‘Buy and Hold’ May Not Work in ‘90s

When the stock market crashed five years ago this week, the 1980s still had two years to run, according to the calendar. But for Wall Street, the ‘80s ended right there.

The 508-point drop in the Dow Jones industrial average on Oct. 19, 1987--to 1,738.74--marked the end of a five-year bull market that had lifted the Dow from 776.92 in August, 1982, and in the process rallied virtually all stocks with it.

After the ’87 crash, many savvy market players predicted that the days of the “rising tide lifting all boats” were over. Wall Street would again become a stock picker’s market, the pros said, a place where a select few stocks would be tremendous long-term winners, and most of the rest would mirror the relatively uninspiring performance of their businesses.

That’s exactly how things have played out, new data show. The broad market, as measured by the Standard & Poor’s index of 500 major stocks, has risen 22% in price since its 1987 peak and is up about 50% if you include dividends earned since then. But among individual stocks, the story is far less pleasant:

* A Merrill Lynch & Co. computer scan of 3,040 major U.S. stocks shows that nearly 58% are trading below their 1987 peak prices, adjusted for any stock splits. The scan covered well-known stocks trading for at least $3 a share.

* Perhaps even more troubling, the Merrill scan shows that 38% of stocks never recovered to their 1987 peak prices anytime in the last five years.

The message in these statistics is that the market has been a brutal place the past five years, especially for one particular type of investor: the individual who has been conditioned to buy and hold a handful of stocks.

If you’ve owned a diversified portfolio the last five years, you’ve come out ahead even if you bought at ’87 peak prices. But if you bought only a handful of stocks at their 1987 highs, you may be underwater even five years later.

Does that matter to the true long-term investor? Many people could argue that even a half-decade is a short span, of course. Stocks that have lagged over the last five years could win big over the next five.

Also, buy-and-holders could argue that it’s unfair to measure stocks from their 1987 peaks, because few people would have paid peak prices--just as few bought at the post-crash lows for the year.

But that’s missing the point: When nearly 58% of stocks haven’t advanced from their old highs after five years, you know the game has changed.

Saying you’re a long-term investor is one thing, but staying with “buy and hold” just for its own sake won’t cut it anymore. You have to be sure the stocks you’ve bought have a good chance of leading the market, or at least keeping pace with it, over the next five to 10 years.

How do you identify the stocks likely to lead the market in the ‘90s? That debate is raging on Wall Street now, because the market appears to be in transition.

Many of the leaders of the past five years--such as drug and food stocks--no longer appear sure bets. The slow-growth economy and unwillingness of consumers to open their wallets is limiting the pricing power of the old-favorite consumer growth companies.

Even Roger Engemann, a well-known growth stock manager in Pasadena, admits, “I don’t think you can ever count on the past growth stocks being the growth stocks of the future.” The old leaders have to constantly prove themselves, he says.

In 1987, Wall Street had identified such then-raging businesses as Home Shopping Network, Marriott and American Express as stocks of the future. But since then, their franchises have faded with consumer purchasing power.

Nonetheless, Engemann believes that the negativism surrounding some of the old consumer stock leaders is unwarranted.

Kellogg and General Mills, for example, often are lumped in with other food companies that have lost pricing power. Yet because of its perceived health benefits, cereal is one of the fastest-growing food product lines worldwide. Given their growth outlook, Engemann sees good reason to believe that shares of Kellogg and General Mills can pace the market in the ‘90s, as they have since 1987.

Even so, Engemann exhorts buy-and-hold investors to expand their potential list of stock candidates beyond the old winners.

Major regional banks, for example, constitute the “No. 1 group that I think is a steal,” Engemann says. One of his favorites is NationsBank, the North Carolina-based giant that dominates the Southeast. The stock is up from a peak of $29.125 in 1987 to $44.

How do other experts identify potential winners of the ‘90s? Here are some strategies:

* Look for companies that have shown solid sales growth--so-called top-line growth--despite the overall economic weakness of the past two years. If you figure on that kind of economy continuing, “top-line growth, by definition, will become an increasingly scarce commodity in the 1990s,” says David Shulman, stock strategist at Salomon Bros. in New York.

Because most companies ultimately need healthy sales growth to generate healthy earnings, Shulman figures that the relative few companies that can boost their sales will be the profit leaders of the ‘90s. Their stocks, naturally, should follow.

Shulman’s list of fast growers includes Southwest Airlines, which has expanded nationwide to take advantage of the weakness of many rivals; insurer American International Group, which Shulman cites for “innovative product creativity” that brings in new business; and Midwest regional bank BancOne, which is taking market share away from competitors via smart acquisitions.

