(MONEY Magazine) – According to Money's forecast, fast-growing small companies figure to be the stock market's headliners in 1995, turning in gains that could reach well into double digits. Even so, every investor in 1995--and beyond--also needs a solid supporting cast of blue-chip growth stocks. These firms are the nimble giants of the market, typically pinnacle players in their industry. They provide liquidity, stability and, often, the kind of growth potential that only the hottest small companies can beat. For example, all seven of our top picks are expected to boost earnings by 17% or more annually for the next five years. And $5.3 billion (in sales) Lowe's, our favorite blue-chip stock for 1995, is projected to return more than 50% next year.

No index captures a more representative collection of these attractive blue chips than Standard & Poor's 500. That's the reason we have rated all 500 stocks in the index by their potential for strong performance in 1995. (The tables begin on page 52.) Money's forecast calls for the index to gain 10% next year on the strength of modest inflation, steady corporate profit gains, stable price/earnings ratios--and, with the recent Republican sweep on Capitol Hill, a possible capital-gains tax cut to boot. A 10% return is not bad, by any means, but the index's overall performance figures inevitably mask some soaring returns by individual stocks. In the 12 months to this past Nov. 1, for example, the S&P as a whole barely broke even, but shares of the top 10 S&P performers--led by Stone Container ($5.4 billion in sales), $1.6 billion computer maker Amdahl and $519 million telecommunications supplier Andrew Corp.--gained an average of 95%.

To help you identify companies that could stand out like that next year, we took a detailed look at the 30 stocks of the S&P 500 that earned our top performance rating. Then we analyzed them further, using data from Value Line and Standard & Poor's--both are New York City firms that provide detailed stock reports to individual investors--and canvassed dozens of brokerage analysts and mutual fund managers. The result: a list of seven blue-chip stocks that appear to have extraordinary potential in 1995.

The starting point for our analysis, including our ratings of all S&P 500 stocks, was the Value Line Timeliness Rank, which is reported weekly in the Value Line Investment Survey ($525 a year; 800-833-0046). The Value Line system analyzes more than 1,700 stocks, favoring those with a history of long-term earnings growth, recent strong price gains and earnings that exceed Wall Street's expectations. Since 1980, stocks rated 1 for timeliness by the Value Line Investment Survey have returned 18.1% annually, tops for that period among the 19 stock-picking publications followed by Mark Hulbert, editor of Hulbert Financial Digest. While the Timeliness ranking doesn't work every year, it has proved especially reliable when market performance was dominated by growth stocks, as Money expects in 1995. In the tables beginning on page 52, you'll find the 500 listed by rank, from most timely (a score of 1) to least (a score of 4 or 5).

We then further scrutinized the stocks that rated a 1 on the basis of their financial fundamentals. We looked for a growing return on equity--a sign of improving profitability--and a price/earnings ratio no more than 1.2 times the rate of earnings growth, which told us that the stock was still moderately priced. These data, supplied to us by Standard & Poor's, are available in the detailed research reports the firm offers on more than 4,600 individual companies at a cost of $9.95 each; call 800-642-2858.

Standard & Poor's also measures Wall Street's opinion about each of the stocks in the S&P 500, which we include in the tables under the heading "Analysts' opinion rating." S&P's system digests the opinion of every major brokerage firm analyst toward a particular stock and translates the consensus into a score. A rating of 1.00 or more means that Wall Street overall rates the stock a buy. An opinion rating of 0.0 or less is a sell, and anything in between is a hold.

Here, then, are our seven picks for the coming year, listed in order of expected return. (Our single best idea, Lowe's, appears above.)

KROGER (KR) New York Stock Exchange, $26 Projected '95 return: 35%

With more than 1,270 supermarkets and sales of nearly $23 billion, Kroger is the nation's largest retail grocery. But as rapidly as the Kroger chain grows, the company somehow manages to increase profits even faster. Net earnings rose a robust 85% for the first three quarters of 1994, exceeding analysts' projections, and same-store sales grew by 2%, double the industry's average growth rate of 1%.

In the past the stock has been vulnerable to downdrafts because of the $5.3 billion in debt the company assumed to defend itself from a hostile takeover in 1988. Since then, however, Kroger has rigorously eased its debt burden by paying off or refinancing virtually all that it owes. Since 1989, the company has sliced its annual interest expense nearly in half, from $648 million to $331 million, partly by replacing long-term debt at interest rates of 11% to 15.5% with obligations paying less than 10%.

"Because of the $3.9 billion in debt Kroger is still carrying, these shares are too volatile for widows and orphans," says Edward Comeau, an analyst at Lehman Bros. in New York City. "But the company's improved balance sheet means far more predictable earnings in the future." Kroger's shares trade at a P/E just under 11, a 25% discount to other supermarket stocks. Comeau believes that shares could rise to $35 in 12 months.

ORACLE SYSTEMS (ORCL) NASDAQ, $46 Projected '95 return: 26%

The world's largest vendor of database software and services, this $2 billion Redwood Shores, Calif. company continues to delight investors by building revenues and earnings even faster than anticipated. Over the past two quarters, Oracle's revenues have jumped 40% and earnings have zoomed an amazing 60%. Analysts say the firm is on track to maintain at least 35% annual earnings growth over the next three to five years.

