Time to Return to ‘Growth’ Stocks?

In search of the stock market’s next leaders, some professional investors are looking to the most familiar of names: the classic “growth” shares of the late 1990s.

Included in this group are some of the largest U.S. companies -- General Electric Co., for instance, along with drug firms such as Pfizer Inc., technology leaders such as Intel Corp. and consumer products makers like Colgate-Palmolive Co.

Their names are well known, but mostly what they’ve been known for since 2000 is disappointing investors. After leading Wall Street higher in the boom years of the last decade, many of these issues crumbled in the bear market of 2000-2002.

As a group, their performance in this decade has mocked the growth label.

A buy-and-hold investor in the average large-capitalization growth stock mutual fund has lost the equivalent of 6.9% a year over the last five years, much worse than the 1.2% average annual loss of the blue-chip Standard & Poor’s 500 index in the same period, according to fund tracker Lipper Inc.

But that lousy performance is exactly what is attracting some investment pros. Wall Street is a place where almost nothing stays out of favor -- or in favor -- forever. After five years under a cloud, it’s finally time for big-name growth stocks to shine again, some money managers say.

“We think large-cap stocks are very attractive,” said George Mairs, a veteran money manager who helps oversee the $2.4-billion Mairs & Power Growth stock fund in St. Paul, Minn. “We’ve been adding very aggressively to those stocks in the last six to nine months.”

His fund owns such issues as GE, Pfizer, Johnson & Johnson and retailer Target Corp.

“We think the time is right to bias equity portfolios toward large-cap growth,” said Liz Ann Sonders, chief investment strategist at brokerage Charles Schwab & Co.

There are good reasons to wonder whether this refrain is misguided, or at least premature. Some investors don’t quibble with the idea of buying growth stocks -- meaning shares of companies whose earnings are expected to rise at a faster-than-average rate. But Wall Street since 2000 has been more interested in smaller growth companies than larger ones.

Some market pros question whether the 1990s leaders even qualify as growth companies anymore.

Still, many old growth stars are attracting enough interest this year to lift their share prices, albeit modestly.

The Cliffs Notes summary of what went wrong with big-name growth stocks is that Wall Street loved these shares too much in the 1990s. Most were growth companies in the true sense of the term, but investors bid the stocks’ prices to extraordinarily high levels relative to those earnings.

The tech sector was where the nuttiest action was in the last bull market, but plenty of non-tech growth issues were caught up in the euphoria of the era.

As the economy stumbled into recession in 2001 and corporate earnings prospects dimmed, the growth stocks that had been market darlings began to look hopelessly overpriced. Investors bailed out in droves, and many have stayed away since.

Consider: GE shares peaked at $60 in August 2000. At that level, the stock’s price-to-earnings ratio was 47 based on the $1.27 a share the conglomerate would earn that year.

By contrast, blue-chip stock P/Es have averaged about 16 historically, according to Standard & Poor’s.

GE shares lost 7% in 2000 and in the following two years slumped 16% and a stunning 39%.

At about $37 now, GE has rebounded from a low of $22 in October 2002. But investors have a much more sober view of the company: The stock’s P/E is about 20 based on the $1.80 a share the company expects to earn this year; the P/E is about 18 based on analysts’ average 2006 profit estimate of $2.05 a share.

It’s exactly that kind of sobriety in the pricing of large-cap growth stocks, at least relative to the late 1990s, that has some financial advisors pounding the table for the shares today.

While investors have been wary of big-name growth stocks for the last five years, they have been eager buyers of many shares in the “value” sector of the market.

Value stocks typically are issues that sell for below-average P/Es because the companies generally have slower long-term growth prospects than classic growth companies.

Since 2000, cash has rolled into mutual funds that buy large-cap value stocks. In that same period, large-cap growth stock funds have had net redemptions in four of five years, including this year.

But investors’ love affair with the value sector -- industries like financial services, energy and railroads -- has made it much tougher to find bargains in those groups, said Ed Keon, chief investment strategist at Prudential Equity Group in New York.

“I think there is more value in growth today than value in value,” he said.

