and 3DO, which are selling at P-Es of 119 and 116, respectively, can generate earnings to prove they are worth the price. With new technology, it sometimes is prudent to invest ahead of earnings, he says, but multimedia is not a new technology: It's old technology in a new package.
PLAYING CHICKEN. But the hottest--and priciest--stars of 1993 were stock IPOs, which can now be considered too hot to handle. "You would think everyone who could go public reasonably has already done so," says John H. Laporte, manager of T. Rowe Price New Horizons and New America Growth funds, but he says there is another group of new issues waiting at the door. "There are far too many companies that are really at the development stage trying to go public and actually succeeding."
Professionals are scoffing at price runups, such as the one Boston Chicken experienced on its first day of trading, when it rose from 20 to 48. It was selling at 37 3/4 a share on Dec 13. "When you've got companies with zero earnings doubling in price, I'm concerned," says Palomba Weingarten, chairman of the Pilgrim Group of mutual funds.
Evergreen's Falcone advises investors to avoid any new issue with multiples of 30 or 40. Snapple, Starbucks, and Gentex all have price-earnings ratios over 60. Sunglass Hut, which operates kiosks selling expensive eyewear, has good earnings and good sales, she says, "but if you stumble one quarter, you're down the tubes on the stock. That's just something I wouldn't dream of doing to my investors." However, if you can get in on the deal early, you may stand to take a quick profit.
Aside from stock IPOs, new REITs and closed-end fund offerings also are being churned out for an overly eager investing public. They all fall prey to the same major disadvantage: They are promoted by underwriters who profit handsomely from the up-front fees, regardless of how they perform long-term.
MALL MADNESS. Bundles of real estate properties are being traded at huge premiums to the value of their underlying properties. Investors typically buy them for juicy yields, but analysts question the ability of some managers to supply the projected cash flows. Investor demand for new REITs seems to be slowing, as the public shies away from the questionable shopping-center REITs that have been offered lately. Analysts suggest avoiding Mark Centers Trust and Crown American Realty Trust.
Buying on the initial offering of a closed-end fund is never advised. The beauty of these investment vehicles is that you can usually buy shares at a discount to the value of the securities in the portfolio. To buy a new fund at net asset value plus a sales charge is almost never worth it. But it's just plain dumb to buy a new issue of a generic bond fund when you can buy one just like it at a discount for a higher yield.
But for most sectors of the market, it's a lot tougher to judge whether you ought to be in or out in 1994. Health care is a particularly tricky area. You may think these outfits already took their lumps when President Clinton was elected and the health-care package was announced, but not all analysts agree. Kobrick, for one, warns that more fallout is on the way. "It's an area for the general public to avoid unless they really have a method to pick the winners," he says. Stay away from hospital-supply and medical- devices companies, which will face volume cutbacks and pricing pressures, such as U.S. Surgical and C.R. Bard, Kobrick says.
Contrary to much of the thinking on Wall Street, Joseph V. Battipaglia, chief investment strategist at Gruntal & Co., says some personal-computer makers, such as Dell and Zenith, should be avoided: "They are basically just assemblers with no value added," he says. Battipaglia also recommends that investors steer clear of natural resources, including chemical and metals companies: "We believe any industrial demand will be more than offset by cash-starved producers looking to clear inventories at any price."
To really judge a stock a loser, you have to look at the "innards" of the company, says Kobrick. This means doing some research-or trusting your broker. Falcone searches for stocks with high current income that can provide a cushion in a downturn.
However, Falcone says, an unusually high dividend can be an indication of weakness at a company. If the company's earnings are not covering the dividend, it may be in a period of slow growth. "The quality of earnings is a big issue," says Peggy Woodford Forbes, president of Woodford Capital Management Inc., based in New York. "We've seen a lot of growth happen because of restructuring and downsizing. Now we have to see whether that leanness and efficiency will pay off."
REST AND MOTION. Also look sharply at the recent price movements of any stock. There is nothing wrong with "momentum" investing, or picking the stocks that are rising the fastest in price, on the theory that "a body in motion tends to stay in motion," says Buck Newsome, managing director of the Cambridge Financial Group, an investment advisory firm in Columbus, Ohio, that depends on this strategy. But these stocks tend to fall as fast as they rise, he says. If a stock has had a long price runup and momentum is starting to stall, you had best invest elsewhere. You might end up investing in a downward-momentum stock. It's likely that the new year will include more derivatives of mortgage-backed securities and strange new limited partnerships. The rule here is: Avoid what you don't understand. And if you're not going to close your ears to hot stock tips in 1994, do enough homework to make sure you don't get creamed.
STOCKS TO AVOID Stock Price* P-E ratio BOSTON CHICKEN 37 3/4 (def) SNAPPLE 23 61 STARBUCKS 22 1/2 75 GENTEX 30 3/4 63 QUALCOMM 54 5/8 119 3DO 24 1/2 116 U.S. SURGICAL 22 7/8 38 C.R. BARD 24 30 MARK CENTERS TRUST 153/4 21 CROWN AMERICAN REALTY TRUST 15 42 *As of Dec. 13. DATA: SURVEY OF ANALYSTS