‘90s Growth Stocks Are Waiting for a Second Chance
In a world where so much changes so quickly, Microsoft Corp. stock looks like a paragon of stability. At about $25, the price is almost exactly where it was seven months ago. And three years ago. And seven years ago.
This has been a bad joke for tens of thousands of the software giant’s investors, of course. Seven years without a capital gain is a bitter pill indeed.
But by going nowhere for so long, there now may be an advantage for Microsoft and other big-name growth stocks of the 1990s that have mostly disappointed their owners in this decade. If there are bargains to be had on Wall Street, the blue-chip growth sector is the place to look, many investment pros have asserted this year.
The pitch isn’t new, but it may be gaining traction with more investors amid increasingly jangled nerves in the equity market.
In a September survey of about 80 big U.S. money managers by Russell Investment Group, 65% of the managers had a bullish 12-month outlook for large-capitalization growth stocks. That was the strongest bullish rating by far among 13 stock and bond market sectors.
Maybe those managers were just trying to talk up what they already own. Or it could be that what they find most appealing in the large-cap growth sector isn’t the old-line names like Microsoft, Coca-Cola Inc. and Colgate-Palmolive Co., but up-and-comers like Google Inc. -- which certainly is a growth company and now has a market capitalization of $100 billion, equal to Coke’s.
In any case, the market’s recent trend suggests that investors at least are in no hurry to part with many of their blue-chip growth shares.
Over the last four weeks, mutual funds that focus on large-capitalization growth stocks have lost 1.6%, on average, according to research firm Lipper Inc. That is about half the 3% drop in funds that replicate the Standard & Poor’s 500 index, and far less than the losses in energy, utility and emerging-nation stock funds, which had led the market for most of this year.
Fear has been in greater supply on Wall Street in the last few weeks, and that is causing a shift in peoples’ priorities.
Federal Reserve officials are chanting in unison that short-term interest rates must continue to rise to fight energy-driven inflation. Investors now seem to believe them. Long-term interest rates have jumped since Sept. 1, boosting concerns about the future of the housing market, consumer spending and the economy in general.
When investors are optimistic, they’ll buy almost anything. When optimism wanes, people start thinking about how much they don’t like to lose money. Stocks that are perceived to be safer bets suddenly get attention.
Many derogatory things have been said in recent years about Microsoft, Coke, Colgate, Wal-Mart Stores Inc. and other large-cap growth leaders of the 1990s. They’re now considered mature companies that will never repeat the sales and profit growth rates of their glory days.
But it’s also true that they still make money, and lots of it. If the economy slows dramatically or goes into recession, companies like these may be hurt, but they will survive. That may not be true of some of the smaller companies whose stocks have been the market’s favorites since 2000.
For many fans of old-growth stocks, the basic appeal is the valuation of the shares -- the price relative to earnings, for example. As earnings at most of the companies have continued to rise in this decade while the stocks have languished, the valuations naturally have gotten cheaper.
At Microsoft’s peak in 2000, the stock sold for about 70 times earnings. Now, at about $25, the shares are priced at 19 times analysts’ average earnings estimate of $1.30 a share for the fiscal year ending in June.
Although that’s still above the average blue-chip stock price-to-earnings ratio of about 16, Microsoft is cheaper than it looks, says Charles Carlson, portfolio manager at Horizon Investment Services in Hammond, Ind. The wad of cash on the company’s balance sheet is worth about $3.50 a share, he says. Subtract that from the share price, and the stock’s price-to-earnings ratio is about 17.
As for some of Microsoft’s peers in the old-growth club, Wal-Mart stock is priced at 17 times this year’s estimated earnings; Coke sells for 20 times earnings and Colgate-Palmolive sells for 20 as well.
But the drug industry, racked by rising competitive issues, has shown just how “cheap” once-favored growth stocks can get.
Pfizer Inc. looked inexpensive early this year, when its shares were priced at about 13 times estimated 2005 earnings. Last week, Pfizer reported a 52% plunge in third-quarter profit and withdrew its earnings guidance for 2006 and 2007. Stunned investors pushed the stock down 13% for the week, to an eight-year low of $21.25 by Friday. It’s down 21% year to date.
There is no law that says an out-of-favor stock must eventually stage a stunning comeback. Sometimes they stay out of favor forever, as growth-hungry investors move on to new ideas.
Sometimes the best you can hope for with a mature company is a modest amount of stock appreciation each year and a decent cash dividend yield.
That may be one of the problems with the 1990s growth stocks: Their dividends aren’t very substantial. Coke pays an annual dividend of $1.12 a share. At Friday’s stock price of $41.93, the dividend yield is 2.7%. That’s less than the 3.2% average yield on money market mutual funds.
Microsoft’s dividend yield is about 1.3%, although the company also paid a special dividend of $3 a share last year, and some of its investors expect another special payment at some point.
The continuing struggle of the 1990s growth stocks is a reminder of another era on Wall Street. From 1966 through 1978, a time of rising inflation and rising interest rates, the S&P; 500 index’s entire net price gain was 4% -- not 4% a year, but 4% over 13 years. There were many rallies and declines within that period, but for a buy-and-hold investor, the net advance was abysmal.
No investor really wants to contemplate that the market could do so poorly for such a long stretch in this era. But then, it was probably inconceivable to most Microsoft investors seven years ago that the stock would make no net progress by 2005.
With the old-growth stocks, as with the market as a whole, the critical question facing investors these days may be this one: Just how patient can you be?
Tom Petruno can be reached at tom.petruno@latimes.com.
