Growth Stocks Appealing Again
Here’s a sure thing, an investment tip that can’t lose: Buy stocks of companies whose earnings likely will rise at a healthy clip.
Sound silly? The most obvious “tip” you’ve ever heard? That’s the point--it is obvious. But on Wall Street, the obvious has only recently come back into vogue. And there still are people fighting it.
With the death of takeover mania last fall, many Wall Streeters proclaimed that fundamental investing would return: Investors would buy “growth” stocks again rather than stocks that were likely to be takeover targets.
The growth stock advocates have been right, to a degree. So far this year, investors have flocked to many stocks whose earnings outlooks appear to be dynamite. Boeing has risen to $67.375 from $59.375; Microsoft has soared to $111 from $87.
A lot of smaller growth firms--particularly in the technology field--also have been spectacular performers this year. Adobe Systems, a software designer, has gone to $41.75 from $20.25.
Even so, there are a lot of skeptics out there, especially on the subject of smaller growth stocks such as Adobe. They look at the dismal record of smaller stocks in the 1980s and use that as a predictor of future performance. Don’t be fooled by this spike up, they say--it’s still a loser’s game. And indeed, there are many small stocks that have yet to follow their bigger peers higher this year.
True, the average small stock fared poorly for most of the ‘80s, compared to big stocks. The Hambrecht & Quist growth stock index rose and fell periodically in the ‘80s, but it ended 1989 at 617.54, the same level as early 1984. In the same period, the Dow Jones industrial average rocketed to 2,753 from 1,200, up 129%. No contest.
Big stocks outperformed smaller stocks for a number of reasons, but the takeover/restructuring binge was key. That was a big-stock game, and it was the only game going for much of the decade. When you were making jillions on takeovers, who needed to buy stocks based on earnings?
Now the takeover game is over. Everybody knows it. So some other theme has to come to the fore on Wall Street. “The investment world is moving on,” said Barney Hallingby, Hambrecht’s stock research chief, “and I believe growth stock investing will fill the void.”
Some growth stock fans draw strength from investors’ wariness. Jeffrey Miller, executive vice president of Pasadena-based Provident Investment Counsel, a $3.8-billion money manager, said many major investors still would rather just “index” their portfolios--meaning, buy all of the Standard & Poor’s 500 stocks (mostly big stocks) and let them sit. It’s simpler, and for most of the past 10 years it has been a more rewarding strategy than trying to pick growth stocks.
But the more prevalent that attitude becomes, said Miller, the more he’s convinced that back-to-basics stock picking is a better option: “When something becomes most popular, it’s usually the worst time to get involved with it.”
Why Buying Growth Works: One problem with the growth stock debate is that side arguments often obscure some pretty basic truths. For example, the debate over whether smaller growth stocks are worth buying casts a cloud over the entire concept of growth investing.
But look at the track record of some major growth names. Even while Wall Street focused mostly on takeovers in the late ‘80s, the stock of toy store giant Toys R Us rocketed 346% from the end of 1982 to the end of last year. The fuel for that surge was simply earnings growth--from 48 cents a share in 1983 to $1.64 last year.
There are plenty of other stocks in the Toys R Us class. They were keepers--stocks you could feel comfortable holding for a long period in the ‘80s. Many of those same stocks may prove to be keepers for the ‘90s as well.
The argument of the smaller growth stock fans is that their companies will once again begin to be noticed alongside those like Toys R Us. And that gets to the heart of the matter: How do you pick a winner when you’re searching for a growth stock?
By definition, you want a company whose earnings have been strong. Beyond saying “above average,” what constitutes strong growth may vary. But a benchmark might be 15% a year.
Most important, you want to feel confident that the company can keep up that growth. The price of a stock relative to earnings per share--the price/earnings ratio--is a measure of how fast the company is growing and how confident the market is about that growth. Growth stock bulls make the case now that P/Es are too low--that the market should be paying more for these franchises. Here’s a sampling of some highly rated stocks, and the arguments behind them:
Hambrecht’s Hallingby searches for companies that meet two broad criteria: The business offers “substantial long-term opportunity,” and management knows how to tap that opportunity. Oracle Systems, a software designer, is a good example of a firm that is strong on both counts, Hallingby said. Another: Occupational Urgent Health Care, a provider of medical cost-containment programs to workers’ compensation benefit plans.
Brian Berghuis, a portfolio manager at T. Rowe Price’s New America Growth fund in Baltimore, focuses on companies in the service industry, including retailing and restaurants. Despite the periodic shakeouts in those businesses, “companies that execute well gain market share,” he said, and that leads to top-notch growth long term.
Three stocks high on Berghuis’ list: Shoney’s, a strong national restaurant chain that should benefit if more baby boomers begin to favor sit-down meals with their kids; Hancock Fabrics, a leading fabric retailer that should show “20% annual earnings growth as far out as I can see,” Berghuis said, and Staples Inc., which runs a fast-growing chain of office supply stores.
Paul Mackey, a growth stock analyst at Dean Witter Reynolds in New York, searches for growth companies that dominate their field. Two names he likes now: Carnival Cruise Lines, the leader in the burgeoning cruise industry; and First Brands, the 1989 spinoff from Union Carbide that makes such products as Glad Bags and Prestone antifreeze. First Brands’ products all have excellent growth potential, Mackey said, “but I don’t think stock investors have caught on to the company yet.”
SOME LONG-RUN WINNERS . . . A few of the growth stocks that have been consistent stellar performers for years:
Thurs. Change, Year ’90 Stock close ‘83-’89 to date P-E* Microsoft $111 +729% +27.6% 28 Wal-Mart 46 1/2 +620% +3.6% 20 Home Depot 44 +573% +20.1% 15 Waste Management 33 1/8 +423% -5.4% 22 Wrigley 49 3/4 +404% -7.2% 17 Toys R Us 39 5/8 +346% +10.5% 19 H&R; Block 35 3/8 +245% -1.7% 14 Corning 45 1/8 +161% +4.9% 15 S&P; 500 338.07 +151% -4.3% 13
. . . AND SOME NEW IDEAS Some issues that could be hot growth stocks
Thurs. Earnings per share: ’90 Stock close ’89 ’90 est. P-E* Boeing $67 3/8 $2.94 $5.50 12 Carnival Cruise 20 1/2 1.44 1.70 12 First Brands 19 3/4 1.98 2.50 8 Hancock Fabrics 32 5/8 2.11 2.55 13 Occup. Urgent Care 18 3/4 0.37 0.62 30 Oracle Corp. 26 1/8 0.61 1.00 26 Shoney’s 12 5/8 0.41 0.75 17 Staples 19 3/4 0.60E 1.10 18
1990 earnings estimates from Dean Witter, T. Rowe Price, Hambrecht & Quist, DLJ Securities and Value Line. * 1990 P-E: stock price/earnings ratio based on 1990 earnings estimate.
