A Quandary for Bargain Hunters: Is It a Bargain?

Bargain-hunting investors on Tuesday--or at least, the lucky ones who managed to get their stock trades executed--seemed most interested in recent industry favorites, domestic-oriented issues and some of the most badly beaten-up brand-name giants.

Meanwhile, smaller stocks--the undisputed market leaders before Monday’s market plunge--took a back seat to blue chips Tuesday. But many Wall Street pros believe that smaller stocks could soon reassert their leadership.

Maybe the biggest question, however, is whether the bargain hunters were buying true bargains, or simply found themselves once again acting out the Pavlovian response to all stock declines in this 7-year-old bull market: Buy first, ask questions later.

Did a 13% decline in the blue-chip Standard & Poor’s 500 index, as measured from the index’s record closing high of 983.12 on Oct. 7 to its intra-day low of 855.27 on Tuesday, really make the market a great buy?

Some money managers don’t think so. “If you gave us a 20% drop in stocks [from current levels] we would be bullish,” says Rob Arnott, head of Pasadena-based First Quadrant, an investment firm that manages $24 billion.

But for now, Arnott’s computer models suggest a portfolio that is 35% stocks, 45% bonds and 20% cash makes more sense than barreling back into stocks.

That’s almost certainly way too conservative a stance for most portfolio managers, however. Many of those managers who had cash available on Tuesday couldn’t resist some of the prices they saw, so they were buying along with the army of small investors that tried to storm the market.

Steven Check, head of Check Capital Management in Costa Mesa, snapped up some AlliedSignal for about $34 a share early Tuesday, and was well-rewarded by the close of trading: The auto parts and aerospace conglomerate’s shares, which had plunged from their 1997 high of $47.13 to a low of $31.63 by Tuesday morning--a 33% decline in all--soared to $37 at the close, for a 10% one-day gain.

Check viewed the company’s shares as undervalued after the price was hammered last week, when AlliedSignal missed analysts’ consensus third-quarter earnings estimate by a mere penny a share.

Likewise, he thinks he found a bargain in industrial and consumer products company Crane Co., which slumped from a 1997 high of $47.44 to $39.56 at its Tuesday low (a 17% drop), then closed at $41.88.

But Check admits that, overall, “we’re still not finding that many names” that are true bargains. He figures that after Monday’s market plunge, stocks’ valuations were about where they were at the start of the year--which he judged as fairly valued, but not undervalued.

With Tuesday’s rebound, prices may have jumped back into overvaluation territory, he said.

Value is in the eye of the beholder, of course, but it’s tough to find a seasoned pro on Wall Street who won’t admit that stocks are historically high relative to underlying earnings, dividends, net worth and most other traditional yardsticks.

The price-to-earnings ratio of the Standard & Poor’s 500 index now exceeds 21, based on operating earnings per share through the 12 months ended June 30. That’s down from 24 a couple of weeks ago, but it’s still a number that in any other era would have frightened plenty of investors.

Many market bulls, however, say that because of current moderate interest rates and very low inflation, among other things, stocks deserve these richer valuations.

Plus, depending on your faith in 1998 corporate earnings growth, the market can appear much more reasonable. Abby J. Cohen, brokerage Goldman, Sachs & Co.’s well-known investment strategist, told clients Tuesday that based on her firm’s estimate of 1998 earnings for the S&P; 500, the blue-chip index was priced at 17 times earnings.

She calculates that in other periods historically when inflation and interest rates were well-behaved, the S&P; P/E on expected earnings was typically in the range of 18 to 22.

So by her standards, the market was about 5% undervalued early Tuesday--although that undervaluation didn’t last, given that the S&P; surged 5.1% for the day.

In any case, many buyers Tuesday weren’t thinking about the overall market, but about the stocks they found to be attractive even if the broad market arguably is not.

Some themes were evident in Tuesday’s buying wave:

* A return of the favorites. Some of the strongest stock groups were those that investors have been hot for all year, including brokerage stocks, computer issues and oil field services stocks. The main appeal of those groups is that their earnings growth trends remain very healthy, analysts say.

Despite the stocks’ recent drubbing, “we still see technology as the growth area of this business cycle,” said Beth Dater, manager of the Warburg Pincus Emerging Growth stock fund in New York.

* New respect for domestic-oriented companies. If Asia’s economic turmoil is going to slow global economic growth and crimp multinational companies’ earnings, stocks of companies whose fortunes depend mostly on the still-strong U.S. economy are the place to be, many investment pros say.

Hence, stocks of general retailers were red-hot Tuesday, with Dayton Hudson surging 15% to $60.13 and Wal-Mart jumping 7.4% to $34.56.

Douglas Cliggott, U.S. equity strategist for J.P. Morgan Securities in New York, believes the best domestic-oriented stocks to own include some of the Baby Bells, wireless communications companies, newspaper shares and computer services issues.

He favors domestic companies over multinationals not because of slower global growth concerns but because he figures Asia’s debacle will strengthen the dollar soon, putting greater competitive pressures on multinationals.

* Looking for beaten-up brand names. Shares of Coca-Cola rocketed 7.8% on Tuesday to $57.75. It still isn’t cheap by most yardsticks, but, down 31% from its 1997 peak to its Tuesday intra-day low, it got cheap enough for some investors.

Finally, one key test for the market looms: Can smaller stocks, which have outpaced blue chips since May, retake the lead?

The Russell 2,000 index of smaller stocks gained just 2.3% Tuesday versus the Dow’s 4.7%.

Arnold Kaufman, editor of Standard & Poor’s Outlook investment newsletter, believes that if market volatility settles down in coming weeks, “small stocks will come back” to the forefront. But if the recent crazy swings in the broad market continue, he expects many investors to keep their focus on the more liquid blue chips.