Special Report on Investments and Personal Finance : In a Raucous Market, Four Proven Winners Offer Sound Advice

The dollar plummets. The trade deficit soars. A renegade derivatives trader brings down a venerable London bank.

It’s more than enough to give an investor the jitters.

In tumultuous times like these--and what times aren’t tumultuous?--it’s especially worthwhile to consider the strategies of investors famed for their success over the long haul.

While many are losing their heads, here’s the current thinking of four who aren’t: stock-market sages Peter Lynch, John C. Bogle, Warren Buffett and George H. Michaelis.

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Peter Lynch, vice chairman of Fidelity Management & Research, who made his fortune purchasing undervalued companies for the Magellan Fund, remains bullish on the stock market.

Continued cost cutting by most U.S. firms, completion of painful defense industry cutbacks, containment of health-care cost inflation to less than 5% a year and the strongest equity levels in the nation’s banking system since the 1950s are all reasons for optimism, Lynch recently told a group of business leaders in Boston.

In his latest book, “Beating the Street,” Lynch exhorts investors to buy stocks. From technology and pharmaceuticals to restaurants and retailers, he is keen on a wide variety of sectors. Rich rewards still can be found in growth stocks and special situations, he says: “Star performers come straight from nowhere.”

Given the choice between investing in a good company in a great industry or a great company in a lousy industry, Lynch will take the latter any day. Good management, a strong balance sheet and a sensible plan of action can overcome many obstacles, he writes.

And Lynch especially likes spinoffs such as Allstate Corp., the insurance unit that Sears, Roebuck & Co. will distribute to its shareholders this year. “When companies get spun off, something seems to happen to them,” Lynch says. “They get better run, even though they were well run before.”

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There’s good news and bad news--but it’s safe to assume that both are already reflected in stock prices, according to John C. Bogle, chairman of the Vanguard Group of mutual funds, which manages a $140-billion portfolio for about 6 million investors.

In an international scene that is “somewhat overplayed” and with liquidity and price risk too high in emerging markets, Bogle’s motto is: “Stay the course.”

“The reason people fail is that they let themselves down by either getting overly optimistic and buying at highs or becoming fearful and selling at lows,” he says.

Bogle recommends a strategic allocation of stocks and bonds that varies by your age. His basic rule: “The bond portion of your total investment portfolio should be roughly equal to your age. The remainder should be invested in equities.” In other words, a 30-year-old should have 30% of her money in bonds and the remaining 70% in stocks; the proportions would be reversed for a 70-year-old.

With dividend yields at 2.7%--and at such lows for only the third time in history--Bogle believes that stocks are fully valued. Prudent investors may want to reduce their stock holdings by 15% in favor of a combination of short, intermediate and long-term bonds. To further limit risk, he recommends dollar-averaging by regularly sinking money into your portfolio on at least a quarterly basis.

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For years, investors have turned to Berkshire Hathaway’s annual report to glean words of wisdom from Warren Buffett, the man Peter Lynch calls the “greatest investor of them all.”

In the latest edition, issued last month, the chairman of the Omaha, Neb.-based holding company says that some of his best investment decisions came when fears about the economic big picture were high. So what’s he buying now? Buffett has just loaded up on financial services companies, which have been depressed for months, purchasing big chunks of PNC Bank, First Interstate Bancorp, Federal National Mortgage Assn. (or Fannie Mae) and SunTrust Banks and boosting his stake in American Express.

Ignoring both political and economic forecasts--which he calls expensive distractions--and recent market performance, Buffett focuses on a small group of well-managed franchises. Normally, more than 75% of Berkshire’s common stock holdings are in just five securities.

For example, in 1988 and 1989, Buffett purchased more than $1 billion worth of Coca-Cola stock-- after the shares already had risen more than fivefold in the prior six years. Since then, the company’s stock price has tripled. During the 1990 panic in banking stocks, Buffett bought 10% of Wells Fargo. At the end of 1994, that 5-million share stake had enjoyed a 150% gain.

Buffett’s approach is to search out undervalued companies, rather than to try to time stock purchases.

“We like a business with enduring competitive advantages that is run by able and owner-oriented people,” he says.

But even this guru makes an occasional mistake. At year-end, Berkshire wrote down 75% of its $358-million investment in USAir Group, after Buffett grew impatient with management efforts to get the airline’s cost structure under control.

“In an unregulated commodity business, a company must lower its costs to competitive levels or face extinction,” he wrote.

USAir was a mistake that Buffett--and Berkshire Hathaway stockholders--could afford. Despite the airline’s nose-dive, Berkshire’s net worth rose by $1.45 billion, or 13.9%, in 1994.

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The weakening dollar is generally good news for American companies, many of which have business overseas that earns them revenue in foreign currencies, says George H. Michaelis, president of Source Capital, a closed-end mutual fund, and chairman of First Pacific Advisers Capital in Los Angeles.

Such companies--including electronics manufacturer Molex Inc. and adhesives maker Loctite Corp.--have seen their revenue marked up overnight.

A self-described “value investor in really good businesses,” Michaelis looks for companies with a demonstrated ability to earn high returns over the long term.

He is less enthusiastic today than a year ago about pharmaceutical firms such as Johnson & Johnson and Pfizer, which have enjoyed stock price gains in excess of earnings increases without significant product announcements or new-product approvals.

In contrast, Michaelis likes the retailer Toys R Us, which is trading at a four-year low despite continued earnings growth.

Michaelis seldom buys foreign stocks, preferring to gain exposure to foreign economies by investing in U.S. companies. “It’s what you don’t know that can hurt you. As you start moving outside the U.S., information is harder to access and the quality of the information is less reliable. The risks get a lot higher,” he says.

Investors should buy shares in companies in which they have a comfort level and knowledge, according to Michaelis. That way, if the price falls, they will have the confidence to pick up more shares at cheaper prices.

“If a stock drops dramatically and you don’t feel like buying more,” he says, “then you made a mistake to begin with.”

Business Bookshelf

To learn more about these investors’ financial philosophies, pick up these books:

“Beating the Street” by Peter Lynch with John Rothchild. Paperback. $12.50. Published by Fireside.

“The Warren Buffett Way” by Robert G. Hagstrom Jr. Hardcover. $24.95. Published by John Wiley & Sons.

“Bogle on Mutual Funds” by John C. Bogle. Hardcover. $25. Published by Irwin Professional Publishing.