High-quality stocks still best for long run

By Elmer L. (Al) Meszaros, CFA, Partner

Many of our clients have worked a lifetime to accumulate their present assets and thus rightly take a cautious view about risk.

That’s why Midwest Investment Management adheres to an investment philosophy that minimizes stress for the prudent investor, while seeking to build wealth at a satisfactory rate. Our high-quality, low-risk client portfolios are positioned to grow steadily, protect the downside, and deliver a rising level of dividend income every year.

What happened in 2004?

In some years, high-quality stocks are not popular among investors who seek better rewards by investing in stocks of smaller, riskier companies. However, any good investment strategy will hit a rough stretch at some point—if it adheres to its discipline. In fact, no invest-ment strategy will be popular every year.

Such was the case in 2004, as the stocks of large, quality companies lagged in comparison, although their performance still outpaced the inflation rate of 2.7%.

A useful measure

Index benchmarks are useful, although sometimes misleading. Ultimately, investors in any risk category should judge their long-term returns against the rate of inflation—a method used by most endowment funds. Historically, the equity markets have returned 6% to 7% annually after inflation. We believe that future post-inflation returns of 5% to 7% are possible (pre-inflation returns would be about 8% to 10%).

Where are we now?

It appears now that quality large-cap com-panies are ripe for a reversal (higher overall returns) because their valuations (Price/Earnings ratios) are currently very favorable compared to small-cap stocks (see chart below). In addition, as earnings gains moderate in 2005, the stocks of stable industry leaders are likely to be attractive again.

Investment success comes from staying with a good strategy and avoiding untimely shifts into an expensive sector merely because it has done well lately.

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Building long-term wealth requires patience and a disciplined approach to stock selection. If you’re not currently a Midwest Investment Management client, Al Meszaros can help you get started. Contact him at (216) 830-1133 or elm@mimllc.com

*The Dow Jones 30 Index is an unmanaged index that includes only 30 large companies. The S&P 500 Index is a broad market-weighted average of U.S. blue-chip companies. The S&P 100 Index measures large-cap company performance and is a subset of the S&P 500. The S&P Mid-Cap 400 is a most widely used index for mid-sized companies. The S&P Small-Cap 600 is a widely used index of small-cap companies.

The Russell® 2000 Index measures the performance of 2000 companies with a smaller market capitalization.

Direct investments cannot actually be made in any of these indexes.