Jubak's Journal Recent articles: • Has Congress sparked a banking crunch?, 9/16/2005 • Oil backlash? These 5 drillers will still find profits, 9/14/2005 • Buy gourmet stocks at fast-food prices, 9/13/2005 More... | Jubak's Journal 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 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 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. And that brings me to my strategy suggestion for investors looking to make profits next year rather than those hoping to find a time machine that will let them buy last year's winners and score big all over again. I certainly think that energy is likely to be an above-average performer for the next 12 months. But the odds are that it won't lead the market again, and that the gains will be less than in 2004 and 2005. The price of oil is up 45.7% so far in 2005, according to the Energy Information Administration. A comparable increase in price over the next 12 months would take oil to $92 a barrel. At $92 a barrel, you can bet that the price of oil would start to drive down demand for oil. So while I don't think there's any reason to dump your energy blue chips now, the time to load up on energy stocks is over. But there are two other kinds of blue-chip stocks that worked well in the 50 Best portfolio last year, and I think they'll outperform again over the next year. Introducing this year's 50 First, there's a group that I'd call smaller and unconventional blue chips. These stocks aren't household names. They're not as large as the classic blue chips and they're often in markets that are less familiar to investors than the classic blue chips. But in the current global economy, those are all advantages rather than disadvantages. Because the stocks are less familiar, they often sell for more modest price-to-earnings ratios. Because these companies aren't already at $50 billion in revenue, it's easier for them to find significant growth opportunities. Because they're in smaller markets or niche markets, they often face fewer competitors and retain more pricing power. I'd put companies like Broadcom For my annual revision of the 50 Best -- by the rules of this long-term portfolio I make changes in membership only once a year on the anniversary of the first list, and I add no more than five stocks, deleting the same number -- I'm adding five stocks that I think fit this bill. They're all successful graduates of my more aggressive "Future Fantastic 50" portfolio. This year's additions are Adobe Systems Second, there's a group that I'd call classic blue-chip turnaround stories. These are blue-chip companies that have faltered, temporarily, but that have kept intact the long-term competitive advantage that led me to pick them in the first place. Over the last 12 months, blue-chip turnaround stories were some of my biggest winners in the 50 Best portfolio. Charles Schwab Over the next year, I think eight classic blue chips currently in the 50 Best portfolio have this turnaround potential. I'm giving each of them a buy rating to indicate that I think they're a good place to put new money now for investors willing to look out 12 months and more. The eight are AIG-American International Group Not all the blue chips in the 50 Best portfolio that have struggled over the last 12 months are turnaround candidates. Some have simply lost the competitive edge that earned them a place in this portfolio and need to be dropped from the list. Deciding when a company is suffering from temporary problems and when the foundations of its success have genuinely been eroded is tough. I'm sure I'll get some of these wrong. It's my opinion though, that while these stocks can still make investors money in the short run, they no longer have the long-term competitive advantage that would make me recommend them as part of the core of a long-term portfolio. To make room for five new stocks, I have to drop five from this portfolio. The five drops this year are First Data Updates Sell RWE Now that's a fine mess. The German election contested on Sept. 18 has wound up in a virtual dead heat with neither Angela Merkel's Christian Democratic Union (with 35.2% of the vote) or Gerhard Schroder's Social Democratic Party (with 34.3% of the vote) in a position to put together a majority in parliament even with the support of allied smaller parties. The most likely result, according to the same German pundits who predicted a sweeping Merkel victory only a few weeks ago, is a grand coalition government of the Christian and Social Democrats. That's a recipe for wrangling and stagnation and not the kind of market-based reforms that looked possible when Merkel held a big lead. RWE, one of Germany's top two suppliers of electricity, would have been a big beneficiary of those market reforms, in my opinion, and now that investors are looking at deadlock instead, I think it's time to sell the shares, which have climbed to near my December 2005 target price of $71. The shares are up 10% since I added them to Jubak's Picks on June 10, 2005. Sell Peabody Energy That didn't take long. On September 13, I raised my target price on Peabody Energy to $76 by October on increases in Wall Street earnings estimates. The stock closed near $80 on September 16 and then moved higher on Monday, as the market bid up all energy stocks over the threat to the Gulf Coast from Hurricane Rita. I think that in the short-term the shares are now ahead of themselves and I'm going to take my profits here. The shares are up 85% since I added them to Jubak's Picks on April 26, 2005. New developments on past columns When I gave the Fantastic Future 50 portfolio its annual overhaul on July 19, I named eight of those stocks for the long-term buys for new money now. I'm updating those buy ratings for new money, nine in all, as of Sept. 20. I've deleted two buys, ChoicePoint Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: AIG American International Group, Microsoft, Whole Foods Market. He doesn't own short positions in any stock mentioned in this column. | |||||||||||||||||
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