Dear Mr. Berko:

What do you think of large-cap issues in today’s market? I think that the timing might be right to put together a quality portfolio of large-cap stocks that have good fundamentals but have lagged the market. I know the small-cap issues have done well over the past few years at the expense of big companies like Coca-Cola Co., US Steel, Wal-Mart Stores Inc., etc. But please recommend a portfolio of these stocks for me, if you think 2005 or 2006 might be the year of the large-cap issues. I’d like to invest about $2,000 each in about 25 to 30 large-cap issues, if you think it’s the right time to do so.

E.B., Oklahoma City

Dear E.B.:

As a rule, I try to stay away from large companies like Intel Corp., Microsoft Corp. (both of which I panned back in June 2004), Procter & Gamble Co., 3M Co., IBM Corp., DuPont, etc. In fact, during the past quarter-century, the 100 smallest issues in the Standard & Poor’s 500 index outperformed the 100 largest companies by an average of 7 percent per year.

You might remember way back in 1998 and 1999, when Lucent Technologies Inc., Motorola Inc., Time Warner Inc., J.C. Penney Co. Inc., SBC Communications Inc., Sprint FON Group and Albertson’s Inc. were approaching $30 billion in revenues. I suggested then that many companies tend to blow apart at their corporate seams when revenues reach the $30 billion level. I frequently counseled that it would be unwise to purchase shares of those companies because their share prices tend to remain flat or decline in value.

The $30 billion revenue number seems to create a quirky psychological phenomenon. Management of these companies tends to be more interested in resting on its laurels and maintaining the status quo rather than aiming at higher revenues, earnings and dividend growth. Size tends to foster a risk-averse, multilayered bureaucracy in which the executives cautiously insulate their fiefdoms from change or new ideas.

That helps explain how the Dow Jones industrial average rose just 3 percent and the S&P 500 (which has both large- and small-cap issues) rose 8.9 percent last year, while the S&P 400 Mid-Cap index and the Russell 2000 were up 15.2 percent and 17.1 percent, respectively.

Even though the largest 25 issues in the S&P 500 have an average price-earnings ratio of 16.4 (predicated in expected 2004 earnings) vs. 18.1 for the entire S&P index, I’m still not sanguine on those large-cap issues. Though those 25 large-cap issues have a dividend yield of 2.3 percent compared with the 1.7 percent yield of the S&P 500, I still prefer small- and mid-cap issues over large-cap issues for 2005. And even though the best returns in the stock market over the past five years were earned by mid- and small-cap issues, I still doubt this will be the year for large-cap issues.

However, it’s difficult to ignore companies like Coke, General Electric Co., DuPont, Pfizer Inc., Intel, Wal-Mart, Citigroup Inc., 3M, Cisco Systems Inc., Johnson & Johnson Inc., American International Group Inc., ChevronTexaco Corp., Lockheed Martin Corp., Boeing Co., Dow Chemical Co., GlaxoSmithKline PLC, Honeywell International Inc., Tyco International Ltd., United Technologies Corp., US Steel, Morgan Stanley, Unilever PLC, Archer-Daniels-Midland Co. and Albertson’s. If you must own large-cap issues, those represent some of the best in the group. Considering valuation levels, dividend growth, balance sheet considerations and P/E ratios, they look hugely attractive.

But if you’d like to save a king’s ransom on commission costs and buy one issue, consider the Dow Diamonds (DIA-$106), an exchange-traded fund with a 2 percent dividend yield. An investment in this ETF represents a proportionate undivided interest in each of the 30 stocks that make up the Dow Jones industrial average.

I’m very comfortable with the Dow Diamonds. If you do purchase this fund, you must be a long-term investor; don’t treat this as a one- or two-year speculation. Frankly, I think the Dow Diamonds can bring some joy to your long-term portfolio. The dividend growth has been fairly good, rising from $1.44 a share in 2000 to $2.18 in 2004, which is a 40 percent increase. Sadly, the price of DIA shares has not done as well, falling from $121 in 2000 to $106 today. But because the fund’s price performance has lagged in the past five years, this year might be the exception you want.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.