Stock Prospects for Investors Seeking Growth at Right Price

With the still-pricey tech-stock sector’s latest plunge, investors’ renewed interest in “value” stocks in recent weeks may get another boost.

But what many Wall Streeters want when they shop for value isn’t just a cheap stock--but a growth stock at a reasonable price.

For long-term investors hunting for such value stocks, The Times asked earnings tracker Zacks Investment Research Inc. of Chicago to screen its database for prospects.

We limited the universe to Standard & Poor’s 500-index members, figuring blue-chip stocks, which generally have the broadest analyst coverage, might make the safest bets in a nervous market.

First, we eliminated any company whose per-share earnings are expected to grow by less than an annualized 15% during the next three to five years, based on analysts’ consensus estimates.

The idea being, there isn’t much “value” in a stock unless it’s accompanied by at least modest growth expectations. Future profits, after all, are considered a fundamental driver of stock prices.

Zacks then ranked the S&P; members that met that growth criteria based on “PEG” ratio, a tool sometimes used by value-oriented investors looking for growth at a good price.

PEG, which stands for price-to-earnings-growth, can be calculated several ways. We defined it as a company’s stock price-to-earnings ratio (based on estimated earnings for the current fiscal year) divided by the projected rate of earnings-per-share growth over the next three to five years.

The lower the PEG the better, because it means the stock’s current P/E is low relative to the company’s expected earnings growth rate.

The 25 stocks listed in the accompanying chart all have PEGs of 0.8 or less, compared with about 1.6 for the S&P; 500 index overall.

Any PEG ratio below 1.0 is generally considered cheap. By contrast, fast-growing tech stocks tend to command steep PEGs: Fiber-optics giant JDS Uniphase’s PEG is 4.7, for example; Internet infrastructure firm Juniper Networks’ PEG is 14.1.

Of course, low P/Es and low PEG ratios often indicate stocks that are out of favor on Wall Street--and frequently for good reason.

This screen is no exception. While some firms on the list are simply viewed as too “cyclical” to be considered true growth stocks, others have recently missed earnings-growth targets, issued warnings about near-term results or encountered other troubles.

Top-ranked Compuware Corp., for example, saw its shares plummet 40% on April 12 when it issued a profit warning. Analysts said a program to retrain year-2000-bug computer programmers was taking longer than expected.

Office Depot, also on the list, said its first-quarter earnings were down 5% from a year earlier because of higher costs for paper, new stores and advertising.

Among others in the screen, Unisys Corp. blamed its disappointing quarterly numbers on delayed computer-service contracts and a revamping of its sales force. Harrah’s Entertainment said gamblers at its Rio Suite Hotel & Casino in Las Vegas have been winning too much lately.

Then why look at these stocks? Value-oriented investors usually have a long-term horizon. They’re betting that a company will overcome short-term problems and get back on a solid growth track.

It’s great when it works, but there are, of course, risks. There’s the so-called value trap risk: The company never gets it together, or investors run out of patience as the stock becomes ever cheaper.

The cockroach theory also can work against value stocks. This theory holds that you rarely get just one piece of bad news from a company--just as when you see one roach, more are sure to be lurking in the walls.

In other words, one quarter of missed earnings targets may not be the last.

Another danger with value stocks is that Wall Street analysts can be too sanguine when it comes to the companies they cover. Just as they tend to be conservative with their quarterly earnings-per-share estimates for rapidly growing companies, allowing them to consistently beat their targets, they may cut managements too much slack when things are going badly.

Analysts can be like the angry voter who wants the entire Congress tossed out--except his or her representative.

Still, while many of the companies in this stock screen are relatively unloved, it isn’t always because of some evident problem.

Nucor Corp., the nation’s second-largest steelmaker, said first-quarter profit nearly tripled as prices and shipments rose and imports declined.

Analysts expect Nucor to earn $4.16 a share in 2000 and $4.74 in 2001, and during the next five years they see profit rising an average of 16.7%.

Masco Corp., which sells home-improvement and building products, was recently recommended by several analysts after the stock fell to a 52-week low of $17.25. It was upgraded to “recommended list” at Goldman Sachs & Co., raised to “strong buy” at Raymond James Financial Inc. and rated new “buy” at Salomon Smith Barney.

Analysts expect Masco to earn $1.87 a share in 2000 and $2.16 in 2001, with profit rising an average of 15.6% during the next five years.

Yet those two stocks are still in a funk, down 18% and 12% year-to-date, respectively.

While the expected earnings growth rates of Nucor, Masco and others in this screen may look tepid to true growth-stock investors--by comparison, JDS Uniphase and Juniper Networks are expected to grow by an annualized 45%--it’s all relative: You’re still paying high P/Es for tech stocks, leaving little room for error.

By contrast, for still-unloved value stocks, any favorable surprises in terms of earnings or other fundamentals may go a lot further in driving the stocks higher long-term.

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Bloomberg News was used in compiling this report.

Times staff writer Josh Friedman can be reached at josh.friedman@latimes.com.

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‘Value’ Candidates

To find potential value stocks, The Times asked Zacks Investment Research Inc. of Chicago to screen its database of Standard & Poor’s 500 index members. Companies whose per-share earnings are expected to grow by less than an annualized 15% over the next three to five years were eliminated. The remaining stocks were ranked based on “PEG” ratio: price-to-earnings ratio based on estimated earnings for the current fiscal year, divided by the estimated earnings growth rate. The top 25 stocks:*--*

Est. 3-5 yr. Ticker Mon. P/E EPS growth “PEG” Company symbol close ratio rate ratio Compuware CPWR $11.00 8.6 29.8% 0.29 Kaufman & Broad Home KBH 19.88 5.0 15.3 0.33 Freeport McMoran FCX 10.00 13.1 32.3 0.41 SLM Holding SLM 32.69 10.2 18.8 0.54 Willamette Industries WLL 38.19 9.8 18.1 0.54 Assoc. First Capital AFS 22.31 9.3 15.1 0.62 TJX TJX 20.44 10.7 16.7 0.64 Nucor NUE 45.13 10.8 16.7 0.64 Tricon Global Rest. YUM 33.06 10.2 15.2 0.67 Office Depot ODP 11.88 11.6 17.0 0.68 Providian Financial PVN 90.00 17.3 25.3 0.68 Adaptec ADPT 29.75 14.0 20.5 0.68 Unisys UIS 22.50 13.2 19.1 0.69 Staples SPLS 18.38 20.0 28.2 0.71 Consolidated Stores CNS 12.50 12.8 17.8 0.72 BMC Software BMCS 37.94 19.3 26.5 0.73 MCI WorldCom WCOM 39.75 21.1 28.5 0.74 Kansas City Southern KSU 65.13 13.5 18.0 0.75 Masco MAS 22.44 11.9 15.6 0.77 Computer Associates CA 50.13 13.7 17.7 0.77 Harrah’s Entertainment HET 21.13 13.0 16.9 0.77 Carnival CCL 23.69 13.0 16.8 0.77 Kroger KR 18.88 13.2 16.8 0.79 AutoZone AZO 24.94 12.6 15.6 0.81 Quintiles Transnational QTRN 14.38 17.8 21.9 0.81 S&P; 500 1,429.86 25.0 15.2 1.64

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EPS=earnings per share

Source: Zacks Investment Research