New Equity Boom Raises Scrutiny on Older Stocks

The Age of Equity is here, and the load of new stock that comes with it promises to change the rules of investing--even for people who don’t want any part of the new stuff.

Faced with a torrent of fresh stock offerings that could continue for years, big investors may increasingly be compelled to sell the old to fund the new: Laggard stocks in a portfolio may be jettisoned much faster to make room for more promising offerings.

If that sounds like a market even more volatile and unforgiving than what we’ve seen of late--well, it may be. But those kinds of markets can also produce extraordinary profits for investors who find and stick with strong stocks.

So far this year, American companies have been selling new shares of stock at a breakneck pace. As interest rates have fallen and stock prices have surged, investors’ hunger for equity has ballooned. So young and established companies alike are only too eager to step up to the plate. What better way to raise capital?

Time Warner just collected $2.8 billion from a stock sale. Now, Chrysler Corp. wants to raise $420 million that way, and Sony Corp. reportedly wants to raise $2 billion to $3 billion.

The huge deals in the pipeline could make this a record year for stock offerings:

* Secondary stock sales--that is, sales of new shares by established companies such as Time Warner--have reached $19.4 billion so far in 1991, says Securities Data Co. With five months to go, the 1991 figure is already higher than any full-year figure except for 1983 and 1986.

* Initial public offerings, which are first-time stock sales by either young firms or by older, private firms, have reached $11.6 billion so far this year. That’s more than the full-year figures for 16 of the past 21 years.

Some analysts fear that the supply of new stock has grown too large for investors to absorb and that far fewer companies will be able to sell shares next year and beyond because of the 1991 “bubble.” But chances are the fretters are wrong. “I think this market is still in the early cycle stage,” says A. C. Moore, strategist at Argus Investment Management in Santa Barbara.

What’s happening is nothing less than the unwinding of the debt mania of the past decade, Moore and others argue. Debt was used to fund the takeovers, leveraged buyouts, stock buybacks and other hot transactions of the ‘80s. It made more sense for companies to borrow because stock prices were relatively low for much of the decade--investors weren’t willing to pay up.

Now, the stock market is near all-time highs, which means selling new stock makes far more sense for many companies than borrowing. Meanwhile, investors who are fed up with falling interest rates are much more willing to look at stocks, figuring that they’re worth the bigger risk because of the potential for much higher returns.

When these “re-equitization” periods begin on Wall Street, “they can go on for a number of years,” notes Carmine Grigoli, strategist at First Boston Corp. in New York.

New companies, and the re-emergence of older, private companies (all those streamlined LBOs from the ‘80s), can captivate Wall Street. “Many of these deals are exciting, they’re new and in many cases they have the potential for significant earnings gains” as public companies, Grigoli says.

Indeed, that is exactly how Wall Street has embraced such new stocks as Duracell, RJR Nabisco and retailer Filene’s Basement this year. These stock offerings are a reason to cheer; they give companies the cash with which to expand here or overseas. The money won’t always be used wisely, of course, but enough of it will, and that’s got to be good for the economy. “The stock market is acting like a capital market again, instead of just the casino that it was during the 1980s,” says Edward Yardeni, economist at C. J. Lawrence Inc. in New York.

But the amount of money out there isn’t infinite. And as the supply of new stock continues to increase during the next few years, the competition for investors’ dollars means that laggard stocks will be shown no mercy--because there will be plenty of better ideas around. (Remember, the ‘80s saw a shrinkage of stock because of takeovers and buybacks. Some stocks rose by default in that period, just for lack of competition.)

All this means that investors large and small will have to be much more vigilant over all their stocks. If a company’s growth rate begins to decline, you probably can’t afford to keep it because Wall Street will be brutal when it reassesses the stock’s value. And that will happen sooner rather than later.

The flip side is that the strong companies, whether new or established, may increasingly see a higher value placed on their stocks. If it sounds like we’re headed back to those halcyon days of the early 1970s, when growth stocks sold for 50 to 80 times earnings per share, that may very well be the outcome of this new Age of Equity.