Not All Large-Caps Should Be Avoided

 | Oct 24, 2013 | 1:00 PM EDT  | Comments
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One of my favorite RealMoney contributors is Tim Melvin. Tim's column's are certainly a must read, even if you may not fully agree with the particular point of view.

In investing, having multiple prisms through which to consider the current landscape is absolutely critical. That's why his commentary Wednesday on treading carefully with respect to large-cap stocks was definitely insightful.

It is indeed true that size and safety often go hand in hand. After all, the reason many large-cap stocks are known as blue-chips is because you can depend on them to be around in good times and bad and to be appreciating steadily. Most large-caps also provide a little income, making them all the more attractive to investors during any market environment. But the safety of a large blue-chip does not imply that these stocks can be bought at anytime.  

Price dictates value and even the highest quality stocks can turn out to be the worst investments if investors pay too high a price. Remember the Nifty Fifty? Back during the 1960's, the love for stocks created a bull market that eventually sent 50 of biggest and financially sound companies to stratospheric valuation levels.

 In 1972, McDonald's (MCD) commanded a price-to-earnings ratio of 71 while Johnson and Johnson (JNJ), the ultimate blue-chip, was valued at nearly 60x earnings. As a group, the average P/E was 41x at the peak in 1972. Needless to say, when the bear market struck a year or so later, this entire group of large, stable stocks was decimated.  

Despite today's market enthusiasm, not all titans are trading at unattractive valuations. Deere (DE) trades for under 10x earnings and yield 2.4%. IBM (IBM), part of the old Nifty Fifty, trades for 12x earnings and counts Warren Buffett as one of its largest investors. Shares in IBM have fallen, trading near a 52-week low and close to prices that Buffett was buying into.

 But today's bullish market has certainly taken a lot of large-caps out of buy territory. And many of them like Amazon (AMZN), and perhaps even Google (GOOG) have started to take on Nifty Fifty status. We are nearly five years into what seems like an unstoppable rise in the stock market. That type of environment tends to give investors a greater sense of confidence about future expectations. Don't fall into that category. In any market environment, your money is made on the buy side, not on the sell side.

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