Most Popular Stocks Usually Poor Investments

Investors need to be choosy. Highly popular stocks almost always turn out to be unsuccessful investments.

According to a study by David L. Babson & Co., which manages $6 billion in assets, someone who invested in the stock with the highest price/earnings ratio on the New York Stock Exchange each April from 1982 through 1994 and held those stocks until April 1995 would have lost 4 percent. By comparison, investments in the S&P 500 in the same period would have returned 113 percent.

Brad Perry, a David L. Babson researcher, says popular stocks perform badly because investor enthusiasm builds up unrealistic expectations and because highly successful companies inevitably attract a horde of competitors. That slows growth and shrinks profit margins.

“When someone tells you, ‘You’ve got to own this stock, it’s going to be a big winner,’ watch out,” Perry cautions. “Gotta-own stocks are almost certain to be losers.”

Stocks for the ages

Under “Stocks For Different Times of Your Life,” the S&P Outlook prints these classifications:

Singles: Birmingham Steel, Cisco Systems, Harley-Davidson, IBP Inc., Reynolds & Reynolds and Time Warner.

Young Marrieds: Franklin Resources, General Motors Class H, Home Depot, Microsoft, Pepsico, Thermo Electron.

Mature Families: Automatic Data Processing, Chubb, General Electric, Gillette, Merck, Old Kent Financial.

Retirees: Deluxe Corp., Exxon, Great Western Financial, Health & Retirement Properties, Pacificorp, US West.

Before investing, ask your broker to send you reports on some of the above.

Window-dressing transparent

“Window-dressing” is a venerable gimmick by mutual-fund managers and other institutional investors who want to disguise poor investment performance by loading up at the end of a reporting period on stocks that did well when they didn’t own them.

It’s hard to imagine anyone can be fooled by this. If the fund is down 5 percent in the latest quarter, for example, but lists as its principal holding stocks that on average were up 10 percent in the quarter, you can bet the good-looking stocks were acquired late in the game.

Money manager David Klaskin, of Oak Ridge Investments in Chicago, says stock purchases by mutual-fund managers may be posted in the fund on the day the order is executed; so, it’s possible for them to window-dress up until the last day of the quarter. Client statements for most individual brokerage accounts, however, record the ownership on the fifth day after the order was executed.

Window-dressing by professional fund managers may be deceptive, but Klaskin notes you don’t want to bet against it by selling or selling short the stocks that are likely windowdressing candidates in the days just before and after a quarter ends.

Bull on last legs

One handicapper who manages $1.3 billion in assets predicted early on the market would rise at least 20 percent in 1995.

The market, up 10 percent in 3 months, has borne him out.

“This is the last leg up in a bull market, but it will be a very strong leg nonetheless,” says Ken Fisher, chief executive of Fisher Investments, author and a longtime Forbes columnist.

Fisher focuses on the S&P 500, not the Dow industrials. But both, historically, have moved roughly the same. So if he’s right - and he has a good track record - the Dow will break 4,600 this year. Fisher says it could easily crack 5,000.

There are both studious and fanatical bulls. Fisher is among the former. His optimism is based on surprisingly low inflation, heavy insider buying, modest valuations and an upward sloping yield curve. That means long-term interest rates are higher than short-term interest rates and hence bankers are anxious to keep lending money.

Fisher cites a bit of history, too. The market has a natural tendency to rise after a mediocre year such as 1994, which Fisher calls “a year-long correction.” And the year after a midterm election is almost always good.