Big Cap Techs Still Too High

By on October 31, 2006

Originally Published in September 2000:

INDEXES ON 9/8/00

DJIA 11,220.65

S&P 500 1,494.50

NASDAQ 3,978.41

Editorial

It has been an interesting nine months since the last issue of this newsletter was sent out. The NASDAQ collapsed almost 40 percent from its spring high and recovered about ½ of the lost ground. Amazingly, the Dow is only about 4 points less than when the last issue went out in early December 1999. Listening to the purveyors of the bearish case has been hazardous to your wealth and will likely continue to be for some time. Despite several extremely overvalued large caps headed by Cisco Systems (NASDAQ: CSCO; 63 7/8) which trades at an unprecedented valuation for a company of its size and scope, there are some very reasonably priced stocks in the market. Of course, the reasonably priced can become more reasonably priced which has been the case the last few years. This has caused momentum trading to be the favored investing style by professionals and the general public. The concentration of attention towards stock price momentum has led to an almost total disregard for the “value” methodology. Some very attractively priced stocks right now which could be considered good values are Carnival (NYSE: CCL; 20 3/8), Ford (NYSE: F; 26 5/16), Goodyear (NYSE: GT; 23 1/2), Hasbro (NYSE: HAS; 11 7/8), Honeywell (NYSE: HON; 35), Kulicke and Soffa (NASDAQ: KLIC; 15 11/16), Royal Caribbean (NYSE: RCL; 22 11/16), and Whirlpool (NYSE: WHR; 39 13/16). There are many more out there. It just takes a little digging. Disclosure: Of the stocks mentioned above I currently hold positions in CCL, GT, HON, KLIC, and RCL.

Let’s touch on the subject of momentum investing. Just listen to the radio. In my area of the country, the favorite daytime AM radio shows are led by an array of momentum players. These luminaries include Gary Qualcomm (a/k/a Kaltbaum), Chief Technical Analyst for JW Genesis Financial Group (soon to be subsidiary of First Union); MG and Stock Doctor; and the squirrelly Tom O’Brien of the Tiger Financial News Network. Thankfully, the infomercials by the infectiously upbeat Wade B. Cook have been on the wane. However, he has been replaced by a new breed of investment hypster. These are the kind of gurus who won’t touch a stock like Boeing (NYSE: BA; 58 1/8) when it is languishing around 35, but when it hits 60 it is a much more attractive stock to buy. A couple more examples; Qualcomm (NASDAQ: QCOM; 61 9/16) is a core holding at 200, but a definite sell at 60!….Nokia (NYSE: NOK; 42) breaking above 60 is a sign of higher prices to come; when it falls below 40…oh well, see ya later.

The radio guys don’t label themselves as momentum disciples, but their words plainly point to the fact that if a stock looks good on the chart it is a stock worth buying. Stock price and volume action is paramount. Recent abnormal earnings and revenue growth is most desirable. Valuations are secondary. But who can blame them? If something has worked for the past five years, it’s easy to assume that it will work for the next five. The momentum followers have certainly had their successes, but unfortunately the market is seldom so easy to figure out. When too many jump on a particular style of investing the days that style will work become numbered. Extreme earnings and revenue growth tends to be transitory and predicting past trends into the future is not an exact science by any means. It was a great run for the momentum guys, but it looks to be just about over. The valuations of the momentum favorites speak volumes. Corning (NYSE: GLW; 304 7/8) is trading at 120 times earnings. Sun Microsystems (NASDAQ: SUNW; 120 ¾) changes hands at 113 times earnings. The previously mentioned Cisco Systems trades at 125 times earnings and sports a market capitalization of $449 billion! These kind of valuations for companies of this size is very freakish, unprecedented historically and dangerously risky for investors. They may be core holdings for the radio gurus, but you had better be very close to the exit if you’re playing this game. I haven’t heard any of the radio gurus mentioning the overall rates of return of their recommendations, but they sure sound like they know what they’re talking about. These pundits are persuasive enough to convince multitudes to attend their seminars where they can sell their wares. Unfortunately, what they preach is short-term speculation, which very few investors ever succeed at.