* Look for U.S. industry leaders now picking up market share overseas. Athletic shoe maker Nike Inc. seems to fit that bill. Its hot performance since 1987 has largely been based on its domestic sales gains. But Norman Yu, a growth-stock manager in Newport Beach, notes that Nike’s best prospects going forward may lie overseas.

* Make at least some bets on a stronger economy. Steven Resnick, strategist at Cowen & Co. in New York, says investors are mistaken to assume that the economy will grow slowly forever. In fact, he believes that Americans will demand that the government engineer faster growth, even if that means higher inflation.

If you buy that scenario, the market leaders of the next few years will include many capital-goods makers that should see demand for their products rise in a stronger, more confident economy, Resnick says. He includes computer-chip giant Intel and electronic-equipment leader Hewlett-Packard in that group--and Microsoft as well, because software will have to power that equipment.

Lessons From ’87 Market Madness A Merrill Lynch computer survey of 3,040 major stocks on the three major U.S. markets finds that most are now trading below their 1987 peak prices--a sign of how tough the stock-picking game has been since then. Percentage of issues now trading below ’87 highs. AMEX 68.4% NASDAQ 56.9% NYSE 55.3% Stocks surveyed exclude those trading under $3. Prices were adjusted for splits where applicable. Five Years Later: 20 Laggard Stocks, and 20 Stars Anybody could have made money buying at the market low in 1987. But what if you had bought individual stocks at their ’87 peaks , and stuck with them--as a true long-term investor? The surprise may be that some of the most promising stocks of ’87 remain well below their peaks of that year. Here is a look at 20 big laggards since ‘87, plus 20 other stocks that have been stars in the same period. Losers Since 1987

1987 Stock (market) peak Today Change Home Shopping Network (N) $47 $5 7/8 -88% Digital Equipment (N) 199 1/2 34 3/8 -83% Pacific Enterprises (N) 61 1/4 18 1/2 -70% ClothesTime (O) 24 1/2 8 3/8 -66% IBM (N) 175 7/8 70 3/4 -60% Maytag (N) 32 1/4 13 5/8 -58% Marriott (N) 43 3/4 18 3/4 -57% Northrop (N) 52 5/8 23 1/4 -56% Occidental Petroleum (N) 39 5/8 17 1/4 -56% Lotus Development (O) 39 3/4 17 1/2 -56% American Express (N) 40 5/8 20 -51% Chrysler (N) 48 24 1/4 -49% Great Western Financial (N) 24 3/8 13 5/8 -44% Beverly Enterprises (N) 18 7/8 10 5/8 -44% TRW Inc. (N) 70 50 -29% Lockheed (N) 61 1/2 47 1/4 -23% Nordstrom (O) 40 3/4 33 1/4 -18% Apple Computer (O) 59 49 -18% Limited Inc. (N) 26 3/8 22 7/8 -13% CBS Inc. (N) 226 1/4 202 1/4 -11%

Winners Since 1987

1987 Stock peak Today Change Nike Inc. (N) 12 3/8 77 5/8 +527% Microsoft (O) 17 5/8 85 3/8 +384% Federal Natl. Mortgage (N) 16 1/8 68 +322% Circus Circus (N) 16 3/4 53 1/2 +219% System Software (O) 7 21 7/8 +213% Southwest Airlines (N) 8 3/8 24 5/8 +194% Wal-Mart (N) 21 3/8 59 1/2 +178% MBIA Inc. (N) 22 7/8 57 1/2 +151% Philip Morris (N) 31 1/8 77 1/4 +148% Sara Lee (N) 24 5/8 57 1/2 +134% General Mills (N) 31 1/8 67 1/2 +117% Dillard Dept. Stores (N) 19 1/4 40 3/8 +110% Kellogg Co. (N) 34 3/8 71 3/4 +109% BancOne (N) 22 1/4 44 1/2 +100% Intl. Flavors & Fragrances (N) 58 105 1/2 +82% Merck (N) 24 3/4 42 1/2 +72% Mapco Inc. (N) 33 1/4 56 7/8 +71% American Intl. Group (N) 67 108 1/4 +62% Gap Inc. (N) 19 1/2 30 3/4 +58% Intel Corp. (O) 43 1/2 63 1/4 +45%

Prices adjusted for stock splits where applicable. Percentage changes count only stock prices, not dividend returns. Markets: N -- NYSE; O -- NASDAQ.