Sell-off a Dow warning INVESTING: Procter & Gamble's tumble was a wake-up call that, in the New Economy, blue-chip stocks are no longer a safe haven.

March 12, 2000

By JAMES B. KELLEHER The Orange County Register

Watch out, widows and orphans.

That was the warning on Wall Street last week after investors turned on Procter & Gamble, sending its shares plunging 31 percent in a single session and lopping $36 billion off its total market value.

The frenzied sell-off proved once again that the whirlwind that has whipped up computer technology, biotechnology and telecommunications shares - lifting the Nasdaq from the 3,000 mark to 5,000 mark in just four months - has ripped into the once-staid world of blue-chip stocks.

Companies like P&G, with strong brands and long histories of profitability, suddenly seem as vulnerable to stomach-turning price declines as those dot-com start-ups whose founders don't look old enough to be running paper routes, let alone public companies.

And "widows and orphans" - a traditional name for the conservative investors who buy P&G and other blue chips looking for safety and surprise-free performance - have been put on notice that they can no longer count on those stocks to shield them from volatility and negative returns.

"Nothing is safe anymore," said Dennis Reiland, a money manager at the Private Management Group in Irvine.

"These are some of the best companies in the world, with large barriers to entry and good, solid businesses. They generate cash, earnings and dividends. ... But let them disappoint the market a little bit and they get blitzed. ... It just doesn't make any sense."

FRUSTRATED INVESTORS

It may not make sense, but it is making headlines.

Last week P&G, the 163-year-old company that practically invented the consumer-products business, suffered one of its worst one-day drops ever after it warned it would report lower-than-expected third-quarter earnings because of rising raw-material prices.

The sell-off left P&G seeing stars and left its shares trading at a three-year low. It also pulled the Dow Jones industrial average - that already battered blue-chip barometer - down 374.47 points Tuesday, one of its biggest point drops in history.

P&G only accounted for half the Dow's losses. Investors frustrated with the way other blue chips have underperformed over the past year used the P&G announcement as an excuse to cut their losses and move on.

"People were down on paper in those stocks and already frustrated," said Mark Stewart of Stewart Securities in Newport Beach. "The bad news gave them a reason to throw in the towel. They said, 'Forget this. I'm going to some of these tech names.' "

Many investors are also dumping their value funds - which invest in stocks that are relatively cheap compared with their earnings potential - and pumping their money into technology funds. Almost $100 billion sloshed into tech funds in the first two months of 2000 alone, AMG Data Services reported.

That has removed a safety net that used to be there for widow-and-orphan stocks.

"In the old days, when a stock got crushed and became more of a value-oriented play, the value managers would step in and support the price," said Reiland. "They're just not doing it anymore because they don't have any money. In fact, the value guys are even having to sell stock into weakness."

stalled index

To understand why blue chips are under such pressure, consider the performance of the Dow Jones industrial average, the 30-stock index that's chockablock with big-name companies like Johnson & Johnson, Merck and DuPont.

For the first eight years of the current bull market, the Dow dominated the headlines as it smashed through the 3,000, 4,000, 5,000, 6,000, 7,000, 8,000 and 9,000 levels in fairly quick order. It was the can-do index that seemed unstoppable.

But so far this year, the Dow has fallen 13.64 percent, while the Nasdaq has risen 24.07 percent. Even before P&G's woes shook the index, companies like Wal-Mart, International Paper and Coca-Cola were trading well below their 52-week highs.

"Some of the long-term growth stocks that people counted on as a sure thing, even if they haven't dropped, they've been kind of resting and not going up," said Jim Mitchell, a value-oriented money manager at Mitchell Partners in Costa Mesa.

"So people are voting with their feet and moving their money to the funds that invest in just the high-tech sector."

Some of the biggest beneficiaries of that exodus have been small-cap tech, biotech and communications companies in Orange County, including Newport, Techniclone, MedCom USA and Powerwave, which have jumped in value in recent months - even though some of them were on the brink of bankruptcy or delisting as recently as just a few months ago.

"People are not looking at (price-earnings) ratios or any kind of ratio right now," said Stewart. "All they're asking themselves is, 'Is my stock going up 50 percent a year?' If not, they get into the stocks that have gone up 50 percent a year. Anything else just won't do.

"I guarantee you that there were people out there who dumped Procter & Gamble and went into stocks trading at 500 times revenue (per share), which is scary."

