Ten to Count On?
To commit yourself to holding a stock for a year, you’ve got to believe in the stock. But to commit to holding it for five years, you’ve got to believe in the business.
In compiling a portfolio of 10 growth stocks for the new decade, we asked a group of money managers to adopt a five-year time horizon because we wanted to take factors such as short-term price momentum out of the equation.
Our stock pickers focused on such things as a company’s strength of balance sheet and competitive position, the depth of its managerial talent and the prospects for the growth of its industry.
“We’re looking for a moat around the castle,” explained Steven Check of Check Capital Management in Costa Mesa. “We try to understand [a company’s] edge and see if it’s sustainable.”
The five-year criterion is a little arbitrary, of course--even the most fervent buy-and-hold advocates do not recommend blindly clinging to a stock for years. Most experts say you should periodically review your reasons for owning a stock and should sell it if those reasons no longer apply.
Arbitrary as it may be, adopting a five-year horizon can be useful if it helps an investor strip away some of the flashy elements that can make a stock a good short-term performer but detract from long-term results.
Even with that in mind, you may think the portfolio here is an eye-opener. First, there’s what it doesn’t contain: There’s not a “dot com” in the bunch, and there are only two real technology stocks.
It isn’t that our experts don’t believe the online revolution is here to stay. Rather, the lack of an Internet stock has more to do with the difficulty of picking one or two likely survivors from a group of new and expensive players.
Second, there are no members of the Dow Jones industrials, nor are there any of the blue-chip glamour stocks that have led the bull market for the last few years--no General Electric Co., no Microsoft Corp., no Wal-Mart Stores Inc., no Lucent Technologies Inc.
What several of the stocks do have in common, though, are debt-free balance sheets and strong cash flow, which the experts say help companies control their destinies in a fast-changing economy.
In terms of market capitalization, or total stock value, only three of the 10 stocks are larger than $5 billion. The median size is just above $2 billion.
In the main, these are mid-cap stocks that haven’t had a lot to brag about lately. Four of the 10 have shown a negative total return over the last year, and another barely was even.
In an odd coincidence, the only business that got more than a single mention from our five stock pickers was the mortuary industry.
Three panelists put funeral home and cemetery operators on their lists, two of them citing the same firm, Stewart Enterprises Inc. of Metairie, La.
Check and Suzanne Zak, founder and chief executive of Zak Capital in Minneapolis, both called funeral home consolidator Stewart Enterprises a bargain.
The stock has fallen more than 30% since last June, in a case of what Zak called “guilt by association.”
The market has tarred Stewart with the same brush as its larger competitor, Service Corp. International Inc , which surprised Wall Street in January with a warning of lower profit, triggering a sell-off of all funeral home stocks.
Check thinks Stewart can grow at a solid 20% per year during the next five years.
Stewart has a strong “moat” too, as it tends to buy the leading funeral home operator in a community. It is tough for competitors to enter a market where there is an entrenched rival.
Check’s other pick was Newark, Calif.-based Ross Stores Inc., the 350-store discount clothing chain.
The company has no long-term debt and keeps sales growing by opening about 25 new stores a year, all financed from its own cash flow. How long can it do that trick? Check notes that Ross is in only 15 states, which leaves plenty of room for expansion.
The stock trades at about 15 times trailing earnings, and the company’s sales have been growing consistently.
Along with Stewart Enterprises, Zak recommended another stock that has been punished recently, Total Renal Care Holdings Inc. of Torrance, a kidney-dialysis provider that formerly was a subsidiary of National Medical Enterprises, now Tenet Healthcare Corp.
After growing quickly during the last four years through acquisitions, Total Renal ran into problems digesting its new facilities and in February was forced to take a $12.3-million charge against earnings, mainly due to uncollectable accounts receivable.
Instead of the 20% “haircut” that Zak thought the announcement would precipitate, the stock lost more than half its value in a single day, tumbling to $8.75 from $21.
Private insurance and government reimbursement for dialysis treatment provide a predictable revenue stream, however, so if the company can manage its growth--as Zak thinks it can--it may be a bargain now at around 10 times trailing earnings.
