Feeling Blue Over Blue Chips
After disappointing profit news Tuesday from supposedly consistent earners like Merck and Walt Disney, should investors suddenly worry about highflying blue-chip stocks?
Or should they instead look at the plunge in Merck’s shares--and potential fall today in Disney’s--as great buying opportunities in coveted large caps?
That’s the issue for investors in several big-name companies whose ability historically to turn out reliable profits has made them investor favorites. That list includes McDonald’s, 3M and Hershey Foods. All either have turned in disappointing results recently or warned that near-term earnings will be softer than expected.
The danger in holding the stocks is that they could undergo sharp short-term declines even though their long-term prospects remain positive. The flip side, of course, is that the market is smack in the middle of a large-cap love fest and investors might pass up a chance to do what seemingly everybody wants to do these days--buy on dips.
For a little insight into today’s situation, it’s worth examining a similar market environment that took hold almost a year ago.
In early August 1997, a similar set of blue-chip earnings jitters hit Wall Street when stalwarts Coca-Cola and Gillette issued surprise earnings warnings a week apart.
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At the moment of their warnings, both stocks already were way off their earlier highs. Coke was down 8.4% from its peak in mid-June 1997, and Gillette was a whopping 15.3% off its mid-July 1997 high.
So much for the notion that blue chips are invulnerable. And there was more downside to go.
Within three months, the Asian financial crisis would hit the market with full force. At the bottom, Coke was 31% off its high while Gillette was down 27%.
Despite the widespread belief that blue chips quickly shake off their woes, it took a while for both stocks to make new highs. Gillette didn’t break through its old high until late February; Coke didn’t make a new high until early March.
The bright side is that each made new highs. Coke reached almost $89 last week. Gillette neared $63 in April and again two weeks ago.
What should investors do with Merck and today’s other troubled blue chips?
Many analysts believe it would be a bad idea to unload them simply because of one quarter’s profit worries.
“I wouldn’t be taking money off the table here,” said Ned Brines, a senior research analyst at Roger Engemann & Associates in Pasadena.
Disney said after the close of the market that its third-quarter profit fell 2%.
But Disney is a “hit-driven” business, Brines said. While its overall earnings trend will be up, the company will experience some temporary profit weakness.
As for Merck, the stock fell 7.1% after second-quarter earnings came in at the lower end of estimates. But the company still notched a 14% profit increase. That’s impressive for a company the size of Merck.
That doesn’t necessarily mean investors should buy Merck on weakness. It’s price-to-earnings ratio based on projected 1998 earnings is still twice its growth rate.
“With some of the pharmaceuticals trading at some of the multiples they are, we aren’t sure what constitutes a great buying opportunity,” he said.
Michael Sandler, co-manager of the Clipper Fund, worries that Disney and Merck might be unable to continue growing at their historic growth rates.
“Disney and Merck are high-quality companies, and we have a lot of respect for the managements of those companies,” he said. “But there’s only so much growth” to be had.
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Sinking Blue Chips
These blue-chip stocks, usually viewed as dependable earnings-growth issues, have either disappointed Wall Street recently or are facing increasing doubts about the level of profitability they can maintain.
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1998 Tuesday Pct. decline Company high close from high P/E* 3M $97.88 $82.00 --16.2% 16 Hershey Foods 76.38 65.00 --14.9 28 Walt Disney 42.75 37.75 --11.7 37 Gillette 62.63 56.50 --10.0 44 Merck 139.13 128.56 --7.6 36 McDonald’s 74.94 69.25 --7.6 30 Coca-Cola 88.94 84.25 --5.3 55 S&P; 500 1,186.75 1,165.07 --1.8 26
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*Price-to-earnings ratio based on most recent four quarters’ earnings per share
Source: Times research
