Caution is key as market soars

Donald Saltz

January 24, 1992|By Donald Saltz

Remember Aesop's fable about the hare and the tortoise and how the persistent tortoise won, thus teaching the overconfident hare that "slow and steady wins the race."

The tortoise, not the hare, is the is the one that stock buyers should emulate. A robust market such as we have seen in recent months tempts people to pay too much for stocks.

Too many of us have a hunger for shares after they've soared, and when caution should prevail.

Just this week, the Wall Street Journal warned of excessively high price-earnings ratios, referring to stocks priced at 30, 35 or even 40 times annual earnings.

Assume a stock sells for 30 times its earnings -- an example is Coca Cola -- and pays half its earnings in dividends.

Thirty times earnings means the company earns a little more than 3 per cent of its selling price, and, if it pays dividends amounting to half of its earnings, it's yield is only 1.5 per cent. In the case of Coca Cola, it's 1.3 percent.

An investor who pays 30 times earnings for shares of Coca Cola is assured of a low yield for years, even though there should be increases. And with a P-E ratio so high, there is a risk of a sharp drop in the share price if the upward earnings trend is interrupted, and it does happen.

Investors should always keep in mind that a price-earnings ratio should be reasonable -- probably not more than 15 times annual earnings for most companies, and often lower.

The powerful market rally during recent weeks has elevated the P-Es of many stocks to unjustified levels, so it is necessary to restrain oneself when P-Es are "just not right."

Mercantile Bankshares Corp. of Baltimore has to be included in any group of fairly priced stocks. Conservatively managed, it was not affected by the risky real estate loan syndrome that bought several area banks to the brink of insolvency.

Although Mercantile is trading near $28, close to its all time high, its ascent has been gradual -- which builds a more solid foundation. Mercantile sells for about 12 times earnings, and yields slightly more than 3 per cent.

The "go-go crowd" won't go for Mercantile stock, preferring the hare, not the steady tortoise.

Citizens Bancorp is another value-priced banking stock.

Based in Laurel, it, too, is operated conservatively and, although earnings have dipped a bit because of certain real estate loans, PTC those earnings have not been shattered.

The dividend yield is close to 6.5 percent, and the shares sell for 10 to 11 times earnings. Trading at $17, this stock trades in a relatively narrow range and may well rebound to over $20 when the banking picture brightens.

Baltimore Gas and Electric Co. will be split 3-for-2, an action that is usually favorable for a stock, since it expresses management optimism.

BG&E also yields about 6.5 percent, but earning have been sluggish. Nevertheless, the shares are nearer the high than the low of last year.

Martin Marietta shares have grown gradually and sell for only about eight times earnings. This company is diversified, and earnings are gradually gaining, with a conservative dividend yield of under 3 percent.

The company displays the classic sign of a solid stock -- its price has held up well and the trading range for the past year was about $42 to $60, a modest range.

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