Investors’ Focus Shifts to Growth

Like major earthquakes, dramatic shifts in investors’ stock market preferences are rare events. And once those shifts occur, their effects tend to be long-lasting.

That was the case at the start of this decade, when Wall Street turned away from technology stocks and other highflying “growth” shares in favor of more mundane “value” issues in commodities, heavy industry and other unsung businesses.

The penalty for ignoring that tectonic shift was huge. On average, blue-chip value mutual funds have generated about twice the investment returns of their growth-stock counterparts over the last five years.

People who have been light on value stocks in their 401(k) portfolio or other investments have paid a price. They may be much further behind in their savings plan than they had expected.

Now, the buzz on Wall Street is that growth stocks -- specifically, the biggest of the big names in that sector -- are returning to favor and could be poised for a multiyear stretch of strong performance.

It could be bunk. The same buzz was out there a year ago, but the stocks couldn’t muster much of a run.

Still, growth and value have repeatedly traded places on the market leader board. After nearly seven years with value on top, “by virtue of time, of course, the odds get better for growth,” said Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter in Brooklyn, N.Y.

But even if the market is turning, picking winners among individual stocks and mutual funds may be no simple task. What looked like a growth stock seven years ago may look like a value stock today -- which raises the possibility that traditional value fund managers may again be in the right place at the right time.

“Growth” and “value” are to investing what “conservative” and “liberal” are to politics: generic terms that suggest polar opposite points of view, when in reality the differences between them often are shades of gray.

The classic definition of a growth company is one whose earnings are expected to grow at an above-average -- and dependable -- pace. The market is supposed to reward that growth by keeping the company’s stock at a premium price relative to underlying earnings per share, the net value of the company’s assets and other measures.

A value company, by contrast, typically has been one whose earnings either are growing at a comparatively slow pace or whose growth is cyclical and therefore often undependable. Value shares tend to reflect those growth handicaps by selling at fairly low prices relative to earnings and other measures.

In practice, growth and value always are in the eye of the beholder.

A common refrain on Wall Street these days is that many big-name growth stocks of the 1990s have become value issues. After badly lagging behind the broader market over the last six years, the stocks are reasonably priced compared to earnings and ready to rebound, some assert.

Cases in point are Microsoft Corp. and computer chip giant Intel Corp. Both are holdings of the Third Avenue Value fund, managed by Martin Whitman, one of the pillars of the value-investing discipline.

It would have been impossible to imagine Whitman touching most technology stocks in the bubble days of the late 1990s. But this year, Whitman said, he was able to buy Microsoft and Intel each for less than 15 times annual earnings per share. (He arrived at that price-to-earnings ratio by first subtracting the per-share value of the cash on the companies’ balance sheets from the stock prices.)

By comparison, the average blue-chip stock in the Standard & Poor’s 500 index is priced at about 16 times estimated 2006 operating earnings, without adjusting for cash holdings.

“When Marty Whitman is buying Microsoft, you know something has changed in the world,” said Russ Kinnel, director of mutual fund research at Morningstar Inc. in Chicago.

Yet Microsoft, Intel and other major tech stocks also still qualify as bona-fide growth stocks to many fund managers of that persuasion.

Growth Fund of America, managed by the Los Angeles-based American Funds group, had Internet search leader Google Inc. as its largest holding as of Sept. 30, according to the company’s website.

The fund -- the nation’s largest stock fund, with $147 billion in assets -- also had tech titans Oracle Corp., Cisco Systems Inc. and Microsoft among its 10 biggest holdings.

Paul Herbert, an analyst at Morningstar, notes that Growth Fund of America has always had “an eye for value,” despite its growth moniker. So it isn’t surprising that, like Whitman, the fund’s managers would find some tech stocks too cheap to ignore, he said.

But in a recent report, Herbert said he was concerned that Growth Fund of America “doesn’t appear to be very well positioned for the rebound in the type of beaten-down large-cap growth names that appear to be the cheapest right now.”

When many on Wall Street think of classic growth stocks, the names that pop up tend to be those of old-line consumer-oriented companies such as Wal-Mart Stores Inc., McDonald’s Corp., Pfizer Inc. and Time Warner Inc. All have been miserable stocks to own since 1999.

Is it their time to shine again?

Money has been flowing into many of those issues since mid-July, when the overall market turned decisively higher.

Pfizer shares have soared 23.1% since July 17, more than double the 10.6% gain of the S&P; 500 index. In the same period, McDonald’s is up 21.3%, Time Warner 21% and Wal-Mart 12.6%.

By contrast, old-school value stocks such as machinery giant Caterpillar Inc. and financial services leader Citigroup Inc. have lagged. Caterpillar is nearly unchanged since mid-July; Citigroup is up 8.6%.

Why should the classic growth stocks come back into favor? Sheer momentum is one factor: Once money starts pouring into a market sector, the trend feeds on itself. Hedge funds and other opportunistic investors can’t stand not to be on the train.

Fundamentally, there’s an argument that investors again are appreciating the global reach and financial stability of established growth companies without having to pay the stratospheric price-to-earnings ratios that the stocks commanded in the late 1990s.

Even so, it’s reasonable to wonder whether the stocks are cheap enough, given that, as mature companies, their growth prospects naturally aren’t what they used to be.

The good news is that the confusion over whether to affix a growth or value label to some of the stocks means they have fans on both sides of the aisle.

Shares of Pfizer, the nation’s largest drug company, meet the criteria of growth portfolios such as the T. Rowe Price Blue Chip Growth fund in Baltimore.

They also meet the strict value criteria of Jim Cullen, co-manager of the Pioneer Cullen Value stock fund in New York.

Cullen’s fund limits its holdings to stocks whose price-to-earnings ratios are in the bottom 20% of the market universe.

“The Achilles’ heel of investing is overpaying,” said Cullen, reciting the mantra of the value school.

Many growth investors learned that the hard way seven years ago. They think they’re a long way from overpaying now, but they’ll only know that in time.

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tom.petruno@latimes.com

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Old growth, new again?

Here is a sampling of classic big-name growth stocks, including their price-to-earnings ratios based on estimated 2006 earnings per share.

*--* Fri. YTD P/E on est. Stock close change 2006 EPS General Electric $35.98 +2.6% 18 Intel 21.60 -13.5 27 Johnson & Johnson 64.58 +7.4 18 McDonald’s 42.11 +24.9 18 Microsoft 28.37 +8.5 20* PepsiCo 62.45 +5.7 21 Pfizer 27.59 +18.3 14 Time Warner 19.06 +9.3 22 Wal-Mart Stores 48.46 +3.6 17 Walt Disney 31.11 +29.8 20 S&P; 500 index 1,365.62 +9.4 16

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*For fiscal year ending June 2007

Source: Thomson Financial, Bloomberg News