New vs. old

Of course, the Dow's troubles aren't limited to the fact that a lot of investors have deserted it to look for higher short-term returns.

Contributing to the Dow's woes -- and P&G's problems last week -- is the whole notion that the U.S. economy is experiencing a once-in-a-lifetime revolution that is creating a whole new world of corporate winners and losers.

On the one side are companies like P&G, which, the argument goes, are hopelessly tethered to the Old Economy and especially sensitive to rising interest rates and commodity prices.

On the other side are companies like Orange County's Broadcom, which belong to the ascendant New Economy. These companies, tracked by indexes like the Nasdaq, develop new technologies for the Internet and broadband wireless communication.

But investors who write off companies like P&G as old economy has-beens may be underestimating P&G's resourcefulness - and misunderstanding the nature of the technological changes behind all this New Economy talk.

Sure, P&G is a behemoth, with 110,000 employees in 70 countries and a dizzying array of deodorants, face creams, toilet papers and detergents that it sells in 140 countries. And as last week's warning showed, when pulp and oil prices rise, P&G has problems.

Yet in the 163 years since P&G was founded, the company has managed to navigate its way through a fair number of economic sea changes every bit as profound as the current one. These included the industrialization and urbanization of America, the development of the railroad, the discovery of electricity, and the invention of radio and television.

And P&G doesn't just survive, it thrives. In fact, P&G's ability to exploit the business-building opportunities offered by TV, the last New, New Thing, is legendary. That's why they call those shows soap operas.

Is the Internet revolution going to displace P&G? Hardly. The Internet promises to streamline the ways companies buy from their far-flung suppliers. Last month, General Motors, Ford and DaimlerChrysler announced plans to buy all their parts over a private auction site, a move that analysts said demonstrated the business-to-business savings that the Internet will foster. It's difficult to imagine that P&G won't be able to improve its massive purchasing operations in similar ways.

Historic viewpoint

The development of the Internet has been likened to the development of the railroads in the 19th century. Both were important infrastructure revolutions that transformed communication and the distribution of goods.

Yet in the current frenzy to buy New Economy stocks, many investors seem to be missing an important point. If the comparison to the railroads is valid, then Broadcom, Qualcomm and Cisco might be the workers laying the tracks. The folks who will wind up riding the virtual rails to riches will be companies like P&G that have something to sell.

"These big companies have the most to gain from this business-to-business Internet thing, because they can save a lot of money just by shaving a couple of cents off the way they do things," said Stewart.

And of course, despite all the hype, no one yet has claimed that the Internet will fight cavities, soften laundry or make wrinkles disappear the way P&G's Crest toothpaste, Bounce fabric softener and Oil of Olay cream do.

"These are still solid brands that will be around forever," said Stewart. "The smart people were the ones buying P&G (last week) and saying, 'Let's wait three years and see what happens.' It'll probably double in that time."

Blue-chip problems

Of course, some people believe the blue chips deserved what they got last week.

Mitchell, for one, thinks that companies like P&G, which traded at 50 times earnings per share before the sell-off and about 34 times earnings afterward, are simply too pricey and therefore primed for trouble.

"One of the old yardsticks for stocks, which we seem to have abandoned, was that you could afford to pay a multiple that matched annual earnings growth," Mitchell says. "In other words, if a company was growing its earnings by 25 percent a year, then you could justify paying 25 times earnings.

"So you have to ask yourself: Is Procter & Gamble going to be able to grow its earnings at 35 percent a year? I doubt it. So it may still be overpriced and that may be why nobody came running to the rescue."

But if P&G was overpriced and just waiting to correct when it was trading at 50 times earnings, what about the now-hot tech stocks like Broadcom that are trading for 650 times earnings? The past, Reiland says, may be prelude.

"If you go back to the hottest stocks from one or two years ago and look at some of the names that were in the news then, I think you'd probably find that they are down an absolute ton," said Reiland

-- cin (cinlooo@aol.com), March 12, 2000

Answers

I wish I could give you the link, but there's an article today on Excite or Yahoo quoting Warren Buffet. Despite lackluster advances for his investors this year, he isn't buying into tech stocks and doesn't plan to. Why? He can't tell which companies will actually yield profits and he isn't ready to take the risks...

-- Mara (MaraWayne@aol.com), March 12, 2000.

Ralph Nader for President.

-- NOTA (vote@this .time), March 13, 2000.