‘Nifty Fifty’ Era May Stage a Comeback

Ready for the new “Nifty Fifty”? Or maybe just the old Nifty Fifty, back again?

Investors’ already-hot love affair with big blue-chip stocks is about to turn torrid, some pros contend.

They foresee a period like 1971-72, when investors paid extraordinarily high prices for a select group of growth stocks that came to be known as the Nifty Fifty--companies like McDonald’s, Coca-Cola, Johnson & Johnson and General Electric.

The Nifty Fifty envisioned today would include many of those original names, along with some new giants that were nonexistent or tiny in 1972, such as Microsoft and Nike.

The basic idea behind a Nifty Fifty list would be the same: Many investors would regard them as “one-decision” stocks, the kind you buy and hold forever, and the kind that deserve a high premium in their prices because their long-term earnings growth prospects appear unmatchable by most other companies their size.

Naturally, the concept has plenty of doubters and critics, who point out that the soaring stock prices of the 1972 Nifty Fifty crashed in 1973-74, in what became the worst bear market since the Great Depression.

Some of the original Nifty Fifty stocks have never fully recouped their declines, as the stellar earnings growth that seemed so certain in 1972 didn’t materialize for all firms on the list. Xerox, for example, actually remains below its peak stock price of 1972 (adjusted for splits), 24 years later.

But Salomon Bros. investment strategist David Shulman, who has been telling clients that the odds favor a reemergence of the Nifty Fifty concept, points out that many of the 1972 Nifty Fifty stocks, in fact, eventually recovered from the 1973-74 market plunge and have been excellent long-term investments even for investors who paid peak prices in 1972, provided they held on.

Whether that justifies sharply higher prices for the stocks today is another question. In any case, the market’s trend over the last 18 months has strongly suggested that a select group of blue-chip stocks is, indeed, emerging as an “all-weather” portfolio favored by big and small investors alike:

* In 1995, a powerful advance in blue-chip names drove the Standard & Poor’s 500-stock index to a 37.5% return for the year, far outpacing nearly every other stock index.

* So far this year, the Dow industrial average--the bluest of blue-chip indexes--has risen 9.1%. While smaller stocks had a strong run in the spring, they are now lagging blue chips again. S&P;’s Small Cap stock index is up 8.1% this year.

* Boosted by their gains in 1995 and so far this year, some of the stocks that would make almost any Nifty Fifty list are growing increasingly gargantuan in market capitalization, which is stock price times number of shares outstanding--the value the market places on a company.

Coca-Cola, for example, now boasts a market capitalization of nearly $117 billion. Just six years ago, Coke’s capitalization was $33 billion.

Although you would expect that a company’s market value would rise as its sales and earnings rise, Coke’s 253% gain in market value since 1990 far outpaces the 165% jump in its per-share earnings between 1990 and this year’s estimate.

*

What has happened is that investors have become willing to pay a higher price for Coke’s stock relative to its underlying earnings. Coke’s current price-to-earnings ratio, based on Tuesday’s stock price and 1996 earnings estimates, is 34--more than double the average blue-chip stock’s P-E of 16, using the S&P; 500 index as a proxy and taking analysts’ estimated per-share earnings for those companies as a group in 1996.

One of the oldest questions in investing is “How high is too high?” And to some veteran investors, Coke’s P-E is simply too high now.

“No thanks,” says John D. Messner at San Diego’s Meridian Capital Management. To investors who believe Coke is a wonderful company well worth the price, Messner simply reminds that “the risk is up commensurately” as well.

Salomon’s Shulman, in hypothesizing that a new Nifty Fifty era is dawning, says: “There is no question that some of these stocks are expensive. I’m saying that they could get more expensive.”

At their peaks, the 1972 Nifty Fifty traded at 42 times earnings, on average, double the market P-E of about 19 that year, Shulman says. His current list of Nifty Fifty stocks, he says, trades at an average P-E of 24, versus 16 for the market. Thus, if history begins to repeat even on a small scale, Shulman says, the Nifty Fifty stocks’ prices relative to their earnings could go much higher.

Why would investors suddenly agree to pay substantially more for these stocks? Because of rising expectations that corporate earnings growth overall is going to slow markedly in coming years, Shulman and others say.

Facing an increasingly competitive global economy, and perhaps unable to wring much more in earnings from cost cutting, the average big firm’s earnings growth may slow to a 5% annual rate over the next few years, Shulman says.

That could spark another stampede into the Nifty Fifty stocks, he says, as institutional and individual investors alike convince themselves that the 15% to 20% annual earnings growth that still seems plausible from names like Coke, Microsoft, Merck and other classic blue-chip growth stocks is worth a higher P-E than the market is currently affording many of those stocks.

And although many smaller stocks might well offer faster growth, they can’t compete with the Nifty Fifty-types in one key trait: liquidity.

Philip Orlando, investment chief at Value Line Asset Management in New York, argues that many of the Nifty Fifty-list stocks are, in fact, worth higher P-Es if the economic backdrop remains favorable--meaning that interest rates stabilize or come down, inflation remains in check and the global economy expands. He also points out that despite the Nifty Fifty stocks’ high-priced image, some of the stocks are currently just at market-level P-Es--McDonald’s, for example.

The risk? That something comes along and smashes the blue chips’ earnings potential, as health-care cost cutting did for big drug stocks in 1992 and 1993. Higher interest rates or inflation could do it. A rising dollar also poses a threat.

For investors who fully believe in the Nifty Fifty’s ascendance, the Pasadena Nifty Fifty fund ([800] 648-8050) is one way to play them. But if you simply own any blue-chip growth stock fund, chances are you own a lot of these stocks.

Some investors justify Coke’s P-E, in particular, by noting that investment legend Warren Buffett remains one of the company’s biggest shareholders. But it’s also worth noting that Buffett was buying several years ago, before the stock’s huge recent gains.

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Big Names, Big Prices

The surge in prices of blue-chip stocks over the last six years has boosted the companies’ market values by far more than the average stock in the Wilshire 5,000 index. Peak market values in 1990 and current values:

Market value in billions of dollars:

General Electric

1990: $66.1

1996: $140.7

*

Coca-Cola

1990: $33.1

1996: $116.9

*

Merck

1990: $35.3

1996: $79.3

*

Microsoft

1990: $92

1996: $71.3

*

Johnson & Johnson

1990: $24.6

1996: $62.9

*

% changes:

Microsoft: +675%

Coca-Cola: +253%

J&J;: +156%

Merck: +125%

GE: +113%

Wilshire 5,000: +84%

Source: Value Line Investment Survey

Blue-Chip P-Es

Here are 1996 earnings-per-share (EPS) estimates for major blue-chip firms, and the stocks’ current price-to-earnings ratios (P-E) based on those estimates.

*--*

Stock Tues. price Est.’96 EPS P-E Microsoft $120.00 $3.37* 36 Coca-Cola 47.50 1.39 34 Boeing 90.38 2.82 32 Nike 108.75 3.77** 29 Gillette 60.13 2.15 28 Walt Disney 57.50 2.29 25 Johnson & Johnson 47.25 2.14 22 Merck 64.63 3.10 21 Procter & Gamble 88.25 4.30* 21 General Electric 84.63 4.38 19 Intel 73.38 4.49 16 McDonald’s 44.75 2.75 16 S&P; 500 index 654.75 41.00 16

*--*

* Estimate for year ended June 30.

** Actual for year ended June 30

Source: IBES Inc.