For Value Seekers, a Drop in Price May Not a Bargain Make

NEW YORK —  For years, value- oriented money managers have predicted a comeuppance for glamour stocks that they insisted were trading at prices far higher than justified by earnings growth.

Now look.

The major market indexes might be down only about 10% from their peaks, but former darlings such as Coca-Cola, Gillette and Mattel have crashed to multiyear lows.

Is it time for value managers to take a look at former growth stars?

“Don’t confuse fallen angels with bargains,” cautions Scott Black of Delphi Management in Boston. “Gillette is still overpriced. Coke has no real growth and still has a high [price-to-earnings] multiple.”

Black and many other value managers--at least, those in the old-style value school--believe the big growth stocks have been the most extreme examples of market excess.

“I’ve been investing since 1966, and this is the most speculative market I’ve ever seen,” Black said.

And, given what are still relatively high price-to-earnings ratios for many growth issues, they’re too dangerous to go near, he contends.

Investors who want to buy bargains today, managers such as Black say, can find plenty of better--and much cheaper--ideas.

But note: You may have to be patient waiting for a payoff. True value managers often have multiyear time horizons. And they know “cheap” stocks can get even cheaper before recovering.

Caveats in place, Black now is looking at a sector he considers “beaten-down but with good fundamentals”: home builders.

“Interest rates are up, so people are acting like nobody’s ever going to buy a home again,” Black said. “Well, they are.”

He likes D.R. Horton, Lennar and Toll Bros., all of which are selling at near their lows for the year, with single-digit price-to-earnings ratios but annual profit growth rates in the mid-teens.

Among auto parts makers--another downtrodden sector--Black likes Lear and Dana.

John W. Rogers Jr., president of Ariel Capital Management in Chicago, thinks the market overall could fall another 25% from here because there are so many companies selling at 30 or 40 times earnings but with annual growth rates of less than half that.

“I’d stay away from expensive, trendy stocks,” Rogers said.

Instead, he favors names like Davenport, Iowa-based Lee Enterprises, a Midwestern newspaper chain that he says enjoys stable earnings and cash flow.

Another couple of meat-and-potatoes Midwestern firms Rogers recommends are Hussmann International of Bridgeton, Mo., and Specialty Equipment of Aurora, Ill., , both of which make refrigeration systems and other equipment for restaurants. With P/Es in the low double-digits, both are modestly valued, he said.

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One sector that is particularly vulnerable to interest rate concerns is financial services, but E. Wayne Nordberg, vice chairman of banking specialist Keefe Bruyette & Woods, thinks regional banks have been unfairly trampled.

Three he likes range from super-regional First Union of Charlotte, N.C., to mid-sized AmSouth Bancorp of Birmingham, Ala., to tiny UCBH Holdings of San Francisco, parent of United Commercial Bank, which caters to small businesses in ethnic Chinese areas.

All three have good franchises in growing markets and sell at low P/Es.

Among insurers, Nordberg favors Allstate, owner of a “tremendous long-term franchise” whose stock has been pounded to a three-year low largely because of recent profit warnings about hurricane-related losses.

In an environment in which minor earnings disappointments can cause popular stocks to be eviscerated, the best policy might be to avoid anything popular and seek what’s out of favor, said Earl Gaskins, a portfolio manager at Brandywine Asset Management in Wilmington, Del.

And what could be less popular than Toys R Us, the old-fashioned bricks-and-mortar chain of toy stores? After all, said Gaskins, the retailer’s chief executive recently quit, and its whole franchise supposedly is about to be swiped by Internet-based retailers such as EToys of Santa Monica, which went public in May, has never made a profit, yet has a market capitalization of $7.5 billion--twice that of Toys R Us.

But even if Toys R Us never gets its e-commerce act together, Gaskins believes the stock is protected from going much lower. He estimated that its real estate holdings are worth $15 a share--about the same price the stock is now selling for. In other words, you buy the real estate at fair value and “you’re basically getting the toy business free,” he said.

Another somewhat distressed retailer that Gaskins likes is J.C. Penney. Again, the stock has tumbled 35% from its peak of last Christmas, largely on fears that Internet competitors will chew up its market share.

That may happen, Gaskins acknowledged, but it will take a while. And in the meantime, Penney is selling at a reasonable P/E of 15--and has a dividend yield of 6%.

An even less glamorous company Gaskins admires is IMC Global, the world’s largest producer of fertilizers. It’s a slow-growth industry that got even slower with the Asian economic crisis and the worldwide slump in farm prices.

But over the long haul, Gaskins said, IMC should benefit from several powerful global trends: rising population, a dwindling supply of arable land and a shift by a large segment of the Third World population “up the food chain”--that is, toward a more protein-rich diet.

If more people start eating chicken, demand for grain-based chicken feed should grow, as should demand for fertilizers to boost the yield of shrinking farmland, Gaskins said.

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While value investors believe the market is finally coming around to their viewpoint--or will soon--other veteran money managers aren’t so sure.

Phil Orlando, chief investment officer at Value Line Asset Management in New York, says he continues to favor many of the “dominant, well-managed category killers” that have led the market for years.

It’s true that such technology giants as Cisco Systems, Microsoft, Dell Computer, Qualcomm and EMC are highly valued stocks, Orlando said. But they should be, because their earnings growth rates are three or four times that of the broad market, he said.

He also believes the Federal Reserve is finished raising interest rates for now, which should help such financial services behemoths as Chase Manhattan, Citigroup and American Express.

Buy value now, or buy growth? Investors who can’t make up their minds can always take the easy way out: Invest in both.

Thomas S. Mulligan can be reached by e-mail at thomas.mulligan@latimes.com.

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Opportunities Among the Downtrodden?

Here are details on some of the stocks favored by money managers who are bargain-hunting amid Wall Street’s beaten-down shares. The price-to-earnings (P/E) ratios listed are based on analysts’ estimates of 1999 operating earnings per share.

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Ticker 52-week Recent Pctg. Est.’99 Stock symbol high price decline P/E IMC Global IGL $27.31 $14.06 -49% 8 Allstate ALL 48.38 24.50 -49 8 D.R. Horton DHI 23.00 12.38 -46 5 First Union FTU 65.75 35.25 -46 10 Lennar LEN 27.88 15.63 -44 6 Toys R Us TOY 24.75 14.81 -40 10 J.C. Penney JCP 56.13 36.00 -36 13 Lear LEA 53.94 35.00 -35 9 Dana Corp. DCN 54.06 37.00 -32 9 AmSouth Bancorp ASO 34.56 23.50 -32 14 Toll Bros. TOL 25.50 18.44 -28 7 Specialty Equip. SEC 34.13 24.50 -28 11 Hussmann Intl. HSM 19.38 16.50 -15 12 UCBH Holdings UCBH 20.63 17.88 -13 9 Lee Enterprises LEE 31.50 27.75 -12 19 S&P; 500 index 1,419 1,283 -10 26

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Sources: Bloomberg News, Zacks Investment Research