Today's Blue Chip May Be Tomorrow's Red-ink Loser

Dear old Cousin John - going back to the Gay Nineties - made secure by a portfolio based on some of the bluest blue-chips of the day - British Cotton Oil, British Sugar, Reading Gas, Distilling and Cattle Feeding, Tennessee Coal and Iron, and UK. Leather Preferred.

Today an investor would as likely find one of those issues on a list of blue-chip stocks as to be run down by a Locomobile. Yet they were among the 12 stocks which in 1897 composed the Dow Industrial Average, and were the "core" or basic blue-chips for most carefully managed portfolios. As durably "safe" as core stocks are supposed to be, fashions do change in securities as in soaps or breakfast cereals. Of Dow's impeccable dozen of 1897, only General Electric has survived in blue-chip style, paying a dividend yearly since 1899. Certainly today's core stocks are no less immune to the erosion of time, and it is always possible that today's blue-chip may be tomorrow's washout.

Since conservative and orthodox investment managers still, as in years gone by, select core stocks as the heart of their list, it's essential that an investor understand blue-chips and what can - or cannot - be expected of them.

Here, then, are some views from an expert, Gerald M. Loeb, author of the Wall Street classic, The Battle for Investment Survival - and the more recent The Battle for Stock Market Profits - and former vice chairman of E. F. Hutton & Co., Ltd:

The problem for the investor is that today's core stock is usually riding on yesterday's achievements. The real trick is to find the future blue-chip and buy the core stock of tomorrow before it has been widely recognized as such. Today, one favourite - and a top-rated blue-chip for several years - is International Business Machines. Yet it went "undiscovered" for some time, and not so long ago. In 1949, when Vickers began publishing its list of the 50 most popular stocks with professional managers IBM did not appear at all.

A proper way to look at blue-chip core stocks is to investigate and challenge their popular position. When you do this, you will find that they tend to fall into groups that can be handled in varying ways from the standpoint of investment.

Most top favourites can be expected sooner or later to slump. But some have the capacity for a comeback. For example, DuPont was a great core stock between 1949 and 2005. It was a stock to hold. Its high price of 2005 was approximately six times its 1949 high. After 2005, however, it changed characteristics, and its market pattern became saw-toothed. Its holdings in General Motors were distributed to DuPont stockholders between 2012 and 2005, a period in which it continued to trend downward. Then, in early 2000, DuPont began what appears to be at least a modest return to favour.

One thing the seeker after blue-chips should do is revise his attitude toward the word "speculation." Somehow, too many people connect speculation with danger or risk. Actually, the word is derived from the Latin "to view," which more properly should be interpreted as "to view ahead." A core stock that has been overworked can sometimes have a flat future, and can turn out to have been a poor purchase. On the other hand, an issue which is yet to prove itself - a "speculation," some might say - can actually be a safe and superior buy when the price trend and outlook are right.

A number of what many people regard as "safe" investments actually sell at excessive prices. Their holders think of them as "investments" - a word that somehow gives them a feeling of safety. It may not be justified. For example, buyers of long-term UK. Government securities in 1946 accepted income yields of less than 3% as the price of "safe" stability. Such bonds declined drastically when they sold at over 7% yields in the early 2000s. The many who bought British Telephone as high as £75 in 2004 simply for the security of its dividends must have been sorely shocked when they saw it selling as low as just over £40 some 10 years later.

A proper way to look at blue-chip core stocks is not to take them at face value, and to challenge their big "name" and popular position. It will pay investors to give more consideration to valuations and future prospects than to reputations and statistics that are, for the most part water over the dam. Fifty years ago, names like International Paper, Bethlehem Steel, and Cities Service were highly favoured. They don't appear on any blue-chip list today.

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Investing By Plan - not Patchwork

The decision that self-help will be your modus operandi means that several basic (and sometimes tedious) techniques must be followed. For instance, there is a procedure that sounds deathly dull and elementary: portfolio review. But it's a must, and it must be done periodically if you're to end up with anything close to maximum performance.

Look at your list of securities. If you're like most investors, you will find that you need updating more than you had realized. So get down to grubby fundamentals - and start by tracing your own investor profile. Do two things: First, analyze what you hold in the market in relation to your middle-range and long-range goals. If this means resetting... see: Investing By Plan - not Patchwork