I like listening to what Jim Grant is thinking. I also like listening to what Jeremy Grantham is thinking. They are both obviously extremely good thinkers. The hard part for me is understanding all the wisdom they are trying to share as I’m not exactly playing with the same mental tools they are.
Both Grant and Grantham have attracted attention for spotting and avoiding bubbles. Grant for example was way out in front of a bubble in junk bonds in the 80s, the tech bubble in the 90s and the housing bubble in the 2000s. Grantham similarly has made a name for himself by warning early of a bubble in Japan in the late 80s, the tech bubble in the 90s and the debt/housing bubble in the 2000s.
When they both agree on something I tend to listen.
And right now they agree that the best place to invest your money is in large-cap quality blue chip stocks that have gone sideways for the past 10 years. These companies have had their earnings catch up and pass their valuations and are now trading at attractive multiples.
In this interview with Bloomberg (click here) Grant laid out what the composite of this group of blue chips currently looks like. He offered the following composite:
- Trading at 10 times trailing earnings
- Paying a dividend of 2.5%
- Buying back shares
- Clean balance sheet
I’m sure this isn’t the first time you have heard someone suggesting that blue chips are cheap. You may well have heard that for the past two or three years. I know I have. So what is taking so long for the market to remedy this undervaluation?
“Why Are Quality Stocks Cheap?
High quality stocks were left very much behind in the great rally last year, which was the biggest and most speculative since 1932. Much more surprisingly, they have underperformed this year, probably for the reasons discussed above.
But unlike small caps, they have been cheap for almost five years and, given the uncertainties around today, this is unusual. There are surely additional reasons, other than the low rates, why the great companies have persistently sold at a discount. Why didn’t quality stocks at least become expensive, and risky stocks become cheap on a relative basis, when we were at the deepest point in the crisis? Most risky fixed income securities certainly became very cheap then.
I understand the general direction of the performance of quality stocks: down in 2005, 2006 and 2007, which were speculative years; up a lot in 2008, which was the year of anti-risk panic; and down in 2009 and 2010, which were also very speculative. But, I’m puzzled by the general value level around which they have been moving. It’s as if there is an extra and unusual force working against them. This type of mis-pricing always has a reason. It may not be particularly rational, but there is a reason. Let me confess that I have no certain answer, but I’ll offer a couple of candidates.
One is the population profile: there are more new retirees per new worker than there used to be. Retirees are selling stocks to pay the bills and to buy more conservative fixed income investments. And what stocks are they selling? By the time they retire, they probably own blue chips, having sold down most of their speculative stocks in the decade before retirement. This is just a guess; I have no good data to prove it. But it does seem reasonable.
A second candidate, accompanied by stronger circumstantial evidence, is the “Let’s all look like Yale” syndrome.
In the last 10 years, institutions and even ultra-rich individuals have, in general, been increasing the share of their portfolios that is invested in private equity and hedge funds, commodities and real estate. And even within their equities, they have been increasing their share of foreign equities, including emerging markets and small caps.
At the second derivative level, hedge funds may feel that they do not get paid to buy Coca-Cola (KO), and private equity firms, particularly now, do not go after many of the great franchise companies. So what is being liquidated to buy all of this new stuff? Old-fashioned blue chip U.S. stocks.
Now I should note that neither man currently is bullish on the stock market. Grant actually thinks valuations are fair to rich, but that the one sector which is attractive consists of the great big blue chips. Grantham is saying basically the same thing that now is the time to be cautious but that the great franchise companies are trading at attractive valuations.
And Grant was kind enough to provide three specific examples (click here) of blue chips that he thinks are worth buying, and those are:
- Wal-Mart (WMT) – Trading at a low teen PE with a 2.68% dividend yield
- Cisco (CSCO) – Trading at a low teen PE with a 1.5% dividend yield
- Johnson & Johnson (JNJ) – Trading at a low teen PE with a 3.36% dividend yield
I’m sure a person could slap a Microsoft (MSFT), an Intel (INTC) and a Kraft (KFT) on top of those and have a nice portfolio that performs quite well over the next 10 years with very little if any chance of permanently losing capital. Boring, but likely pretty successful.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.