Taking a chance: Lotto or stocks?
Ever bought a lottery ticket? You know how it works: You pay for the ticket, and either it’s a winner, or you throw it away.
Maybe that’s how investors should be thinking about many stocks at this point. With shares of some of America’s biggest companies beaten down to single-digit prices, either they’re going to pay off handsomely in the next few years or they’ll be worthless.
Build a portfolio of these stocks, and your odds of winning big with at least a few of them may be a lot better than your odds of winning a real Lotto jackpot.
In the Standard & Poor’s 500 index of major U.S. companies, about 100 -- one-fifth -- were trading below $10 on Friday. The list is remarkable because it includes instantly recognizable brand names.
Most investors know that auto giants General Motors Corp. and Ford Motor Co. have crashed to fast-food menu prices. GM closed at $3.06 on Friday; Ford was at $1.43.
But the single-digit club now spans many industries: Apparel maker Liz Claiborne Inc. is at $1.79 a share; hotel chain Wyndham Worldwide Corp. sells for $3.02; aluminum titan Alcoa Inc. is at $8.44.
This is America, land of giant companies with tiny stock prices. And that didn’t change much Friday, despite the market’s sharp rebound from what was an 11-year low on the S&P; 500 on Thursday.
Now, “tiny” is relative, of course. A low share price doesn’t necessarily mean a company is a bargain. What counts is the earnings power behind the stock.
In theory, companies that are selling in single digits have dismal earnings prospects -- they’re “cheap for a reason,” as the old Wall Street line goes.
Once a stock falls to low-single-digit territory, it often means investors believe the company is doomed. So hunting for a bargain in that realm is fraught with peril.
But I wish I had a nickel for every time some trader or analyst has told me in recent weeks that no one is paying attention to the fundamentals anymore.
Almost every stock chart looks exactly the same: Prices just fell off a cliff beginning in mid-September as the credit crisis worsened and investors began to realize that the global economy was at risk of a severe recession.
“The market doesn’t trade on the fundamentals or the technicals. It’s fear-based,” said Joe Saluzzi, a partner at Themis Trading in Chatham, N.J.
Some investors who’ve been selling have been doing so at gunpoint, so to speak: They are hedge funds and other big players that bought stocks with borrowed money and have been forced to sell as their lenders have called in loans.
Hedge funds and mutual funds also have been forced to liquidate holdings as their investors have demanded their money back.
The point is, fundamentals go out the window in times of panic selling -- or panic buying, for that matter.
Even investors who can take the time to think about the fundamentals -- say, what a company might earn in 2009 -- can’t get very far before throwing up their hands.
We know we’re most likely facing something much more serious than a garden-variety recession, given the pace of the decline in key economic indicators over the last few months, and the continuing reluctance of banks to lend money.
Operating earnings of the S&P; 500 companies fell 21.6% in the third quarter compared with a year earlier, according to S&P.; That was the fifth consecutive quarterly drop.
Most of the decline in S&P; earnings so far has been tied to losses at financial companies. In 2009, outright declines in earnings are likely to be much more widespread.
Six of the 10 major industry sectors in the S&P; 500 are expected to post lower earnings in the first quarter of next year compared with a year earlier, according to analyst estimates tracked by Thomson Reuters.
Until Wall Street has a better handle on just how bad off the economy will be next year, all earnings estimates are total crapshoots. And that means stock prices too are crapshoots -- some obviously more so than others.
I can make the case that there is no investing now; it’s all just speculating.
Here’s what we have to decide: Is the world as we know it ending, or isn’t it?
If it isn’t, some of these single-digit, Lotto-ticket stocks could easily double or triple in a couple of years. In a diversified portfolio, a few big winners could far offset the losses on the ones that never recover or go to zero.
I’m not advocating paying no attention at all to fundamentals. Balance sheet strength is particularly important at a time like this: If a company is deep in debt (as are the automakers) or needs to borrow heavily in 2009 to stay afloat, the risk of collapse is magnified.
I’m also reminded of long-standing advice from master investors including Warren E. Buffett, who say it’s always better to put money into high-quality, industry-leading firms than to take a chance on struggling companies that are also-rans in their industries.
In this vicious bear market, nearly every stock has been whacked. If you want a potential bargain, you don’t have to look to the Lotto stocks.
But individual investors who are tempted by big, well-known names in the single-digit club have an advantage that most institutional investors don’t: You can follow Buffett’s advice to take a truly long-term view. You can be patient. The average hedge fund doesn’t have that luxury.
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