Blue Chips Continue to Lead the Bull, Defying Valuation Hawks
How does that old line go? “I love you more today than yesterday. But not as much as tomorrow.”
That pretty much sums up the way Wall Street feels about big-name, blue-chip stocks as they roll from one new high to another this fall.
Consider IBM shares, which at $154.125 as of Tuesday--up $7.375 for the day--have already gained 69% this year.
What’s the stock really worth? Try $170 sometime in the next 12 months, argues Steven Milunovich, computer industry analyst at Morgan Stanley & Co.
Too low, says Daniel Mandresh, Milunovich’s rival at Merrill Lynch & Co. Mandresh thinks the price could reach $195 in 1997.
We’re into the Battle of the Price Targets. Does anyone hear $250 a share?
Who knows where all of these raving bulls were when IBM was at $71 in 1995, and who cares. That was then and this is now--and now, America’s most recognizable multinational stocks are simply the right answer to every investment question. Strong economy? Buy blue chips. Weak economy? Ditto. Rising interest rates? Falling interest rates? Flat rates? Ditto, ditto, ditto.
As money continues to pour into stock mutual funds, the blue-chip names--IBM, Procter & Gamble, General Electric and a relative handful of others--seem to be the only logical destination for the dollars. At least, that’s the way many fund managers see it.
That is apparent from the performance of the 30-stock Dow Jones industrial average, which zoomed 50.69 points to a record 6,397.60 Tuesday, leaving the index knocking on the door of 6,400 just six weeks after topping 6,000.
The Dow has soared 25% so far this year after a 33.5% surge in 1995. The 1996 gain has far outpaced that of every other major U.S. stock index, and most foreign stock indexes as well.
Yet many Wall Street brokerages see no end soon to the Dow’s record run. Indeed, investors’ love affair with blue chips meets with widespread approval among brokerage strategists, many of whom have come up with their own proprietary lists of stocks that they consider worthy of a new “Nifty Fifty”--a reference to the blue-chip issues that were the one-decision stocks (i.e., just buy ‘em and hold ‘em) of the early-1970s.
Then, the list included names like McDonald’s, Avon Products and Xerox. Today’s Nifty Fifty lists usually have in common such names as Intel, Microsoft, Gillette, Merck and GE.
Morgan Stanley, in a recent report to clients, called them competitive-edge companies--”the most successful, best-managed companies [which] continue to extend their reach” worldwide.
The idea now, as in the early ‘70s, is that some companies are just so good at what they do that their growth prospects are virtually unlimited.
That may, in fact, be true enough for some businesses. But for investors, there’s still an issue here: There is a “fair” price to pay for a stock at any given moment, relative to the earnings the company is expected to generate in the near future. The more you pay relative to those earnings, the greater the distance the stock could fall if something goes wrong with the business (imagine that!), or if investors’ perception of the business’ value changes.
So when does a prudent investor just say “no” to blue chips?
William Dodge, senior managing director at money management firm Marvin & Palmer in Wilmington, Del., concedes that he’s “probably more concerned [about stock valuations] today than at any time since late 1993,” just before the Federal Reserve Board began tightening credit.
Among blue-chip stock owners, Dodge says, “There’s a lot of complacency, a lot of rationalization going on.”
Coca-Cola has become the poster child for overvalued blue-chip stocks. Its earnings are expected to rise about 19% this year, which while undeniably a respectable rate is dwarfed by the stock’s price-to-earnings ratio of nearly 40. In other words, investors who buy Coke at its current price of $51.75 are paying twice its earnings growth rate.
Certainly, the old textbook rule that a stock’s P-E ratio shouldn’t exceed its growth rate has proven far too rigid for many investors in the 1990s. But twice the rate for Coke? Will flavored water be found to cure cancer?
Coke may be alone on its own mountain, but plenty of blue-chip issues share rarefied air not too far below it in P-E valuations. And still they continue to rise, as the Dow index attests.
Peter Anderson, veteran investment strategist at IDS Advisory Group in Minneapolis, notes that many of the investors who have herded into names like Gillette, Merck, Coke and other blue chips have done so because “they are scared to death of disappointment.” In other words, with the economic outlook uncertain (when is it ever not?) investors see blue chips as a great place in which to hide. And it doesn’t hurt that Wall Street keeps talking about what spectacular global businesses these all are.
But how high will ultimately be too high for the stocks? Who knows, the bulls ask--except that they’re confident the final highs will be above today’s prices. So why would you stop buying now?
Lehman Bros. strategist Jeffrey Applegate, in a fresh report, argues that all the worry over valuations is overblown. If this period of low inflation, relatively low interest rates and consistent economic expansion continues, he says, then blue-chip valuations can expand further. For the most part, he says, they still haven’t reached their peaks of 1958-1972, the last similar economic period.
Then what? Maybe a collapse--or maybe even higher peaks. For now, as Dodge notes, “Acrophobia is a disease we’re wiping out on Wall Street.”
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What Keeps Them Buying
Even as blue-chip shares continue to surge, many Wall Street brokerages advise clients that the stocks aren’t excessively expensive by most traditional measures. Here’s how a new report from Lehman Bros. assesses the Standard & Poor’s 500-stock index today compared with the 1958-1972 period--the last era of sustained economic growth with low inflation.
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End 1958-1972 Valuation ratio Now of ’95 Min. Max. Avg. Price to earnings 18.3 16.2 14.7 22.5 17.8 Price to cash flow 7.8 6.9 6.0 8.7 6.6 Price to sales 1.2 1.0 0.9 1.3 1.1 Price to dividends 49.0 42.7 23.8 37.3 31.3 Price to book value* 1.3 1.1 0.8 1.6 1.2
*--*
* “Replacement” book value
Source: Lehman Bros.
