In Enron’s Aftermath, Investors Rethink Strategy
Mutual fund managers with cash to invest had a choice in late July. They could have paid about $28 a share for Krispy Kreme Doughnuts, the fast-growing retailer of tasty, if not exactly healthy, mass-produced pastries.
Or they could have paid about $45 a share for Enron Corp., which at that point still enjoyed a reputation as the premier U.S. energy-trading firm.
One basic argument against Krispy Kreme was that the share price then was a lofty 70 times the 40 cents a share Wall Street expected the company to earn in 2001. Enron shares, by comparison, were priced at 26 times expected earnings for the year.
Six months later, Krispy Kreme shares are up 39% and are sporting a price-to-earnings multiple of nearly 90 based on 2001 profit estimates. Enron, meanwhile, is all but finished as a going concern.
Of all the lessons that the Enron saga ultimately may teach professional and individual investors, the simplest may be about simplicity itself: In the wake of the many investment disasters of the last two years, easy-to-understand businesses--from doughnuts to auto-parts retailing to Winnebagos--suddenly have enormous appeal.
That’s at least partly because investors whose portfolios have exploded since 1999 are, in many cases, being forced to admit that they didn’t truly understand much of what they owned.
Consider JDS Uniphase, now at about $7 a share. It was a market star at $153 a share in 2000. But how many of its institutional or retail investors then could detail why JDS’ fiber-optic components were better than its competitors’, if they were?
As for Enron, each new revelation suggests it was less an operating business than a concept--and one that probably few investors could have explained without help from an Enron senior executive.
More recently, onetime biotechnology industry darling ImClone Systems has seen more than $4 billion of stock market valuation melt away in six weeks as federal regulators refused to even accept its application to market an anti-cancer drug that ImClone had touted as a blockbuster.
Investors who bought ImClone at $73 a share in December now are holding stock worth $16.50 a share--and must be wondering whether they really have a clue what ImClone is all about, given that congressional committees, the Securities and Exchange Commission and the Justice Department have launched investigations of the company.
Meanwhile, consider some of the names that have been on Wall Street’s leader board for most of the last 12 months, and are still there:
* Shares of H&R; Block, the tax-preparation and financial-services giant that has long been a household name, hit a record high Friday, at $46.26, and are up 128% over the last year.
* Motorcycle leader Harley-Davidson recently reported a 26% jump in fourth-quarter earnings, thanks to still-strong demand for its bikes despite the economic recession. Its stock is up 25% over the last year and is just below its all-time high.
* Shares of auto-parts retailer AutoZone, the No. 1 player in that industry, are up 142% over the last year on robust earnings gains.
* IHOP Corp., the Glendale-based owner and franchiser of the International House of Pancakes restaurant chain, has seen Wall Street bid its shares from a low of $13.80 on March 10, 2000, to a recent record high of more than $30. Coincidentally, March 10, 2000, was the day the technology stock sector peaked, as measured by the Nasdaq composite index.
The companies above have nothing in common except for the relative simplicity of their business models: Each can be described in a short sentence. Each company also has products or services that an investor can experience firsthand.
It’s true that, even at the height of the dot-com mania, some non-tech simple concepts still played well with investors. It’s also true that the market’s rally since September has been led by many technology shares that had been beaten down to three-year lows in the aftermath of the terrorist attacks. Technology may be a complicated subject, but it doesn’t take a genius to understand that some tech companies will survive this recession and prosper.
Still, the idea of owning something you can understand gains more currency with every new stock blowup. “It’s boring, but it’s profitable” is a line that no longer invites derision on Wall Street.
That idea also dovetails with two trends that have dominated the market for the last 22 months: the renewed appreciation for “value” stocks, meaning those selling for low or reasonable price-to-earnings ratios; and the revival of interest in lesser-known small and mid-size companies, many of which had been virtually ignored by investors in the late 1990s, when blue-chip names ruled the roost.
(Small and mid-size companies also have benefited from the troubles of some big-name companies whose businesses are fairly simple, but whose execution has faltered badly in recent years--for example, retailer Gap and soft-drink titan Coca-Cola.)
Yet any stock or sector that enjoys sudden popularity risks becoming caught up in the momentum game, wherein the shares are bid higher by short-term players merely looking to ride the wave until it crests. A legitimate question to ask about Krispy Kreme today is whether a doughnut retailer merits a price-to-earnings ratio on par with those afforded to some of the nation’s most important tech companies in their heydays of 1999 and early 2000.
Interestingly, history may be repeating. There was an “emerging-growth-stock” mania in the late 1960s which, like the late-1990s tech mania, resulted in stratospheric share valuations for companies that were largely built on dreams (in that period, many were connected to the space program or to the fledgling semiconductor industry).
After those stocks collapsed between 1968 and 1970, many investors fled to the perceived safety of established companies whose businesses were easy to grasp and whose growth prospects appeared stellar. They were the so-called Nifty Fifty stocks, also dubbed “one-decision” stocks because institutional investors believed you could buy them and forget about them for the next few decades.
The Nifty Fifty included such names as Xerox, Polaroid, Avon Products and McDonald’s. Their reign lasted from 1970 to 1972, when they peaked at huge valuations, then plunged in the 1973-74 bear market, the worst decline since the Depression.
So far, no one is calling Krispy Kreme or Harley-Davidson “one-decision” stocks. But that also may be the good news about the respect investors once again are showing for straightforward, non-flashy businesses that stick to their knitting and deliver decent growth: It may still be early in the game.
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: www.latimes.com/petruno.
