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Be cautious of high-flying companies

    The Dow Jones Industrial Average, a stock indice of 30 actively traded blue chip stocks, has fallen back below the 9700 level as buyers worry about future accounting revelations. Uncertainty and rumors have upset an already emotionally stressed situation. Hopefully, corporate America got the message of the market. Investors are mad about using accounting shenanigans to mask poor operating performance and won’t tolerate it any more.

    Looking ahead, investors will need to be patient regarding the market. The real question is what is happening in the economy and when will we see clear signs of an economic recovery. There continues to be positive signs on the economic front. In general the economy held up better in January than some analysts expected. Investing in the stock market should be viewed as a long-term commitment. The market is going through a period of consolidation, which is part of a normal business cycle. Strong companies use periods like this to do everything possible to gain market share at the expense of weaker competitors so that they can enjoy higher profit margins when conditions materially improve. 

    There have been many questions around the Enron debacle. I have recently read an article from an investment strategist that brought up several good points. I would like to share some of his insight. It offers some ideas to consider if you choose to own individual stocks. 

    Companies listed on the exchanges have audited financial statements.  Accountants use footnotes to explain different accounting procedures in the accompanying financial statements. The footnotes are an accountant’s equivalent to the fine print that a lawyer would use in a contract. It is always wise to read these footnotes.

    Investors should be cautious of high-flying companies in any industry, but especially in an industry such as utilities. The utility sector is perceived to be a safe, stable and secure investment.  There is not a lot of excitement— utility stocks traditionally pay good dividend yields and are considered to be a fairly conservative investment. When any company defies the logic and fundamentals of the industry, it should raise questions. If things seem too good to be true, they probably are. 

    Avoid extreme views – some investors thought technology stocks could go nowhere but up. After the recent collapse some investors think technology will never go up again. Both views are extreme and both are wrong. Extreme views should be avoided, especially regarding accountants and audited financial statements.

    Never make an investment decision because you think the company you invest in is simply too big to fail. Enron was the seventh-largest company in the United States. It was larger than the entire economy of numerous countries.   Just because a company is big doesn’t mean someone will step in to bail them out. Remember, size alone does not guarantee investment success.

    It is important to know what you own and why.  Peter Lynch of Fidelity Investments has been preaching this concept for years … never own a stock when you don’t understand what the company does. If you don’t clearly understand how the company makes money, then you really don’t know that company. When you buy Ford Motor Company stock, you know what you own and how that company makes money. 

    Diversification is an important investment discipline. Do not put all your eggs in one basket. Stocks representing a broad range of industries, a mix of Treasury, corporate and municipal bonds and cash for special needs, are key elements in a diversified portfolio. This strategy can enhance growth and reduce exposure to unpredictable factors like political events and natural disasters. By reducing the impact of any one component of your portfolio, you can minimize risk and be in a position to meet your long-term investment objectives. 

    There are many investment styles. It is important for each individual to identify their own specific objectives, risk tolerance and investment resources. This will allow you to create a plan that will meet your needs and expectations. Each person is an individual and has different requirements and risk tolerances. There are many investment vehicles to choose from—pick the ones that are right for you.

    Nancy Hadley is an investment specialist with D.A. Davidson in Sandpoint. Information is subject to change based on market and other conditions and none of this should be construed as a recommendation of any specific security.     

 

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Nancy Hadley

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