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Time to Change Brands?

The best-known consumer brand stocks sell at lofty levels. Some analysts suggest looking for cheaper names.

March 04, 1997|JAMES K. GLASSMAN | James K. Glassman writes for the Washington Post

In the stock market, the brand names have made the big gains over the past year. For example, Gillette Co.--the world's largest seller of razors, electric shavers (Braun), toothbrushes (Oral-B) and pens (Paper Mate and Parker)--has returned 55% for its stockholders in increased share price plus dividends over the past 12 months. That's more than twice the gain of the market as a whole.

Philip Morris Cos., whose brands include Miller beer, Kraft cheese and Marlboro cigarettes, has returned 42%. Coca-Cola, which owns the top trademark in the world, is up 52%. Microsoft has risen 92% and Procter & Gamble (Tide, Folger's, Crest, Charmin, etc.), is up 48%.

In fact, companies that sell brand-name goods have become brand-name stocks. That's happening in part because so many new investors, unsure of their stock-picking skills, are entering the market. Naturally, they're buying what sounds familiar, big and safe.

On Friday, I calculated the returns over the last year of the eight stocks with the largest capitalizations (market value) on U.S. exchanges. These brand-name giants were up an incredible 57%, on average.

By contrast, the Russell 2,000, an index that tracks no-name small-cap stocks, is up a mere 12%.

Have brand-name stocks risen too far, too fast? It certainly looks that way.

I'm not saying you should sell what you own. If you're willing to hold them through a correction or even a bear market, these stocks should continue to thrive over the long haul. But if you're thinking about new investments, it's time to look at companies that are a cut below the brand-name biggies.

Even in a market that may be suffering from "irrational exuberance" (a phrase that Alan Greenspan, the Federal Reserve chairman, reiterated last week), there are promising stocks with good names and managements but without absurd prices.

But be warned: The pickings are slim--and getting slimmer. We'll get to these stocks in a second, but first, let's examine why brand-name stocks have become so popular.

One obvious reason is that U.S. goods and services are spreading throughout the globe, and foreign consumers love Americans brands.

Ed Welles, who edits the newsletter Common Stocks, Common Sense ([508] 371-3023) in Concord, Mass., has another, interesting theory. He believes that brand names have grown in power as people have become more insecure and alienated in a mass culture.

We migrate to the familiar, the branded, because, more and more, we are "cut loose in a society that celebrates the individual but consigns the mass of men to desperate anonymity." He adds that "we see a similar uncertainty among today's 'professional' market investors, many of them under the age of 30."

So, worried consumers seek brand-name goods, and worried investors seek brand-name stocks. Such companies often thrive in aging bull markets, like the one we're enjoying now, because investors want to own stocks that are large and liquid. If the market plummets, they figure, they can always find buyers for brands such as General Electric.

Mutual fund managers, especially, are using brand-name stocks to stash the new cash they're receiving ($29 billion in January alone).

And index funds, which seek to replicate the performance of the market as a whole (usually as measured by the Standard & Poor's 500-stock index) have become far more popular with individual investors over the past two years, in the process helping to boost the biggest of the big stocks.

How? While the S&P is a basket of 500 stocks, the top 10 alone make up 20% of its value--and the top 56 make up 50%. Money in an index fund is allocated according to the market value of each of the stocks that comprise it. So, if you invest $1 million in such a fund, writes R.S. Salomon Jr. in Forbes, "you will buy $28,900 of GE, the largest stock, and just $100 of Shoney's, the smallest."

Thus, the new money that's pouring into index funds goes, in overwhelming proportion, to the brand names. The demand is pushing up their prices.

"In the short run," writes Salomon, "this is a self-fulfilling prophecy." But, inevitably, the valuations of the brand names will get so high that "it will pay to go the other way." Salomon does not think that time has come yet, but I'm not sure I agree with him.

Look what happened last week to McDonald's Corp., a classic brand-name stock. Its shares fell 10% in two days after the company decided to cut prices to boost sluggish sales. The stock is down nearly 20% from its high of 12 months ago.

McDonald's is still making lots of money. The problem is that it wasn't making enough to justify a price-to-earnings ratio (P/E) that had reached 22. P/E is a measure of how many dollars investors are willing to pay for a dollar of profit. A good rule of thumb is that a stock's P/E should not be much higher than the annual growth rate of its profit. But in the year just ended, profit at McDonald's grew only 12%.

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