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STOCKS: 'IT'S NOT HARD TO FIND VALUE'Bargains still abound--in telecoms, autos, energy...On Wall Street and Main Street, at the beach and by the pool, around the water cooler and on the Internet, there is one overriding question: Is the stock market too high? The bulls still argue that, in the New Economy of low inflation and technology-driven productivity gains, stocks deserve higher valuations. The bears pooh-pooh that as delusional thinking that's bound to lead to ruin--in a market that has broken all traditional yardsticks. So is the market overvalued? If you buy stocks that are good value, it shouldn't matter. And believe it or not, there are cheap stocks in today's high-priced market. ''It's not hard to find value,'' says Judith A. Jones, portfolio manager for the Victory Value Fund. ''This bull market has been concentrated in a narrow band of big growth stocks.'' Jones sees good opportunities in telecommunications, autos, insurers, and energy--to name a few. Watching shares of Yahoo! Inc. (YHOO) whiz by at a price 235 times this year's expected earnings can give you a distorted view of what's happening. True, stocks are not cheap by historical standards. Both the Dow Jones industrial average, at 8923, and the Standard & Poor's 500-stock index, at 1098, sell at 21 times the next 12 months' projected earnings. One reason that the price-earnings ratio is high is that investors have bid up prices for the big multinationals that dominate the indexes, the ''Nifty 50,'' which include such giants as Microsoft (MSFT), Coca-Cola (KO), and General Electric (GE). Brian F. Rauscher, U.S. equity strategist at Morgan Stanley Dean Witter & Co. (MWD), says that, based on expected earnings for the next 12 months, the p-e for the Nifty 50 is 24. But for the Un-Nifty 450, it's just 19. One good strategy: do your stock shopping among the 450. Looking at the S&P 1500--a composite of the S&P 500, the S&P MidCap 400, and the S&P SmallCap 600--the disparity in valuation becomes even more obvious. Smaller stocks, on average, sport lower p-e's and higher earnings-growth rates. That's because investors have been much less willing to buy smaller companies, even with their better earnings growth. So far this year, the S&P 500 is up 12.4%, the MidCap 400 up 6.4%, and the SmallCap 600 up 4.2% (chart). ''The earnings for small companies are coming through, and investors will eventually recognize that,'' says Rauscher. ''The valuation of small caps is extremely compelling.'' FINE SCREENS. But buying small-cap stocks or un-nifty large-caps doesn't mean you're getting good value. Investors who troll these waters use a variety of quantitative techniques to find potential investments, and then buy after further fundamental analysis. Perhaps the best-known valuation measure is the p-e ratio. Stocks selling at below-average p-e's are usually said to be value plays--or at least worthy prospects. In that light, consider investments from a pool of stocks drawn by Richard Bernstein, chief quantitative strategist at Merrill Lynch & Co. (BOB). Bernstein looked for companies with at least $5 billion in market capitalization, p-e's lower than average for the S&P 500, and S&P stock ratings of B+ or higher. Those ratings, says Bernstein, are good indicators of high-quality companies. Some 160 stocks fit the bill, including Amoco (AN), Anheuser-Busch (BUD), SLM Holdings (Sallie Mae) (SLM), St. Paul (SPC), Toys 'R' Us (TOY), and United Technologies (UTX) (table). Says Bernstein: ''There are a lot of safe, healthy companies that people are ignoring.'' Of course, such lists are only starting points. Most value buyers will apply other statistical measures as well: dividend yield, price-to-cash-flow ratio, price-to-sales ratio, and how these comparisons have changed over time. Richard J. Moroney, editor of Dow Theory Forecasts, an investment newsletter, says the price-to-sales ratio can be more telling than the p-e: Sales are ''difficult for companies to manipulate and thus free of accounting gimmickry.'' Among the companies most attractive on price-to-sales are Nucor (NUE), Superior Industries (SUP), and Vishay Intertechnology (VSH). Vishay is cheap when it's measured by its p-e of 14.4, but it's cheaper still, says Moroney, in light of its price-to-sales ratio of just 1.3. ''There's no one valuation measure to hang your hat on all the time,'' says Jones. With each stock or sector, particular factors will weigh more heavily than others. Oil companies, for example, take heavy depletion allowances, which depress earnings. So they never show rock-bottom p-e's. But Jones says such companies are bargains because what they sell is cheap--and that won't last for long. ''I'd rather buy an oil company when oil is $14 per barrel than when it's $21,'' she says. Among her energy holdings are USX-Marathon (MRO) in the domestic sphere and Chevron (CHV), Mobil (MOB), and Texaco (TX) among the international companies. SELF-CORRECTING. Another sector attracting value buyers these days is insurance. Bernstein's list includes Conseco (CNC), St. Paul, and Transamerica (TA), and many investors say that, given the success of bank stocks in this era of consolidation, insurance companies are sure to follow. And some investors say the cheapest of the cheap are the reinsurers--where insurance companies repair to lay off some of their risks: ESG Re (ESREF), General Re (GRN), and RenaissanceRe (RNR) to name a few. Like oil, they're all cheap because of overcapacity and falling rates, but those conditions are usually self-correcting. Edwin Walczak, portfolio manager at Vontobel U.S. Value Fund, especially likes Bermuda-based ESG Re, a recent startup. Walczak says the price, at 21, is depressed because of high startup costs. But he has great expectations for ESG because of its management and its focus on European health care. Unlike many other value investors, Walczak will let cash build up in his fund--now 40%--rather than compromise his standards for cheapness. The same goes for Robert L. Rodriguez of FPA Capital Fund, who now has about 30% in cash and short-term bonds. The only stock Rodriguez has bought in the past six months is Oregon Steel Mills (OS), a specialty manufacturer. The company, he says, just completed a major expansion program, so cash flow should swell soon. ''The company's trading below where it was seven years ago,'' says Rodriguez. But he is looking out two to three years, when the now $24 stock could be earning $3 to $4 a share. COCKTAIL CHAT. If investing in a steel company in the eighth year of an economic expansion sounds crazy, consider Scott Black of Delphi Management, who likes homebuilding stocks. These sell at puny p-e's because most investors figure they're at the peak of their earnings cycle. But Black thinks differently, arguing that builders D.R. Horton (DHI), Lennar (LEN), and Toll Brothers (TOL) are still attractive. ''Mortgage rates would have to get to 9% or 9.25% before they hurt them,'' says Black. ''And they have rising backlogs and good exposure to the California market.'' Talking up a steel or oil company at a cocktail party may not win you a popularity prize. But adding them to your portfolio may win you the prize that counts--some neat gains.
By Jeffrey M. Laderman in New York RELATED ITEMS
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Updated June 4, 1998 by bwwebmaster
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