Tech Stocks Pop Up in Hunt for Growth at Reasonable Price

Growth at any price? That’s a tough sell in the stock market these days.

But growth at a reasonable price--that’s an idea more investors appear to be buying.

Indeed, the market’s resurgence over the last month--lifting the blue-chip Standard & Poor’s 500 index to within a hair of a record high--has been powered by gains in a wide cross-section of stocks, as investors hunt for relative bargains.

It’s a much different market than in the first quarter of this year, when technology stocks selling for wild price-to-earnings ratios seemed to be the only issues anyone wanted to buy.

Now, many tech issues remain far below the peaks they reached in late winter or early spring, even as the S&P; index nears record territory. The tech-dominated Nasdaq composite index still is down 16% from its record set March 10.

But could the tech sector now be the best hunting ground for investors seeking growth stocks selling for reasonable valuations? At least one increasingly popular valuation measure suggests that may be the case. That measure is called the PEG, shorthand for comparing a stock’s price to its earnings growth.

Specifically, a company’s PEG ratio is calculated by dividing its stock price-to-earnings ratio, or P/E--considered a basic measure of value--by its expected annual earnings growth rate in the near future.

The lower the ratio, the better, from a value-seeker’s point of view.

Example: If a company’s stock P/E is an otherwise high 40, but its earnings are expected to grow 50% a year in the near future, its PEG is a low 0.8.

Any PEG below 1.0 means a stock’s P/E is less than its earnings growth rate--assuming, of course, those earnings estimates turn out to be correct.

In late May, The Times used Morningstar Inc.’s financial database to search for stocks selling for low PEG ratios. The results were published in a story headlined “Value Stocks Hold Promise for Investors With Guts, Patience.”

On average, the portfolio of 16 stocks named in that PEG screening has performed extremely well since: Paced by clothing retailers Abercrombie & Fitch and American Eagle Outfitters, the PEG portfolio has surged 35% in three months, versus 6.9% for the S&P; 500.

Abercrombie, which beat second-quarter profit estimates (though it sounded a cautious note for the fall), has rocketed 161% since May 30. American Eagle, punished in the spring for price markdowns, is up 102% on optimism for brisk sales through the end of the year.

In late May, Abercrombie’s PEG ratio was a mere 0.2, as investors had hammered the stock after several quarters of earnings disappointments. American Eagle’s PEG at that point was just 0.3.

Other then-beaten-down growth stocks on the May list included laser-surgery firm Visx, mutual fund firm Affiliated Managers Group and data-storage-equipment firm SanDisk--all of which have rebounded sharply since.

Does the stock market really care about relative value--or did our last PEG screen just get lucky?

To try to find out, we updated the screen, again by using Morningstar’s stock database, at https://www.morningstar.com.

Here’s what we screened for: companies with more than $500 million in market capitalization (stock price times shares outstanding); a Morningstar financial health grade of “A”; annualized revenue growth for the last three years of 40% or more; projected annualized earnings growth of 30% or more for the next three to five years; and finally, PEG ratios below 1.5. (The S&P; PEG, by comparison, is 2.2.)

The screen criteria were basically the same we used May 30, but we tightened some of the cutoff numbers after our first try yielded too many stocks. In the May screen, we required trailing revenue growth and expected earnings growth above 20%, and PEGs below 2.0.

The P/E ratio used in the PEG calculation is the P/E based on estimated current fiscal year earnings per share; the growth rate is the estimate for the next three to five years.

Surprise: The new PEG portfolio turned out to be dominated by tech stocks, many of which have continued to languish since spring, despite strong earnings growth.

Of course, low PEG ratios don’t guarantee that these stocks will do well. Still, given that the fourth quarter often is a strong period for tech stocks, the screen might be an interesting starting point for investors still hungry for tech issues.

Companies on the new list include Pixar, the Richmond, Calif., computer animation studio known for the “Toy Story” films and “A Bug’s Life.” The company, whose shares have slid 4.4% in 2000, beat second-quarter profit estimates, but the stock trades on product news rather than earnings.

Analysts fear Pixar could stay fairly flat until Thanksgiving 2001, when its next movie, “Monsters Inc.,” featuring the voice of Billy Crystal, comes out.

But the stock might get a lift this October when “Toy Story 2” is released on video and DVD, and, most important for the long term, Pixar is building perhaps the best brand name in animation. Earnings are expected to grow an average of 31% in coming years, yet the shares trade for a P/E of only 24 based on current-year estimates. Its PEG ratio is 0.8.

Shares of Denver-based e-commerce services provider TeleTech Holdings, which also made the cut this time, tripled in 1999 but have pulled back in 2000.

“This is the premier firm providing customer-relationship services, and it has gotten cheap,” said analyst John T. Mahoney of Raymond James Financial. The stock’s PEG: 1.5.

TeleTech runs phone and Internet centers for the likes of Ford, Allstate and Verizon Communications. “The demand to outsource these services is growing, and so is TeleTech’s market share,” Mahoney said.

