Discovering Diamonds in Rubble

Is growth-stock investing dead?

That sounds severe, for sure. But consider how mercilessly Wall Street has been beating up last year’s hot growth companies--the businesses that once seemed shoo-ins to produce 20%-plus annual earnings gains in the 1990s:

* Centocor, one of the highest-flying biotech stocks of 1991, has crashed from $60.25 in January to $13 now, as hopes have evaporated for fast federal approval of the firm’s key new drug. Many other biotech stocks have fared almost as badly.

* Retailing trendsetter Gap Inc., which could do no wrong in 1991, has watched the market force a 30%-off sale on its shares since January--from $57.625 then to $42 now.

* Slot-machine maker International Game Technology fell from $29.875 last Thursday to $27.125 Tuesday, despite reporting first-quarter earnings up 84% from a year ago.

It’s bad enough that these stocks have already plunged far more than many growth-stock investors imagined could happen.

But the ultimate insult is that Wall Street is dumping growth stocks in favor of clunky industrial stocks that had been mostly ignored since 1988.

There’s a logical reason for this shift in sentiment, of course: If the economy is recovering, those long-neglected industrial companies should see their earnings rebound from the depressed levels of recent years.

Investors always love turnaround stories, and industrial stocks look like one huge turnaround in the making.

Many growth-stock admirers have no problem with the return of the industrial stocks. They just can’t fathom why investors are fleeing growth stocks with such prejudice at the same time.

Though some investors may need to sell growth stocks to raise the cash needed to buy industrial stocks, that alone can’t explain the dramatic declines in many growth issues.

Jeffrey Bronchick, associate director of research at Los Angeles investment firm Reed, Conner & Birdwell, argues that the rush to exit growth stocks has reached the hysteria stage. And that, he says, suggests that many growth stocks may be fantastic bargains.

His firm, which manages $650 million for clients, abides by a time-honored market rule, Bronchick says: “Identify great businesses, and wait to buy them when nobody else wants them. . . . We think people are reaching an emotional peak now, where they’ll buy anything to do with cyclical industries, and they’ll sell anything that did well last year,” meaning growth.

Consider Schering-Plough, one of the country’s major drug firms, Bronchick says. The stock has plummeted from $67.75 in mid-January to $54.625 now. Yet on Tuesday, Schering reported first-quarter earnings per share up 21%.

At Schering’s current price, Bronchick says he’s a buyer. Just look at the numbers, he says.

In January, Schering stock sold for 19 times the company’s estimated 1992 earnings per share of $3.56. Today, after the selloff, the stock is just 15 times that number.

“Even in a year of difficulty, they’ll still grow 12% to 15%,” Bronchick says.

Meanwhile, he asks, can Wall Street really say the same for some of the industrial stocks that have zoomed this year? Farm-equipment maker Deere & Co., for example, still has a rough road ahead. The company is expected to earn just $1.82 a share this year, assuming the economy continues to recover. At the stock’s current price of $52.125, Deere sells for 29 times the 1992 earnings estimate.

If the market has taught anybody anything over the years, it’s that a high P-E stock typically carries more risk than a low P-E stock. The lower the P-E, the lower investors’ expectations for the company. In the case of Schering and many other drug stocks, Bronchick argues, expectations are now ridiculously low.

Some savvy investors agree with Bronchick’s basic thesis that many growth stocks have been battered beyond reason.

But they note that once the market begins to shift away from a group of stocks--for whatever excuse--the surprise often is how deep the stocks can drop into the bargain bin.

“When these things turn, they really kind of crash” before the stocks finally bottom, warns veteran investor James Dunton at Capital Research and Management in L.A.

The growth-stock mania of 1991 was a speculative bubble, Dunton argues. That was more true for some of the stocks than others, but the bursting of the bubble will tar them all, and possibly for many months, he says.

Of the drug stocks in particular, Dunton says, “I think some of them are attractive. But I also think they’ll go down further.”

Are Growth Stocks Too Cheap?

How prices of some growth stocks and industrial stocks have shifted since mid-January, and what the shift has meant for the stocks’ price-to-earnings ratios (stock price divided by estimated 1992 earnings per share).

GROWTH STOCKS

Stock price: 1992 P-E: Company Jan. 14 Now Jan. 14 Now Home Depot 70 7/8 63 1/2 45 41 Amgen 77 1/2 57 3/8 41 31 Gap Inc. 57 5/8 42 30 22 Kellogg 63 1/8 56 3/8 22 20 Schering-Plough 67 3/4 54 5/8 19 15 Eli Lilly 86 5/8 69 17 13

INDUSTRIAL STOCKS

Stock price: 1992 P-E: Company Jan. 14 Now Jan. 14 Now Georgia-Pacific 59 70 32 37 Deere 48 52 1/8 26 29 Reynolds Metals 50 3/4 57 7/8 22 25 Cooper Tire & Rubber 47 3/4 52 7/8 21 23 Air Products & Chemicals 39 5/8 47 1/2 17 20 Ingersoll-Rand 53 1/4 62 1/8 15 18

All Stocks trade on NYSE except Amgen (NASDAQ).

P-E ratios based on analysts’ consensus 1992 earnings estimates from Zacks Investment Research.