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5 baby blue chips you should know
Many of the giants disappointed over the past year, but some lesser-known blue chips have done well. I'm adding five of these to my 50 Best Stocks in the World portfolio.
By Jim Jubak
Psst! Hey, want to buy a blue chip? I've got some good ones for you. A long-term portfolio of 50, in fact, that outperformed the market indexes over the last 12 months (and over the seven years since I first started this portfolio, as well.) And I've also got five new picks to join that list for the next 12 months.
I know that investing in blue chips has been frustrating over the last year. Whatever happened to those great, old dependable stocks? You know the ones I mean: stocks like Coca-Cola (KO, news, msgs), General Electric (GE, news, msgs), Home Depot (HD, news, msgs), IBM (IBM, news, msgs), Microsoft (MSFT, news, msgs), Pfizer (PFE, news, msgs), Procter & Gamble (PG, news, msgs), Sysco (SYY, news, msgs), Wal-Mart Stores (WMT, news, msgs) and Walt Disney (DIS, news, msgs). You used to be able to count on stocks like this to beat the stock market as a whole, year in and year out. (By the way, Microsoft is the parent of this Web site.)
Not over the last 12 months, though. All 10 of these classic blue chips belong to my long-term "50 Best Stocks in the World" portfolio and, for the year ending Sept. 15, 2005, five of the 10 showed a loss. The best gain in the group came from Home Depot -- but even that best-of-the-bunch performance was a gain of just 5.8%. It badly trailed the 8.7% gain of the S&P 500 ($INX).
And these last 12 months aren't exactly an anomaly. These classic blue chips, after bouncing back from the 2000 bursting of the stock market bubble, have been underperforming for a while now. Look at Wal-Mart. Here's a stock that delivered an average annual return of 18.4% over the last 10 years and yet, in the three years that ended on Sept. 15, 2005, the stock shows a cumulative loss of 17%. General Electric and Microsoft returned 39% and 27%, respectively, during those three years, but they still trailed the S&P 500's 47% gain.
It's enough to make investors want to dump all their blue-chip stocks.
But before you do, let me tell you about a blue-chip strategy that will actually beat the market. How do I know this strategy will work? Because for the last two years this strategy, put to work in my 50 Best Stocks in the World portfolio, has out-gained the S&P 500 and the Nasdaq Composite ($COMPX) index very handily, gaining 13.24% in the year that ended on Sept. 15, and 12.9% in the year that ended in Sept. 2004 -- versus 8.71% and 10.2% for the S&P 500 and 12.05% and 1.3% for the Nasdaq Composite.
Related news and commentary on MSN Money
And for the seven years ending Sept. 15, the 50 Best Stocks in the World portfolio is up a cumulative 30.5%. In that period the S&P 500 has gained a cumulative 18.3% and the Nasdaq Composite a cumulative 27.9%.
Why these blues are blue
Let's start by looking at why the 10 classic blue chips that I listed at the start of this column have lagged the S&P 500 for the last two years.
The first explanation is pretty simple: Wal-Mart, IBM, Coca-Cola and the rest aren't energy stocks, the best performing stock market sector in 2004 and so far in 2005. Just look at the gains for the big energy stocks in the 50 Best portfolio for comparison. In the last 12 months, as of Sept. 15, BP (BP, news, msgs) was up 27%, Chevron (CVX, news, msgs) was up 21%, Exxon Mobil (XOM, news, msgs) was up 31% and Schlumberger (SLB, news, msgs) was up 29%. The 50 Best Stocks in the World roughly matches the weighting of the S&P 500 in energy stocks, which certainly helped its performance in 2005.
In contrast to the outperformance of energy stocks, the consumer, financial and technology sectors underperformed. The consumer-discretionary stocks in the S&P 500 have lost 6.2% for 2005 through September 2005. Many of the classic blue chips I've listed therefore have faced a double burden: They aren't energy stocks, and they are consumer stocks.
The second explanation is more complex, though. It has to do with the poor returns that the global economy is awarding to size. In many economic cycles, size is a solidly profitable competitive advantage. Big companies can throw their weight around to get better (and cheaper) distribution, to beat up suppliers for lower prices, to get higher prices for their products and to earn higher margins through efficiencies of scale.
But the current global economy negates many of these advantages. Higher commodity prices are a result of true commodity shortages that raise costs for companies of any size. The ability to outsource manufacturing to huge independent chip foundries or electronics assemblers, and to low-cost suppliers in China or India, makes it possible for relatively small companies to reap efficiencies of scale. The dominance of mass retailers such as Wal-Mart has put just about all companies on an equal playing field, one where Wal-Mart and its competitors are squeezing everyone. Better-quality house brands, the proliferation of low-price new brands and a consumer squeezed by health care and oil costs all work to make brands themselves less important as a competitive advantage. That's an important shift since many of the classic blue chips are built around a competitive advantage created over decades by carefully nurtured brands.
Stalled stalwarts
Take away the advantages of size and the disadvantages come into starker relief: For many of these classic blue-chip companies, the worry voiced by Wall Street and investors has been, "How do you significantly grow revenue at a company already doing $50 billion in sales?" Or $162 billion, in the case of General Electric. Or $300 billion, in the case of Wal-Mart.
Worries about "Where's the growth?" wouldn't have hurt so much over the last two years if these stocks hadn't started the period trading at relatively high price-to-earnings ratios. For instance, Wal-Mart traded at a P/E of 29.1 in January 2003. Coca-Cola traded at a P/E of 31.5 in December 2002. For the last few years, though, these companies haven't delivered anything like their past performance. As it gradually dawned on investors that future growth rates might be substantially lower, they've brought price-to-earnings ratios down. So Wal-Mart today trades at just 16.7 times projected earnings and Coca-Cola at 20.4 times projected 2005 earnings.
Lower price-to-earnings ratios don't make all these classic blue chips bargains today. If Wall Street is right, Wal-Mart will grow earnings at just 9.9% in the year that ends in January 2006 and Coca-Cola's 2005 earnings growth will be just 3.6%. But these low P/Es do make some of these classic blue chips a buy.
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