Blue Chips in Pain: A Contrarian Opportunity?

  • April 11, 2006

I happened to come across an excellent article today on Business Week called Blue Chip Blues that describes how the stocks of some of the biggest and most profitable companies in America have performed terribly over the last five years. The most intriguing part of the article was a section titled “Boiling Down To Zilch” which talks about how “the S&P 100-stock index – the bluest of the blue chips – has returned just 2.03% annually to investors during that span, chiefly from dividends“. Without dividends the annual returns from the S&P 100 index drops down to just 0.19%. They say a picture is worth a thousand words and this chart from the article that shows the disparity between earnings growth and stock price growth made my jaw drop.

I did find it very interesting that Intel (INTC), the company (as featured in the chart above) that had the maximum earnings growth of 173.1% also saw its stock drop 29.9% since 2001. I had considered featuring Intel in the March 2006 edition of InsideArbitrage, but then decided against it. You can read the reasons in my blog entry Stocks That Almost Made the Cut: March 2006. I am glad I decided to hold off featuring Intel as a InsideArbitrage pick since the stock is down another 7% since March.

One important thing this article failed to mention was that stock prices are often driven by expectations of future earnings growth and many of the companies listed in the chart face daunting problems. Intel faces stiff competition from AMD (AMD) and the new “Cell Processor” developed for the Playstation 3, Pfizer (PFE) and Eli Lily face looming patent expirations and loss of market share to biotechs, Oracle (ORCL) has to assimilate all its recent acquisitions and build its “fusion” product, AIG (AIG) faces regulatory problems and both Citigroup (C) and Home Depot (HD) face the challenge of a real estate bust. Given the poor performance of blue chips over the last five years, can a contrarian case be made for going against the grain and investing in them now? As a value investor, I am inclined to believe that the upside potential is greater than downside risk for some of these blue chips. This is reflected by the fact that I chose to feature Johnson & Johnson (JNJ), Pfizer (PFE) and Safeway (SWY) in recent editions of InsideArbitrage.