Market Watch - October 26, 2005

Good Buys Becoming Available

Four years ago, the Dow Jones Industrial Average price earnings ratio was 25 times earnings and the yield was 1.8%. With current price earnings ratios at 19 times earnings, stocks are 25% cheaper than they were four years ago. The Dow averaged 10,200 points in 2001, about what it is today. But both earnings and dividends have increased over the last four years providing some good opportunities to begin building a portfolio.

Question: Last month Market Watch mentioned there were a few quality stocks available with low price earnings ratios and high yields. We just moved here, sold our home up north and have $500,000 that we would like to leave to our grandchildren and from which we do not need the income. What can we do that gives us the best chance to preserve our capital, cause it to grow and leave it to our grandchildren?
Answer: The safest way to preserve your capital and obtain good gains is to buy high quality stocks that have a niche in their market and a good dividend, and be patient over a period of time. Companies that have a history of increasing earnings and dividends will produce the best, safest long term returns. Invest funds using the time proven Dow Theory.

Question: What is meant by Dow Theory?
Answer: Charles Dow was a great market theorist and the founder of the Dow Jones Average and the Wall Street Journal. He had a penchant for buying only stocks that paid a good dividend. He also looked for companies that had a history of increasing their earnings and dividends, and he preached purchasing those stocks when their price earnings ratios trended towards historical lows.

Question: Last month Market Watch pointed out the U. S. economy remains dangerous for stock investors, but that decent buying opportunities are becoming available. Is that still true?
Answer: The market remains vulnerable, overpriced and poised, with interest rates going up, to shed a significant percentage of points on the downside. With a deteriorating market, classic opportunities to invest in high grade stocks are becoming available. It is unlikely we will see any significant change on the upside in the stock market for the next few years.

Question: If there’s potential for the market to go down over the next few years, or remain where it is, why would an investor be in anything except cash or cash equivalents?
Answer: Good question! The answer is that to build a portfolio takes time. When quality stocks become available at prices significantly below their historical averages, it’s time to begin to build a portfolio of good securities.

Question: Last month Market Watch mentioned Citicorp (C), U. S. Tobacco (UST), and Bank of America (BAC). Are they still priced to return a good dividend?
Answer: Yes they are. The best buys in the market right now are bank stocks.

Question: Can we put together a portfolio with the money earmarked for our grandchildren and invest it all in these cheap stocks?
Answer: It would be inappropriate to invest the entire half a million dollars in stocks at this time with so many uncertainties, the unraveling of which could cause the market to take a dive. Better for you to stick with the four principles of managing money espoused for years by Market Watch:

1. Never risk principle
2. Don’t be greedy
3. Respect the time value of money
4. Limit your choices

Bearing that in mind, your portfolio could include $50,000 of UST, $50,000 of BAC, and $50,000 of GLD with the balance of $350,000 invested in a short term tax free fund.

Question: What is GLD?
Answer: GLD is a gold ETF (exchange traded fund). Each share purchased is equal to roughly 1/10th of an ounce of gold. The GLD shares may be redeemed for gold under circumstances explained on the GLD website. As income is not an issue in building this portfolio for your grandchildren, the income from the tax-free fund, and the income from UST and BAC may be plowed back into purchasing more of those securities. The road to riches is compounding, and this is a classic opportunity to enjoy those benefits.

Question: Why the gold ETF?
Answer: All investments in this country are denominated in dollars, and the dollar continues to lose purchasing power. If after 10 years, you had an opportunity to leave your grandchildren $50,000 of cash that you piled up right now, or $50,000 of gold, which do you think will have performed best?

Question: Put that way, I would choose gold. What are the expectations for gold over the next several years?
Answer: Who knows? In the 1980s gold reached $850 an ounce. Adjusted for inflation since then, to obtain a comparable $850 level, gold would be priced at more than $2,200 an ounce today. There are some certainties with gold: it is a real asset; it has been money for 5000 years; and it always retains its purchasing power. That’s not true of paper money. As Voltaire said in 1729, “paper money eventually goes down to its intrinsic value—zero”.

Question: But isn’t gold strictly an emotional investment?
Answer: Absolutely not. That’s what your government wants you to think. Before we got off the gold standard, there was an economic limit upon government spending. Getting rid of the gold standard offered the government the opportunity to print money, create inflation, use the money to buy votes, and do exactly what has happened. We are now in the early part of the second phase of a gold bull market. This is the phase where gold starts to be publicized and the media begin to stimulate the public’s interest in gold. Gold is at a 17 year high. Hard assets like gold and real estate are a way to preserve asset values. Gold is undervalued and real estate is overvalued. So gold gets the wink at this time.

Question: My stockbroker has recommended Sysco Corp. (SYY) because the company’s stock is down. It’s an A++ stock. Shouldn’t some of a security like that be included?
Answer: Not as compared to other buying opportunities. Sysco, an excellent stock, sells at 22 times earnings and yields less than 2 percent. Bank of America sells at 10 times earnings and yields more than twice the dividend earned holding Sysco. With Bank of America and UST, you’ve got excellent yield, moderate risk, and moderate downside price risk because the dividend yield is so good.

Question: Can you show me what my make believe portfolio looks like?
Answer: Of course. Your half a million dollar account would look something like this:

Question: What’s the plan to invest the other $350,000?
Answer: The plan is to exercise caution, to be patient, to be committed to quality and to grab a few good stocks when they become available. And to go slow—there are lots of problems out there that need to be resolved.

Question: I can see, over time, how my grandchildren can become millionaires. It sure helps to start with half a million, doesn’t it?
Answer: You betcha!

Caveat Emptor.
George Rauch
October 26, 2005

*In future months, we will track these investments to see how they are doing and to commit further amounts of capital to the stock market when good buys become available.