Pay $30,000 to own a BMW-a car with name recognition and a reputation for performance--and be known for your discerning taste. Pay 30 times earnings for a stock with the same attributes, and be labeled a fool.
People are willing to pay incredible prices for certain things, but stocks aren't always among them. Investment manager Benjamin Graham and Columbia University finance professor David Dodd, the pair who wrote the value-investing bible back in 1934, made bargain shoppers out of Wall Street's best and brightest, many of whom wouldn't consider buying a stock trading at more than 20 times earnings.
GOOD VALUE. That search for value has prompted many investors in recent years to fixate on trendy sectors, such as biotechnology and electronics, and bypass old-time corporate giants. But some respected investment pros are saying: Don't overlook the Coca-Colas, Johnson & Johnsons, and other perennial performers.
While people may dismiss them as past their prime or too pricey now, good old-fashioned growth companies are often the best value, according to a study by Jeremy Siegel, a finance professor at the University of Pennsylvania's Wharton School of Business. The study focused on the "Nifty 50," a group of large-cap stocks such as Coke, Philip Morris, Gillette, and Merck, made famous in the bull market of the late 1960s and early 1970s when their price-earnings ratios soared to 50 or more. These blue-chips are also known as one-decision stocks, the kind you buy but never sell. The original 50 varied slightly by institution, but many of the same names turned up on all lists.
By tracing the price, earnings, and returns of the Nifty 50 (as defined by Morgan Guaranty Trust) from 1970 through 1995, Siegel found that even with extraordinarily high p-e's, these equities outperformed the stock market over the long term. An equally weighted portfolio of Nifty 50 stocks (2% to each stock, rebalanced monthly) exceeded a value-weighted market portfolio by 37% from December, 1970, through May, 1995. For example, at the market peak in December, 1972, the p-e of McDonald's was 71, a ridiculously high ratio for a drive-in burger chain, analysts argued at the time. Yet despite that assessment, McDonald's dividends and earnings have increased annually for the past 30 years. Even investors who bought high in 1970 and held on through 1995, Siegel says, would have gained more than 18% a year.
Siegel is not alone in supporting back-to-the-future investing. "The bygone era of one-decision stocks may have begun anew when Warren Buffett announced this year that Coca-Cola is a permanent holding of Berkshire Hathaway," says Morgan Stanley investment strategist Thomas McManus. Analysts such as McManus cite numerous members of the Nifty 50, including Walt Disney, PepsiCo, and General Electric, as contenders for tomorrow's market leaders.
You're not likely to make a quick buck investing in veteran growth companies, but the potential for continuing appreciation is there. Just think of your portfolio the way you do a college education: Use Nifty 50 blue chips to build a core curriculum and save the biotech issues for electives. "Over time, what will do better than a J&J or Procter & Gamble?" says Hersh Cohen, manager at the Smith Barney Appreciation Fund.
POTENTIAL. One-decision wonders have a few things in common: good management, strong franchises, and brand- name products that allow them to charge more than their competitors for essentially the same product, McManus says. Look for earnings and dividend growth of 10% to 15% per year for at least 25 years--although Siegel concedes that one mild downturn is acceptable. Past earnings are important, but future potential is crucial. "The main mistake investors make is not overpaying, but overestimating a company's future growth rates," says David Alger, president of Fred Alger Capital Management.
Not all of the Nifty 50 were winners over time, so it's important to diversify within the group. For example, Xerox sold for $180 in 1972; today it's at $130. Polaroid and IBM faltered, too. Portfolios overweighted in such "promising" technology companies fared much worse than those with a mix of tech, retail, drug, food, and entertainment stocks. You'll still want to search for dynamic new companies. But don't get so blinded by today's upstarts that you pass up the stalwarts of old.