'Rubbish rally' is over...focus on growth

Wall Street's earnings estimate game is a foolish exercise. Companies that report real growth deserve to be rewarded more than those that beat low expectations.

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By Paul R. La Monica, CNNMoney.com editor at large

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Defying the downturn
There are still growth opportunities to be found -- even in a brutal recession.
Company (Ticker) Earnings growth*
Oracle (ORCL) 6%
Advance Auto Parts (AAP) 9%
Google (GOOG) 10%
Amazon.com (AMZN) 10%
Hudson City Bancorp (HCBK) 16%
Medco Health Solutions (MHS) 17%
Source:Thomson Reuters * estimates for this fiscal year

NEW YORK (CNNMoney.com) -- It's funny how Wall Street works these days. News that should be considered bad is thought to be good because it's "less bad." But some companies that actually report good news get punished because it's not good enough.

It reminds me of a funny quote from Rosie Perez' character in "White Men Can't Jump" -- aka the last good movie starring Wesley Snipes.

"Sometimes when you win, you really lose, and sometimes when you lose, you really win, and sometimes when you win or lose, you actually tie, and sometimes when you tie, you actually win or lose."

Consider the case of Google (GOOG, Fortune 500). The Internet search giant reported results for the second quarter Thursday afternoon that, to any sane investor, look good. Sales rose 3% from a year ago and were roughly in line with estimates. Profits were up nearly 20% from the same period last year.

Yet, the stock fell 3% Friday morning and many stories about Google's results focused on the fact that sales growth is no longer as robust as it used to be. Well, duh!

Google often gets mislabeled as a technology company. In reality, it's a media company that just so happens to use technology to efficiently sell advertising. And guess what? We're in a recession! The advertising business kind of stinks.

Most media companies would kill for 3% year-over-year sales growth. CBS, Walt Disney, News Corp. and my parent company Time Warner are all expected to post year-over-year sales declines for this quarter -- and over the full year for that matter.

Investors need to focus more on the absolute and less on the Wall Street parlor game of earnings relative to expectations.

Talkback: Are you buying any stocks now? What companies do you think are good investments? Leave your comments at the bottom of this story.

Bank stocks are going up because they are reporting earnings declines that aren't as big as feared. That's all well and good. But wouldn't you rather own a company that's reporting profits that are rising?

"There are still plenty of companies in this environment that are growing earnings at a pretty good clip," said Joe Milano, manager of the T. Rowe Price New America Growth fund. "We're looking for long-term growth in the absolute sense -- regardless of what's going on in the economy. There's always stuff to buy, even in a recession."

Google is one example of a stock that Milano owns in the fund because it has been able to keep growing during the recession. He also likes tech superstars Amazon.com (AMZN, Fortune 500) and Apple (AAPL, Fortune 500) for the same reason. But he said there are many others that are holding up well in a variety of sectors.

In healthcare, he owns pharmacy benefits-management firm Medco Health Services (MHS, Fortune 500) and dental-products supplier Henry Schein (HSIC, Fortune 500).

There are even some retailers that he likes, including Wal-Mart (WMT, Fortune 500), Bed Bath & Beyond (BBBY, Fortune 500) and Advance Auto Parts (AAP, Fortune 500). What all of these stocks have in common is that they are each expected to report earnings growth in the current fiscal year.

That's what investors should be trying to find now. Actual growth.

"We've looked at companies that are turnaround stories but there are still a lot of questions about their quality," said Kent Mergler, chairman of Northstar Capital Management, an investment firm with about $250 million in assets based in Palm Beach Gardens, Fla., that focuses on growth stocks.

Mergler's firm owns several of the companies that Milano has in his fund, such as Google, Apple and Wal-Mart. Merger said he also likes construction company Fluor (FLR, Fortune 500), software giant Oracle (ORCL, Fortune 500) and Hudson City Bancorp (HCBK), a regional bank with a reputation for being ultraconservative.

And like the other stocks, all of them have remained profitable during the downturn and their earnings are expected to increase again this year.

"We have continued to invest in fundamentally strong companies. We aren't buying companies that are running losses and just offering promises of profitable futures," Mergler said.

That is key. Now that the broader market has already enjoyed a nearly 40% pop from the March lows, investors have to pay attention to quality and value reliability over potential.

As I pointed out in a column last month, one disturbing part of the recent rally is that many of the stocks leading the way were troubled firms that were skyrocketing merely because investors realized they wouldn't all go out of business.

Sure, you could argue that a lot of financials, retailers, industrials and other struggling firms were oversold back in March and deserved some bounce. But to justify more gains, companies have to prove to investors that they are capable of putting up decent profits.

"From mid-March through the end of May, most stocks that had rallied were sick companies with disastrous balance sheets," said Bill D'Alonzo, chief executive officer of Friess Associates, a Greenville, Del.-based investment firm that runs the Brandywine family of mutual funds.

"Now, earnings are starting to matter again. People are realizing that it was a rubbish rally," D'Alonzo added.

Talkback: Are you buying any stocks now? What companies do you think are good investments? To top of page

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