An imperfect case for buying "dead money" stocks.
Motley Fool is a venerable consortium of investment analysts closely watched by Main Street investors. Lately it objects to the Wall Street tag "dead money" being applied too liberally to stocks.
The term applies not to losses, necessarily, but the absence of investor gains. A better term might be "playing dead," since the mutt is still healthy, it's just been ages since he was jumping up on visitors.
"While there might be a case to be made for any stock not going up, when the phrase "dead money" is thrown around it typically is talking about a stock that hasn't gone up in the past and therefore is expect to not go up in the future," explains Fool contributor Matt Koppenheffer, a Nevada-based former private equity manager and investment banker.
"The problem with focusing on stock performance in this way is that stock price is not always indicative of the performance of the underlying company. So to suggest that since a stock hasn't performed that it won't perform is...well, it's not a theory I'd like to put to work in my portfolio."
Trouble is (for me), too many dead-money stocks of the past decade have stayed dead. The reasons often are deep-seated, so I'd be surprised if they didn't remain comatose for the next several years, if not indefinitely.
My problem is that I'm having the hardest time, admittedly off the top of my head - thinking of stocks long dismissed as dead money suddenly springing to life. Which is the Fools' thesis, that some of the best buys right now are stocks that have long languished.
The one example that comes quickly to mind of a dead-money stock that has lately sprung to life is Ford Motor Co., whose average annual return over the past five years is an eye-popping 19.9%.
Fool cautions about past performance often being no indicator of future returns. Word for word the fine print in mutual-fund ads, and it's good that government requires that investor warning - though in the ads' case, the caution is that this year's brilliant returns might not be repeated. Fool's argument is the reverse in the case of specific stocks.
But as I said, I'm having a tough time coming up with examples. And Fool doesn't help, noting only that the "dead money" appelation for Microsoft, Intel, Cisco, Citigroup, Apple, Goldman Sachs and a few others isn't warranted. They might go gang-busters over the three- to five-year time horizon Fool counsels.
I'm with Warren Buffett that I only want to buy stocks I'm keen to own forever. But speaking of Berkshire Hathaway Inc., that stock's been dead money for the past five years. The Fool theory that there's a difference between "past dead money and "future dead money" sort of falls apart here, because Berkshire's 5-year average annual return is 5.3%, and over the past decade it's been 7.3%. Unless you count 7.3% as a satisfactory return - as you well might, since it's exactly the average annual return on all stocks over the past century - that's not an impressive investment.
Fool argues that so many of the aforementioned "dead money" stocks were wildly overvalued circa 2000, before the huge dot-com and tech bubbles burst. Fair enough. But GE has had a decade since then to recover to something approaching its inflated stock-market value of 2000 upon the retirement of Jack Welch, possibly the most over-celebrated CEO of the past century. Yet in a decade of stewardship by a non-egomanical Jeff Immelt, GE investors have suffered a miserable annual return of -8.7%. At some point, like a good baseball manager, you say "I've seen enough" and pull the pitcher who's poised to give up even more runs.
As noted, I'm a patient investor - my time frame is forever, more patient even than the Fools'. (Whom I commend for dissuading day-traders and other short-term speculators.)
But guess what? Past performance usually is indicative of a stock's direction "going forward," to quote the Fools. At least in the case of blue-chips, though certainly not flashes-in-the-pan like the late 1990s run-up of Nortel Networks Corp. or Krispy Kreme Doughnuts Inc.
As investors, we have a limited set of tools. By definition, assessing likely future stock performance requires looking at historical record ("past dead money"), unless you have the gifts of a late-night infomercial soothsayer.
You look at the commanding market share of a well-run company, which gives it pricing power; and at its financial resources to fend off upstart rivals. You look to see if most of its products are #1 or #2 in their categories. And you look at the character of management. And the culture of the enterprise.
On the latter point, both Coca-Cola Co. and Procter & Gamble Co. haven't hestitated in the past decade or so to cashier CEOs they felt were not working out. That's rare. That's the character of a good board. As to culture, those two firms and McDonald's Corp. and 3M Co. are relentless innovators, whose culture is all about new-product development. So that's another yardstick: What percentage of sales and profits does the company derive from products that have been on the market five years or less?
And you look at the industry itself. There are, for instance, no good airline stocks - never have been, likely never will be. It's just too easy for would-be rivals to launch a competing carrier that will underprice the incumbents and vapuorize everyone's profits in a price war.
The same goes for automobiles, yet another of the great 20th-century inventions that you would think investors should have made a ton of money from. But no. Production and marketing costs are high, competition is rampant, and consumers are fickle, accounting for the spikes and troughs in Prius sales, for instance, according to volatile pump prices.
I wouldn't buy Ford now, as mightily impressive as its turnaround has been, because the big gains have been made and it is, after all, an auto company. Auto companies make lousy investments. Even after shedding the albatross of Chrysler, Daimler AG (the former DaimlerChrysler AG) boasts a five-year average annual return of just 3.2%. And this is arguably the best-run automaker in the world - indeed, the firm that invented the internal combustion engine we still use - with a wider global reach than its peers.
It's just too simple to assert, as Fool does, that a stock "wrongly" dismissed as dead money now and forever is likely a good buy because, on that consensus opinion, it's priced so cheaply. I'll go out on a limb here with a good word for Royal Bank of Canada and note that it's five-year average annual return is an unimpressive 4.6%.
Of course, that period coincides with the epic global financial meltdown, when all financial stocks took a pummeling. That RBC stock still appreciate at all during that time is impressive. Then you look further back in history, and see that RBC's 10-year average annual return is 13.2%. Closer, that is, to the stock's true history and potential. And I won't mention how much more profitable RBC will become if, as it has said, it proceeds to dispose of its albatross of chronically underperforming U.S. banks, goosing its overall margins and padding its capital reserves in one go.
Nothing says do-nothing stocks can't rise from the dead. It just doesn't happen very often. I couldn't help noticing that in financial blogger Barry Ritholtz's list of five non-financial vocations from which investors can learn, published recently in the Washington Post, the first one he cites is "Historian."
I majored in history, so I have a bias that says a stock I'm told is "just resting" is destined to remain nailed to the perch rather than for reasons unknown begin flying loop the loops. There are too many tood stocks out there to take chances on ones that have disappointed investors for years. Exceptions make the rule, but the retirement kitty goes into stocks with a strong pulse.