Zak also offered Sterling Commerce Inc. of Dallas, which sells software and network services to businesses in a range of industries.
Sterling is not an Internet stock, but it can grow with the Net, Zak said. For example, online bookseller Amazon.com uses Sterling software for order fulfillment, she said. Other big-name customers include Home Depot Inc.
Sterling has no long-term debt and generates far more cash than it needs for its operations, which means that unlike some explosively growing but cash-poor companies that have gone public recently--including Internet firms--it is not captive to the whims of the stock market, Zak said.
Stanley Nabi, chief strategist for Wood Struthers & Winthrop, a New York-based money management unit of Donaldson, Lufkin & Jenrette, said that when he contemplates the stock market today, he asks himself: “Where can I hide?”
Nabi worries that stock prices have risen faster than earnings for so long that the market is vulnerable to a period of stagnation at the least. Since 1995, he noted, the Standard & Poor’s 500-stock index is up nearly 200% while operating profits for those same 500 companies are up only 17%.
Despite its scorching performance over the last six months, the Internet sector doesn’t appeal to Nabi.
“You cannot pay 500 or 600 times earnings for a business with no patents and no proprietary protection,” he said, referring to companies with Yahoo-* and Amazon.com-type valuations. “As competition comes in, the [profit] margins inevitably become thinner.”
Nabi wants to find businesses with a strong franchise and reliable prospects for earnings growth of 10% to 12% a year.
He chose Meredith Corp., the Des Moines-based publisher of Better Homes & Gardens and Ladies’ Home Journal, because it is a consistent grower that “doesn’t depend on reinventing itself every six months, like a tech company.”
Moreover, in addition to its core magazine and book publishing business, Meredith has 12 television stations in major markets.
Bank of New York Co., another Nabi pick, is the only financial services firm on our list. Though down from its high of $76 on April 12, the stock is still up more than double since October.
The Wall Street-based bank, which was founded by Alexander Hamilton, is burrowing deeper into its niche of providing trust services and securities processing and other “back-office” services. Such fee-generating services reduce the bank’s reliance on loan revenue and lessen its sensitivity to interest-rate swings and economic bumps, Nabi said.
He also mentioned Service Corp. International, noting that the company has undervalued real estate that it doesn’t necessarily have to develop as cemeteries. We dropped Service Corp. from our list, however, on the admittedly arbitrary grounds that two stocks from the funeral industry would make for an excessively morbid portfolio.
Asked to look five years into the future, Kim Goodwin, manager of the American Century Growth Fund, first looked five years into the past.
“What did I own in 1994 that I still own today?” she asked.
The answer is a stock she believes she will still be comfortable owning in 2004: Clear Channel Communications Inc., the San Antonio-based radio giant.
Clear Channel has made conspicuously smart buys as it has built its holdings to more than 200 radio stations and about 20 TV stations, Goodwin said.
Even better, Clear Channel has a growing presence in outdoor advertising at a time when sales of out-of-home advertising is growing faster than in-home.
Goodwin also likes Texas Instruments Inc., the largest company on the list and the one with the best stock performance over the last year. TI’s stock has rebounded strongly from a low of $45.38 last October.
What will keep the growth going, in Goodwin’s opinion, is TI’s strength in digital signal processors, which are used in all kinds of wireless communication devices. With sales of such devices growing at more than 30% a year worldwide, TI has “legs into the next century,” Goodwin said.
Beth Dater, co-portfolio manager of the Warburg Pincus Emerging Growth Fund and the Warburg Pincus International Post-Venture Capital Fund, believes there are ways to play the Internet technology revolution without having to participate in the Net stock mania.
One of her suggestions is ACNielsen Corp., the Stamford, Conn., market research firm best known for delivering television audience ratings.
Dater believes that quantifying what advertisers are getting for their dollars will only become more important as the Internet blossoms as an advertising medium.
“They’re going to be a leader” in Internet audience measurement, she said.
ACNielsen has zero long-term debt and generates lots of cash. Dater, like Zak, favors companies that can finance growth internally rather than by issuing stock. Such balance-sheet strength will prove a virtue if a stock-market downturn should ever arrive, she said.
