NEW YORK (CNN/Money) -
Now that third-quarter GDP growth has been revised upward to an annual rate of 8.2 percent, the fastest quarterly growth in almost 20 years, it seems fairly clear that a strong economic recovery is under way.
Stocks are already up more than 30 percent since March. And while there's no way of knowing whether they'll keep moving up quickly or suffer a brief pullback, chances are that the market will move substantially higher over the next few years.
Although the returns of the next bull market may not match those of the late 1980s and 1990s, the average bull market since World War II has gained more than 100 percent.
Generally, more than half your holdings should be in big, well established companies growing a bit faster than the market average. But it's also worthwhile to diversify your portfolio, adding some income investments and inflation hedges to lower your risk, and some more aggressive growth stocks to add a little zing to your returns.
Here are three small-to-midsize stocks that are likely to outpace the market.
T. Rowe Price
Like most fund companies, T. Rowe's income is based on the size of the assets it manages. That means the company's earnings get a double benefit in a bull market. The value of the stocks in T. Rowe's funds goes up as the market rises. And investors add money to the funds.
The result is that assets under management -- and hence earnings -- grow faster than the overall market.
T. Rowe (TROW: Research, Estimates) is also a timely choice because of the scandals afflicting the mutual fund industry. Shareholders are moving money out of troubled firms and into the most conservative fund companies, such as Fidelity, Vanguard and T. Rowe Price.
Of these three, only T. Rowe trades publicly. (Fidelity is privately held and Vanguard is owned by the shareholders of the funds it manages.)
In the five years through 1999, T. Rowe's earnings nearly quadrupled, while its share price rose more than sevenfold. Over the same period, the Dow climbed two and a half times -- a splendid gain but not nearly what T. Rowe managed.
Since 1999, the stock has made no net progress and trades at less than 20 times next year's estimated earnings. But it offers the prospect of leveraged gains if we get a sustained bull market.
Teva Pharmaceutical Industries
The case for Teva, the world's largest maker of generic drugs, is simple: The number of potential products is growing rapidly as blockbuster drugs come off patent.
Generics producers pay very little in the way of research and development -- mostly, they just have to wait. And at the moment, analysts say, the pipeline of drugs soon to come off patent is actually more attractive than the pipeline of newly developed patented drugs awaiting approval.
Teva (TEVA: Research, Estimates) markets around 140 products in more than 400 versions (different dosages, etc.) in the United States and an even larger variety in Europe. Thanks to the number of important drugs coming off patent, Teva's earnings are projected to grow at an impressive rate of more than 20 percent annually during the next five years.
While those prospects are not unrecognized -- the stock trades at 24 times next year's earnings -- shares are still widely recommended by analysts.
Finally, though based in Israel, which might appear to add risk, Teva has been in business for nearly 60 years and has most of its production facilities in the United States and Europe.
Tiffany
Tiffany is a leading retailer of luxury goods. Jewelry accounts for about 80 percent of business. The company has a presence in Europe and Asia in addition to the United States, with especially large operations in Japan.
Tiffany's business strategy calls for carefully broadening its potential market -- with a line of more affordable diamond engagement rings, for instance -- while taking care to preserve its upscale brand image.
Such niche luxury brands tend to be the best shielded from economic fluctuations. Earnings were down in the most recent quarter because last year's number was inflated by an $8 million special tax benefit.
But revenue trends are positive. Diamond jewelry sales are strong in the United States. Worldwide on a constant-currency basis, sales increased 15 percent and comparable-store sales were up 10 percent. The only cloud on the horizon is Japan, where jewelry sales remain weak.
Earnings are projected to grow at a 14 percent rate this year, 18 percent in 2004 and then continue at that rate for the next few years. The stock trades at 27 times 2004 earnings. Tiffany has bought back more than 3 million shares over the past three years and recently announced that it would continue these buybacks through 2006.
Michael Sivy is an editor-at-large for Money magazine. Sign up for free e-mail delivery of Sivy on Stocks every Tuesday and Thursday.
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