Of course, it serves Wall Street’s purposes to suggest that a market shift is afoot, or should be afoot. It gives salesmen something to sell.

Even so, there are reasons to think the time may indeed be right for a sustainable turn in large-cap growth stocks.

One reason is basic valuation: how the stocks are priced compared with earnings, sales, return on equity, dividend payments and other measures of investment appeal.

“On a valuation basis, these stocks look very compelling,” Mairs said. P/Es of 15 to 20 on high-quality large-cap growth shares should be considered bargains for long-term investors, he contends.

It’s true that most of the big growth firms aren’t growing at the rates of the late 1990s.

But many still are expected to generate annual earnings gains in the low teens in the next few years -- a decent rate for companies of their size.

What’s more, the next phase of the economy’s expansion could enhance the allure of classic growth issues. If the economy continues to decelerate, slowing overall corporate earnings gains as well, investors should better appreciate established companies with reasonably reliable profit prospects, growth stock proponents say.

Robert Zagunis, co-manager of the $3-billion Jensen Portfolio Fund in Portland, Ore., put it this way: “We would rather invest in a company growing 13%, with a high probability of that continuing, than in 25% growers with a much lower probability of that continuing.”

His fund holds such names as Pfizer, Johnson & Johnson and Procter & Gamble.

Could large-cap growth stock fans be kidding themselves -- or might they just be (again) too early in calling for a market leadership turn?

There are plenty of risks in the growth sector. Some of the companies, particularly drug stocks, face intense competitive issues that aren’t going away soon. The rebounding dollar could hurt because most large growth firms are multinationals.

And if the economy slows too much, or interest rates and inflation rise much higher than Wall Street now figures, what appear to be reasonable stock price-to-earnings ratios could quickly be seen as excessive.

It could also be that the 1990s growth leaders remain so widely owned that there is no significant new audience of investors to drive the stocks higher.

Still, investors’ views of major stock sectors inevitably move up and down the spectrum over time, from intense dislike to intense affection, then back again. The time to buy, naturally, is when most people wouldn’t.

“One of the most difficult decisions an investor faces is selling the hottest asset class and buying the coldest,” Keon said.

In early 2000, large-cap value stocks were widely disdained after badly trailing large-cap growth stocks for three years.

Now, large-cap growth occupies the doghouse. But history says it won’t be there forever.

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Tom Petruno can be reached at tom.petruno@latimes.com.

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Brand-name ‘growth’ stocks: A sampling

Here are some brand-name “growth” stocks, including leaders from the late-1990s and some that analysts consider up-and-comers. Included are the stocks’ price-to-earnings ratios (P/Es) based on estimated 2005 and 2006 earnings per share (EPS). Market capitalization is a company’s stock market value (stock price multiplied by the number of shares outstanding).

Late-1990s leaders

*--* Market. cap. Friday YTD P/E on est. EPS: Stock (billions) close change 2005 2006 General Electric $391.1 $36.88 +1.0% 20 18 Pfizer 210.8 28.35 +5.4 14 13 Johnson & Johnson 200.5 67.43 +6.3 20 18 Intel 169.1 27.39 +17.1 20 18 Procter & Gamble 139.1 55.76 +1.2 21* 19* PepsiCo 94.8 56.60 +8.4 22 20 3M 59.2 76.98 -6.2 18 16 Target 47.4 53.50 +3.0 21 18 Colgate-Palmolive 26.2 50.06 -2.2 19 17

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Up-and-comers?

*--* EBay $51.7 $38.30 -34.2% 49 38 Diageo 43.7 58.82 +1.6 16* 15* SLM 20.5 48.96 -8.3 20 17 Apollo 14.2 78.36 -2.9 32** 26** Intl. Game Tech. 9.8 28.41 -17.4 23 20 Biomet 9.6 38.22 -11.9 24* 21* Chicago Merc. Exch. 7.3 212.80 -7.0 25 22 S&P; 500 1,198.78 -1.1 17 16

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*Fiscal years end in midyear. **Fiscal years end in August.

Sources: Bloomberg News, Thomson First Call, Zacks Investment Research

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