Investors Can Find Value in Bear Market
The bear market has soured investor spirits and wiped out an estimated $8 trillion in stock wealth over the last two years, but it also has created something, analysts said: bargains galore.
Many money managers and investment strategists said they are finding plenty of worthwhile stocks with reasonable price-to-earnings ratios and decent dividend yields, to use two of the most traditional valuation yardsticks.
Their picks include classic growth stocks such as Pfizer Inc. and Fannie Mae, along with more traditional value names such as Occidental Petroleum Corp.
“Right now there are more opportunities than I’ve seen in a very long time--at least through the 1990s,” said David Dreman, manager of the Scudder Dreman High Return Equity fund in Jersey City, N.J., and a well-known value-stock investor.
Charles Carlson, editor of DRIP Investor newsletter and head of Horizon Publishing Co. in Hammond, Ind., said, “It’s a good time to upgrade your portfolio. There may be stocks you’ve always wanted, but in the past they were too expensive.”
Arnold Kaufman, editor of Outlook, the Standard & Poor’s investment newsletter in New York, said P/E ratios and dividend yields have become more attractive overall as the downturn has driven stock indexes to five-year lows, though he acknowledges that neither yardstick is at a level typically found at a bear market bottom.
That’s a principal argument bears make in warning about the prospect of further losses.
The current 1.8% annualized dividend yield on the blue-chip Standard & Poor’s 500 index contrasts with 5.9% at the end of the 1973-74 downturn, 6.7% at the 1982 market bottom and 4.1% in 1990. Since 1923, the average blue-chip yield has been 4.5%.
“We’re not seeing the juicy 7% or 8% yields this time around, except on the real estate investment trusts,” Kaufman said, “but there are some decent 3% to 4% yields out there.”
P/Es, meanwhile, have tumbled toward historical norms after riding high in the 1990s bull market.
Based on analysts’ operating earnings forecasts for this year, the S&P; 500 trades at an average P/E of about 17, versus the long-term historical average of 14.
Based on analysts’ earnings estimates for 2003, the P/E for the S&P; 500 is about 15. Two to three years ago, the S&P; 500’s ratios were in the mid- to high 20s.
Though P/Es sank into single digits in the 1970s and stayed there for years, conditions were vastly different. High inflation and high interest rates had depressed valuations on stocks.
In today’s climate of low inflation and low rates, the bullish spin is that loftier P/Es, perhaps in the low 20s, are warranted--in other words, the market is undervalued with key indexes near levels last seen in 1997.
Regardless, analysts said there are plenty of risks--as well as potential rewards--for bargain hunters these days.
With the bear market in its third year and no guarantee that last week’s rally marked the bottom, buying requires patience and a strong stomach.
“Three years from now you’ll probably be glad you bought,” Carlson said. “But three months from now, who knows?”
A critical issue is what earnings will turn out to be this year and in 2003.
If the economy slows significantly, analysts’ estimates could be all wet, which means stocks are more expensive than they appear.
What’s more, P/Es based on operating earnings--meaning results before one-time write-offs--trouble more investors these days. Many Wall Street bears said there’s nothing “one-time” about write-offs any longer, and that a fairer way of measuring stocks is based on net income after write-offs.
Calculating P/Es based on net income would mean many stocks are far more richly valued than if operating earnings are used.
Even if investors believe that many stocks are extraordinary values, experts said diversification is crucial because so-called value traps can do a lot of harm to a portfolio. A value trap is a stock that may look cheap but gets a lot cheaper because of fundamental problems at the company.
“A broad portfolio of stocks will help protect against any disasters,” Carlson said.
Buy-and-hold investors naturally want to take a long-term view of stocks, but they need to monitor their holdings closely, Carlson added. Investors have learned the hard way how dangerous it is to ignore deepening troubles in an industry--telecom, for example.
“You can dollar-cost-average your way into oblivion,” Carlson said, referring to the strategy of making regular purchases of the same stock or mutual fund over time. Some investors did virtually that with Lucent Technologies Inc., for instance, which has fallen from its peak of more than $60 in late 1999 to $1.53 today.
“In 1999 and 2000, people tended to give companies the benefit of the doubt and stick with them,” Carlson said. “But the world does change and stocks do too.”
Some areas of the market remain too scary even for die-hard bargain hunters such as Dreman who thrive on what he calls “crisis investing.”
Most technology stocks, for example, hold no appeal for Dreman despite their continuing free fall.
“There’s no sign of pickup in IT [information technology] spending, and the tech stocks still have pretty high projected P/E multiples--based on earnings that probably are not going to come through,” he said.
Instead, Dreman and others who see bargains in the market are typically looking in sectors other than tech:
* Dreman said mortgage lenders Fannie Mae and Freddie Mac are “bargain basement stocks” at current prices, given their steady earnings growth over the years. Both trade at P/E discounts to the S&P; 500 as well as to their own historical averages, he said.
Dreman also likes two tobacco companies that he believes investors have punished in recent months more than is warranted by potential health-care liability risks: UST Inc. and R.J. Reynolds Tobacco Holdings Inc.
Similarly, he thinks drug giant Bristol-Myers Squibb Co., whose shares are down nearly two-thirds since September, is undervalued. Despite a series of management blunders, the company has a strong pipeline of products in the works, Dreman said.
* Carlson sees market sell-offs as an ideal time to buy high-quality stocks at reasonable prices, rather than trying to “bottom fish” with second-tier names. He likes Pfizer in the drug sector, Wells Fargo & Co. in the financial area and Exxon Mobil Corp. in the energy group.
Pfizer is down 26% year to date, Wells Fargo is down 10% from its May peak and Exxon Mobil is off 21% from its April peak.
* Kaufman said S&P;’s equity analysts are bullish on a number of stocks that pay above-average dividends and carry relatively modest P/Es.
These include Occidental Petroleum, Bank of America Corp., chemical maker PPG Industries Inc., metal processor Worthington Industries Inc., real estate investment trust Chelsea Property Group Inc. and engine maker Cummins Inc.
Some of these names have held up well this year even as the S&P; 500 has slumped 25.7%, but nearly all of the stocks have fallen from their spring highs as the bear market has deepened.
