They’re Baaaack . . . Growth Stocks Outdo Value Issues in ’94

Wall Street’s classic growth stocks retook market leadership in 1994 from traditional value stocks, and many investment pros insist that growth will win again in 1995.

The problem: There’s plenty of disagreement over what constitutes a true growth stock these days.

The basic description of a growth company is one whose earnings growth is above average and fairly predictable. Historically, that has defined many food, health care, retail and consumer firms such as Coca-Cola, Johnson & Johnson, Home Depot and Walt Disney.

Value companies, meanwhile, usually are those whose earnings are less predictable and more dependent on the economy’s swings. For that reason, the stocks often sell for relatively low price-to-earnings ratios--hence the “value” tag. Industrial, utility and financial stocks traditionally dominate the value camp.

Growth stocks ruled Wall Street from 1989 through 1991, a period of anemic growth in the U.S. economy and thus a time of waning fortunes for many industrial companies.

Standard & Poor’s Corp., which splits its blue-chip 500-stock index into separate growth and value components, calculates that the growth-stock camp gained 36% in 1989 versus a 26% total return for value stocks. In the bear market year of 1990, growth stocks eked out a 0.2% gain while value stocks slumped 6.9%. And in ‘91, the growth sector zoomed 38% versus a 23% gain for value.

But in 1992 and ‘93, as interest rates plunged and the U.S. economy began to pick up steam, industrial companies’ fortunes improved dramatically. At the same time, many growth stocks’ prices had run up to stratospheric levels. When drug companies--the market’s favorite growth issues of the 1980s--began to slump in 1992 on talk of federal health care reform, the entire growth-stock sector cracked.

The result: The S&P; value-stock camp gained 10.5% in 1992, double the return for growth stocks. And in 1993, value soared 18.6% while growth gained a measly 1.7%.

Then in mid-1994, the tide shifted again. As more money managers began to bet that the economy would slow under the braking effect of the Federal Reserve Board’s interest rate hikes, industrial value stocks’ earnings prospects became more questionable--and the more predictable earnings gains of classic growth companies began to look more appealing.

It also helped that many growth stocks had fallen or gone nowhere in 1992 and 1993, even as profits continued to rise at most of the companies (albeit at a slower pace because of tougher price competition, especially in health care and packaged foods). So by last June, growth issues looked cheap to many fund managers.

Lifted by a second-half surge, S&P; growth stocks’ total return in 1994 was 3.1%, while value stocks lost 0.6% for the year.

Assuming that the consensus Wall Street forecast remains that the economy’s pace will decelerate this year, “I think the established growth stocks are where investors are going to focus,” argues Arnold Kaufman, investment strategist at S&P.;

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But which stocks qualify as true growth issues today--and at reasonable prices?

Donald Yacktman, whose Chicago-based Yacktman Fund is a well-known growth mutual fund, contends that classic consumer growth issues like Philip Morris, Quaker Oats and Johnson & Johnson still are legitimate core holdings in any growth portfolio and should benefit as more investors go growth-stock shopping.

Yet 16% of Yacktman’s $300-million fund is invested in financial services stocks that some of Yacktman’s peers would regard more as value issues--including the Student Loan Marketing Assn., insurer Torchmark and mutual fund firm United Asset Management. Yacktman simply sees them as good growth stocks that happen to sell for low price-to-earnings ratios--unlike Coca-Cola, he says, which at $51.75 a share and 26 times estimated 1994 earnings is far overpriced for his taste.

Other growth fund managers, especially at fund giant Fidelity Investments, have loaded up their portfolios with technology stocks. While tech issues’ earnings growth has historically been considered “cyclical” in nature--i.e., boom and bust, like industrial firms’ earnings--more fund managers now contend that the tech business is riding a long-term growth wave.

Meanwhile, some investment strategists believe that the best earnings growth in 1995, with or without a slower U.S. economy as a backdrop, will be recorded by traditional industrial-value companies that have taken on more growth characteristics in recent years. Machinery giant Caterpillar, enjoying an export boom, may be the best example of that new breed.

The bottom line is that many growth-stock mutual funds are looking more like hybrid growth-value funds these days. Which may not be such a bad thing, because the issue of which sector will dominate in ’95 is far from clear-cut, some pros say. As Gus Sauter, who manages Vanguard Group’s separate S&P; Growth and S&P; Value index funds, puts it: “It’s a struggle. If you look at it from a valuation point of view, value stocks are cheap” at 11 times estimated 1995 earnings, on average. “But from a macroeconomic view, it’s time for growth stocks,” he says.

* More on Stocks: Copies of Standard & Poor’s year-end stock guide for 1994 are available from Times on Demand. Cost is $5.95 plus $1 for mail delivery. To order, call 808-8463, press *8630 and select Option 3. Order Item No. 8515. Also available: a forecast with S&P; analysts’ top stock picks for 1995. Cost is $2.95 plus 50 cents for mail delivery. Item No. 2822.

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Growth vs. Value

Growth stocks, a category that includes many consumer companies, were market leaders in 1994 for the first time since 1990. Value stocks, a group that includes many industrial firms, lost ground last year. Total returns:

1994

Growth stocks: 3.1%

Value stocks: -0.6%

Note: Returns are price changes plus dividend income.

Source: Standard & Poor’s / Barra