NEW YORK (Money Magazine) -
Anyone who has been waiting for the recovery to get rolling (and that includes most current stock investors) has to be disappointed that the market and the economy are both still so listless.
Stocks usually rally after a war ends. And economic growth generally picks up sharply following a recession. So far, though, this recovery hasn't acquired momentum. Some months, in fact, there hasn't been any progress. In March, industrial production actually declined, and 108,000 jobs were lost.
Still, on balance, business conditions are slowly improving. Historically, such lulls following the end of a recession have often proved to be great investing opportunities. And that's just as true for corporations as it is for individuals.
So if you are looking for long-term growth, it makes sense to start with companies that are putting sizable amounts of money back into their own businesses, especially in the form of research and development.
| P/E based on estimates for 2004. Growth rate based on projected 5-year average. | | Source: Thomson/Baseline |
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Heavy R&D investment by itself doesn't guarantee success. But most big R&D spenders are leaders in industries that are growing faster than the overall economy. Their managers put a premium on real growth rather than trying to boost earnings through cost cutting. In addition, high R&D budgets are usually a sign of ample financial resources.
To identify such stocks, we screened the largest U.S. corporations (those with both revenue and market caps greater than $5 billion), looking for exceptionally high spending on research and development (at least $1 billion a year and accounting for at least 10 percent of revenue).
That gave us 18 stocks. From that roster, we dropped Lucent Technologies, Bristol-Myers Squibb and Schering-Plough because the consensus projections for their long-term growth rates were less than 12 percent a year.
In addition, we trimmed four companies that either lost money in 2002 or have less-than-stellar financial strength. After this pruning, we were left with the 11 companies listed in the table below.
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The most remarkable fact about the list is that just two industries -- technology and pharmaceuticals -- account for all the companies. That tells you two things: First, the great growth plays in the U.S. economy are highly concentrated -- at least among large companies. And second, despite the general slump in their shares, the top managers in both sectors still believe that there are plenty of new business opportunities out there, and they are committed to spending what it takes to find them.
The stocks on this list aren't dirt cheap, but they're fair value.
With the exception of Amgen, which has a biotech tinge, the pharmas all have P/Es under 25, based on trailing earnings (for 2002). The tech stocks, by contrast, are cyclical, and at the moment their profits are near a low ebb.
As a result, only two of the six tech stocks on the list -- Microsoft and Oracle -- have P/Es below 30. In addition, they have dividend yields below 0.5 percent, while all the drug stocks except Amgen have yields above 1.5 percent. Here's a look at the most promising picks in each sector.
Cyclical technology
With no debt and $40 billion in cash, Microsoft is able to spend more than $4.3 billion a year on R&D, the highest for any of the tech stocks on the list. Moreover, the company has survived both the bear market and antitrust litigation without losing its dominant position in personal-computer software.
Trying, as usual, to manage expectations, Microsoft is warning that earnings may be soft over the next 12 months. Nonetheless, the company's recent profits have surpassed analysts' estimates and are projected to grow at an average rate of 15 percent over the next five years.
Cisco and Oracle also have little debt and are cash rich. Still, their share prices were hammered during the tech wreck, falling more than 70 percent from 2000's highs. More than Microsoft, both companies depend heavily on corporate customers, and surveys of IT managers find little evidence that corporations plan to boost tech spending anytime soon.
But Cisco and Oracle will survive this dry spell and, if anything, emerge in stronger competitive positions after smaller rivals have lost ground. Long-term earnings growth for both companies is projected at 15 percent annually.
Steadier pharmaceuticals
The most conservative stock on the list is doubtless Johnson & Johnson, probably the most well-diversified health-care company. J&J's pharmaceutical sales over the next 12 months may be a little less robust than usual, but first-quarter earnings were up 13 percent, in line with J&J's long-term growth rate.
Pfizer ranked as the world's largest pharmaceutical company even before its recent $60 billion acquisition of Pharmacia. Considered by many to be the best-managed drugmaker, Pfizer also boasts a massive $5.2 billion annual R&D budget. The company has high expectations to live up to, but the shares don't seem overvalued. With core growth projected at 16 percent a year, Pfizer trades at less than 16 times projected 2004 earnings.
The most aggressive investors considering the sector may prefer Amgen, the stock on our list with the highest projected long-term growth rate -- 21 percent a year. Long dependent on just a couple of drugs, Amgen gained a third hot product -- Enbrel for rheumatoid arthritis -- when it acquired Immunex last July. And with R&D spending above $1.1 billion last year, it's only a matter of time before Amgen finds its next blockbuster.
Michael Sivy can be reached at sivy_on_stocks@moneymail.com
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