Along with the radio gurus, I’d be remiss if I didn’t poke a little fun at the investment newsletter industry. If you’ve ever seen promotions for market newsletters, it is not uncommon to see touts such as “we picked ABC company which rose 200% in 6 months.” This unrepentant bragging does the potential subscriber a disservice. What the publisher won’t tell you is they also picked XYZ company which lost 90% in 3 months. The one and only thing that matters is the overall return of all their recommendations. If the newsletter picked a stock that increased 1000%, but the overall return of all their selections was half that of the market indexes, then the writer should be paying the subscribers to read it. Generally, the chance that you’ll happen to buy the stock that an irresponsible newsletter writer gets lucky on is actually less than the chance you’ll find a similar stock yourself by throwing darts, since several studies have demonstrated that the average newsletters aggregated picks have underperformed the market. Many newsletter writers will tout very risky stocks so that if they happen to get one that soars they can use it in their promotional advertisements and mailings. If a newsletter won’t reveal the long term rate of return for all its investments, you can be certain that it is utilizing a very questionable methodology.

There are a lot of conflicting messages being promulgated by the popular authorities on money and investing. On the one hand Bruce Williams, prominent radio talk show personality, says that it is foolish to pay off a house when you can easily invest the money and make 15% a year. Suze Orman, author of several extremely popular books on people and their money, says individuals should pay off their house. Which one is right? Well, it depends. The answer probably lies somewhere in between. Mr. Williams is making a wildly optimist and rather misleading assumption by implying that it is easy to find investments that will achieve 15% annual returns. He is extrapolating the past 18 years into the future when the markets are at arguably their most fundamentally overvalued juncture in history. Ms. Orman is potentially steering people away from a great opportunity since the actual interest rate on a house is deductible from taxable income. Depending on the rate of interest on the mortgage, paying off a mortgage prematurely could be taking away a source of extremely cheap money. The money not paid on the house can be used to invest at a fairly conservative 8-10% over the long term in a balanced portfolio of stocks and bonds. It is probably in most investor’s best interests (depending on their mortgage interest rate) to add $100 to $200 towards the principal of the house each month and place an equal amount in index stock and bond funds. This way an individual can spread money around more evenly in different pots and come closer to achieving their goals under different future economic scenarios.

I have to admit I’ve been handicapped by the experience of investing in the 1970’s, which is when I started seriously investing in stocks. Back in those days the market did absolutely nothing but move up and down with no discernable trend whatsoever. Anyone entering the market after that dismal period has probably been more bullish, especially on technology, and benefited from that view. However, statistics bear out that the average investor trails the indexes badly which can only be attributed to weak stock selection and bad timing decisions. Investors are usually enamored by the “story” stocks. These are those companies that have developed a product or service that grabs newspaper headlines or gets hyped on CNBC. Usually investors overpay for such companies and become short-term speculators. Many investors are following this road to financial ruin by the siren song on the radio and in the pages of worthless newsletters.

I’d be remiss in my duties if I didn’t say anything regarding the exorbitant salaries being pulled down by corporate CEOs. The Institute for Policy Studies and United for a Fair Economy recently released their “Executive Excess 2000″ report. The report shows that CEO pay has risen an average of 535 percent the past decade. The CEOs of the largest 362 U.S. Companies earned an average of $12.4 million in 1999! This legalized looting of the nation’s corporate coffers is a national disgrace. If the minimum wage had risen at the same rate as the CEOs, it would be $24.13 an hour instead of $5.15. Is it any wonder that most families need two incomes to support a family? I’ll leave you with a quote by Morrie Schwartz from Mitch Albom’s book “Tuesdays With Morrie” which I highly recommend everyone read. “Look, no matter where you live, the biggest defect we human beings have is our shortsightedness. We don’t see what we could be. We should be looking at our potential, stretching ourselves into everything we can become. But if you’re surrounded by people who say ‘I want mine now,’ you end up with a few people with everything and a military to keep the poor ones from rising up and stealing it.” I’ll never be able to say it better myself.

One last note: I just visited a new website which I think most readers will find very interesting. The site provides a fair value for stocks based on the developer’s proprietary valuation model. It’s located at http://valuengine.com and there will, in all likelihood, be many imitators in the future.

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