‘Safety’ Again Becomes Relative Term in Stocks

In the worst stock bear markets, by the time they’ve run their course most investors come to believe that almost nothing is safe.

That mental adjustment may be far along for many people by now. Certainly in the telecom sector the word “safe” has been eliminated from the lexicon. Ditto for the electric power business. And last week, the drug industry provided more reminders of the dangers of making assumptions that firms with big names and long histories automatically provide thick margins of safety for their investors

Shares of Schering-Plough on Wednesday plummeted to their lowest level since 1997 after the drug giant disclosed that the federal government had launched a criminal investigation of the company’s operations.

On Friday, Schering said it agreed to pay $500 million in fines related to quality-control issues at four plants--while the criminal probe still looms.

Another drug firm, Abbott Labs, saw its shares fall 7.1% for the week after it also disclosed that the government has quality-control issues with one of its key plants.

The drug business historically has been one that investors considered “defensive”--in other words, in a rough economy and/or troubled stock market, drug companies’ sales and earnings could be expected to shine through. But investors looking to bolster their portfolio defenses over the last year have found no shelter in the drug sector: Standard & Poor’s index of 13 major drug shares last week hit a two-year low.

The idea that there are few places to hide has been fostered in part by the cloud of scandal that is enveloping an ever-wider swath of corporate America. Even the most ravenous news junkies by now must have lost track of the number of investigations state and federal regulators have initiated in the last six months, questioning the bullish sales and earnings results companies almost universally posted in the late 1990s.

Charles Niemeier, head of accounting for the Securities and Exchange Commission’s enforcement division, last week said the agency increasingly is focusing on accounting tricks companies used to artificially boost revenue in the boom years, apparently to meet Wall Street’s growth expectations.

Niemeier called revenue “the most abused line item in financial statements,” according to an interview with Bloomberg News.

Enron Corp. may be remembered as the starting point for the national soul-searching over cooked books in the boom era, but the ending point doesn’t seem to be on the horizon.

For investors, fear of being caught with “the next Enron” has made for very itchy trigger fingers, helping to drive major stock indexes in early May to their lowest levels since October.

The selling pressure finally abated last week, and most indexes enjoyed big bounces: The Dow Jones industrials surged 4.2% to end at 10,353.08, and the Nasdaq composite, after falling in eight of the nine previous weeks, jumped 8.8% to 1,741.39, for its biggest one-week gain since April 2001.

But companies facing government inquiries of one type or another--including, recently, Schering-Plough, CMS Energy and Edison Schools--saw their stocks continue to plunge.

Wall Street refers to such issues as “falling knives”--as in, good luck trying to catch them without seriously injuring yourself.

The concept that risk pervades the stock market isn’t new, of course, but it was ignored by too many investors in the long bull run. In that sense, the last two years have provided a valuable education, albeit at heavy cost to the nest eggs of millions.

Yet the high-profile stock collapses since 2000, and deepening fears of more widespread corporate scandals, threaten to obscure for many investors that there have been plenty of money-making opportunities in equities this year.

No stock is “safe” if an investor’s definition of that term is no risk of loss. But if you define safe in relative terms--for example, as meaning a reasonable shot at making money in an otherwise weak market--there is a long list of stock sectors that have qualified this year.

Those include defense contractors, small banks, forest products companies, HMOs, soft-drink firms and, as James Flanigan points out elsewhere in this section, home builders.

And although the blue-chip Standard & Poor’s 500 index is down 3.6% year to date, stocks of many small and mid-size companies have gained ground as investors have hunted for new ideas and, perhaps, simpler business concepts.

S&P;’s index of 600 smaller stocks is up 9.4% this year, and the company’s index of 400 mid-size stocks is up 7.3%.

Also notable is that foreign stocks, on average, have been a good place to be this year, as the dollar continues to sink in value against the euro, the yen and other key currencies. That drives up the value of foreign shares for American investors when stronger currencies are translated into more dollars.

The average international stock mutual fund is up 6.4% year to date, according to Morningstar. By contrast, the average U.S. stock fund is down 2.4%.

Investors who only recently have come to the conclusion that no stock is ever really safe obviously didn’t own names such as Eastman Kodak, Gillette or Coca-Cola in the late 1990s.

Those blue-chip giants, among others, saw their share values grind ever lower between 1998 and 2001 as their growth rates slumped and their franchises lost their luster.

In retrospect, they provided an early warning of what would befall the technology sector’s titans--except that few tech investors believed there could be an analogy.

Investors who paid Kodak’s peak price of about $94 in 1997 and have held on now own a stock worth $34.83 as of Friday. If you paid Gillette’s peak price of about $60 in 1999, you’re still far under water, with the stock at $36.51 now.

If the question is how an investor can best protect himself or herself from incurring losses of those magnitudes, some analysts say the answer lies in drawing a line when a stock is purchased: You tell yourself, “If I lose a certain percentage, I’m selling, no matter what.”

That strategy, a favorite of market “technicians” who spend much of their time studying historical stock charts, has long been viewed as anathema by investors who consider themselves buy-and-holders.

If you like a stock, and it drops after you buy it, you’re supposed to buy more, the buy-and-hold strategy dictates.

But the technology and telecom sectors in the last two years, and former blue-chip leaders before that, have shown the perils of refusing to deviate from buy-and-hold in the face of massive price declines.

For many investors, setting a limit of losing no more than 25% on a stock would have preserved substantial capital in recent years, as many stocks have fallen 50% or much more.

To put it another way, the “cockroach” theory of investing, or disinvesting, has been a brilliant strategy: If you see one ugly problem at a company, it’s a good bet that there are many others behind the walls, waiting to emerge.

Tom Petruno can be reached at [email protected]. For recent columns on the Web, go to: www.latimes.com/petruno.