Dater’s other pick, Harte-Hanks Inc., has the same debt-free, self-financing characteristics. San Antonio-based Harte-Hanks is a former newspaper chain that shifted into direct marketing (junk mail and telephone sales solicitation) and publishing of advertising shoppers.
Company management, including Chairman Houston H. Harte, son of one of the founders, owns more than 15% of the company, which gives them an incentive to think like shareholders rather than hired hands, Dater said.
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At the Conference
The Times’ Investment Strategies Conference, to be held May 22-23 at the Los Angeles Convention Center, features two panels on “Growth Stocks for the New Decade.” For registration information call (800) 350-3211 or visit https://www.latimes.com/isc.
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Strategists Pick Their Shots
Analysts surveyed by The Times see these 10 stocks as solid growth prospects for the coming years:
Stock: ACNielsen. Picker: Beth Dater
Ticker: ART
Recent price: $29.88
Market cap, in billions: $1.7
Trailing P/E ratio: 22
Projected 3- to 5-yr. EPS growth: 22
Comment: Experience in measuring audiences positions it to grow with the Internet.
*
Stock: Bank of New York. Picker: Stanley Nabi
Ticker: BK
Recent price: $38.44
Market cap, in billions: $29.5
Trailing P/E ratio: 24
Projected 3- to 5-yr. EPS growth: 12
Comment: Successful consolidator has niche in trust and other fee-producing services.
*
Stock: Clear Channel Communications. Picker: Kim Goodwin
Ticker: CCU
Recent price: $68.69
Market cap, in billions: $22.2
Trailing P/E ratio: 458
Projected 3- to 5-yr. EPS growth: 27
Comment: Smart radio acquirer with complementary strategic niche in outdoor advertising.
*
Stock: Harte-Hanks. Picker: Dater
Ticker: HHS
Recent price: $23.00
Market cap, in billions: $1.6
Trailing P/E ratio: 25
Projected 3- to 5-yr. EPS growth: 18
Comment: Debt-free direct marketer is 15% owned by management.
*
Stock: Meredith. Picker: Nabi
Ticker: MDP
Recent price: $35.75
Market cap, in billions: $1.9
Trailing P/E ratio: 22
Projected 3- to 5-yr. EPS growth: 14
Comment: Better Homes & Gardens publisher also has 12 TV stations.
*
Stock: Ross Stores. Picker: Steven Check
Ticker: ROST
Recent price: $46.44
Market cap, in billions: $2.1
Trailing P/E ratio: 17
Projected 3- to 5-yr. EPS growth: 14
Comment: Fast-growing discount apparel retailer finances new stores with its own cash flow.
*
Stock: Sterling Commerce. Picker: Suzanne Zak
Ticker: SE
Recent price: $38.75
Market cap, in billions: $3.7
Trailing P/E ratio: 28
Projected 3- to 5-yr. EPS growth: 29
Comment: Giants from Home Depot to Amazon.com use its software and e-commerce systems.
*
Stock: Stewart Enterprises. Pickers: Check, Zak
Ticker: STEI
Recent price: $19.06
Market cap, in billions: $2.2
Trailing P/E ratio: 25
Projected 3- to 5-yr. EPS growth: 20
Comment: Funeral-home consolidator is expanding internationally.
*
Stock: Texas Instruments. Picker: Goodwin
Ticker: TXN
Recent price: $106.00
Market cap, in billions: $41.6
Trailing P/E ratio: 53
Projected 3- to 5-yr. EPS growth: 22
Comment: Out of commodity chips and into wireless digital communication.
*
Stock: Total Renal Care Holdings. Picker: Zak
Ticker: TRL
Recent price: $14.06
Market cap, in billions: $1.2
Trailing P/E ratio: 11
Projected 3- to 5-yr. EPS growth: 23
Comment: Stock battered by consolidation problems may provide growth at a bargain.
Source: Analysts, Bloomberg News
*
Thomas S. Mulligan is based in New York. He can be reached at thomas.mulligan@latimes.com.