As an example, he said the massive response to the recall of Bridgestone/Firestone tires on Ford vehicles could speed up the auto maker’s move of its call center operations to Percepta, its joint venture with TeleTech.

Mahoney expects TeleTech’s earnings to surge from 40 cents a share last year to 63 cents this year and $1 in 2001.

The portfolio includes several other telecom firms: Somera Communications of Santa Barbara, an equipment provider that went public in November; Israel-based NICE Systems, whose shares have nearly tripled in the last 12 months; fiber-optic systems maker Harmonic of Sunnyvale, Calif., whose stock rocketed tenfold in 1999 but has plunged 65% this year; wireless equipment provider Carrier Access of Boulder, Colo.; and Huntsville, Ala.-based Avocent, whose “connectivity solutions” services include switching and remote access.

The PEG portfolio also includes several software names: PC-Tel of Milpitas, Calif.; Citrix Systems of Fort Lauderdale, Fla.; Remedy of Mountain View, Calif.; Advantage Learning Systems of Wisconsin Rapids, Wis.; and Canada-based Creo Products.

Also making the cut: MarchFirst of Chicago, which helps companies such as FAO Schwarz build and retool Web sites; chip-component maker PLX Technology of Sunnyvale, Calif.; Management Network Group, an Overland Park, Kan., consulting firm; computer services specialist Cognizant Technology Solutions of Teaneck, N.J.; cancer database manager Impath of New York; and Denver-based StarTek, whose e-commerce services include supply-chain management.

Will a low PEG help these stocks recover? We’ll revisit this stock screen later this year.

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

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The New Screen: More Stocks With Low ‘PEG’ Ratios

Here are 18 stocks that turned up in a new Times screen that focused on companies with low PEG ratios, which is price-to-earnings ratio based on the company’s current fiscal year estimated earnings, divided by the expected rate of annual per-share earnings growth over the next three to five years.

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Est. Ticker Friday YTD PEG Company symbol close change ratio MarchFirst MRCH $18.06 --66.3% 0.6 Remedy RMDY 23.69 --50.0 0.6 Pixar PIXR 33.81 --4.4 0.8 Carrier Access CACS 51.14 --24.0 0.9 PC-Tel PCTI 26.50 --49.4 0.9 Somera Communications SMRA 13.31 +7.0 0.9 StarTek SRT 40.19 +10.9 0.9 Creo Products CREO 28.38 --26.2 1.0 Avocent AVCT 50.06 N/A* 1.1 Citrix Systems CTXS 22.50 --63.4 1.1 Management Network Group TMNG 19.88 --39.1 1.1 NICE Systems NICE 80.88 +64.4 1.2 Advantage Learning Systems ALSI 30.06 +168.7 1.3 Cognizant Tech. Solutions CTSH 38.38 --29.8 1.3 Harmonic HLIT 33.13 --65.1 1.4 Impath IMPH 35.00 +175.2 1.4 PLX Technology PLXT 31.63 +67.0 1.4 TeleTech Holdings TTEC 32.63 --3.2 1.5 S&P; 500 index 1,520.77 +3.5 2.2

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* N/A: Not available. Formed by merger of Apex and Cybex Computer Products effective July 3. Sources: Morningstar Inc., Bloomberg News

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Growth at a Cheap Price: How a May Stock Screen Has Fared

These 16 stocks were featured in a Times screen May 30 that sought solid growth companies selling at below-average valuations. The stocks made the screen based on their low “PEG” ratios--that is, price-to-earnings ratio divided by estimated rate of annual earnings growth over the next three to five years. The portfolio has handsomely outperformed the blue-chip Standard & Poor’s 500 index.

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Change Ticker May 30 Friday since Company symbol close close May 30 Abercrombie & Fitch ANF $9.19 $24.00 +161.2% American Eagle Outfitters AEOS 15.75 31.75 +101.6 Affiliated Managers Group AMG 34.25 56.25 +64.2 SanDisk SNDK 55.13 88.50 +60.5 Watson Pharmaceuticals WPI 43.25 63.41 +46.6 Visx VISX 19.00 27.75 +46.1 AmeriCredit ACF 18.50 26.63 +43.9 Advanced Digital Info. ADIC 13.44 17.38 +29.3 ECI Telecom ECIL 25.31 30.25 +19.5 United States Cellular USM 63.50 73.31 +15.4 Knight Trading Group NITE 27.94 31.69 +13.4 Compuware CPWR 10.31 10.44 +1.3 Avant AVNT 15.00 15.06 +0.4 Papa John’s Intl. PZZA 25.00 22.63 --9.5 Fossil FOSL 20.25 17.25 --14.8 Pacific Sunwear PSUN 16.13 13.06 --19.0 Portfolio average +35.0 S&P; 500 index 1,422.45 1,520.77 +6.9

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Sources: Times research, Morningstar Inc.