Fueling Oracle's growth is the worldwide corporate switch from lumbering mainframe and midsize computers to more nimble office PCs and workstations. Dollars spent on electronic downsizing are expected to grow by more than 40% annually, as fewer than 10% of companies have so far completed the process. Oracle has a 40% share of the $5.6 billion market for the software and service expertise needed to help companies complete the transition.

However, Oracle stock isn't cheap. It trades at a P/E of nearly 33 times 1995 earnings, and conservative investors should get aboard carefully. "Oracle is the kind of company to buy if you're looking to hit a home run and can stomach the risk," says analyst Frank Michnoff of Donaldson Lufkin & Jenrette in New York City. Even so, Michnoff believes the stock could reach $58 in the next 12 months.

UNITED HEALTHCARE (UNH) NYSE, $52.75 Projected '95 return: 23%

Based in Minnetonka, Minn., $3 billion United Healthcare owns or operates HMOs in 20 major metropolitan areas with a total enrollment of more than 3 million. When you consider that only about 50 million Americans now belong to such plans (roughly 20% of the total population), it's easy to understand why analysts believe United can grow at a hefty 28% annual rate over the next five years as more and more employers switch to managed care.

"Usually a growth rate that high means you're buying a small, less stable company," says analyst Eleanor Kerns of Alex. Brown & Sons in Boston. "But United is an established performer with a strong track record and proven management." The company has increased operating earnings over the past five years at a phenomenal average annual rate of 62%. The company also has $2.4 billion in cash that it could use to continue acquiring rivals. Last September, for example, United agreed to purchase St. Louis' largest health plan, GenCare Health Systems, for just over $500 million. The deal, when finalized, means that United will serve more than half the HMO customers in metropolitan St. Louis.

The company's growth strategy is to avoid states already saturated with HMOs and stick to underserved areas. United has a 25% share of the market in Georgia, for example, where only about 8% of the population is now covered by managed-care plans, compared with, say, California, where about 45% of the residents already belong. Kerns figures that as earnings grow and the risk of sweeping health-care reform all but vanishes in a Republican Congress, United shares could rise to $65 by the end of '95.

MATTEL (MAT) NYSE, $29.25 Projected '95 return: 21%

Rising from near bankruptcy a decade ago, $2.9 billion Mattel has transformed itself into the pre-eminent global toymaker. Roughly 40% of sales now come from 141 foreign countries, where revenues are growing at twice the U.S. rate of 7%. Markets whose burgeoning appetite for playthings remains largely untapped include Asia and Latin America, home to 920 million children. (Compare that with the U.S. and Western Europe, Mattel's biggest markets now, which total only 110 million kids.) Additionally, a pending acquisition of Britain's J.W. Spear, which owns the international rights to Scrabble, will boost worldwide sales in Mattel's least developed area: board games.

The company also has an enviable list of powerhouse brands, headed by Barbie, the well-dressed doll who celebrated her 35th birthday in 1994 with record sales of more than $1 billion. Mattel's other key brands include Hot Wheels cars, Fisher-Price toys, and merchandise based on animated Disney characters such as the Lion King, expected to generate revenues approaching $100 million. "Core brands account for 80% of Mattel's sales, which makes for a company with predictable performance," says Barry Rothberg, an analyst at Furman Selz in New York City. He expects the toymaker's earnings to grow 18% annually over the next three to five years. His 12-month target price for the stock, which yields 0.8% and trades at a P/E of 15, is $35.

MICROSOFT (MSFT) NASDAQ, $63 Projected '95 return: 21%

In the volatile technology sector, where products can become obsolete before some customers even know they exist, $4.6 billion software giant Microsoft is a paragon of consistency. In 1994 the maker of MS-DOS and Windows posted its 19th straight year of sales and earnings growth (24% and 25%, respectively), and analysts expect Microsoft to sustain 20%-plus annual earnings gains over the next five years. The Redmond, Wash.-based company's high-quality growth doesn't come cheap, however: Its P/E of 27.3 on 1995 earnings represents a 23% premium to its growth rate.

Fueling growth over the next 12 months will be the introduction by June of the company's new operating-system replacement, Windows 95. Analysts say this should be Microsoft's best-selling upgrade ever--worth more than $1 billion. By the middle of 1995, the firm also plans to enter the burgeoning field of on-line services for business and home users (everything from computer banking to electronic magazines), which are billed per transaction and generate tremendous revenues. A pending $1.5 billion merger with financial-software developer Intuit should further bolster the company's on-line capabilities. To capture market share rapidly, Microsoft plans to integrate its on-line service, called the Microsoft Network, with Windows 95. (Analysts estimate there will be some 30 million users of Windows 95.) "Microsoft should be a major player in on-line services for years to come, making the stock a great buy for long-term investors," says Therese Murphy, an analyst at Smith Barney in San Francisco. She believes the company's shares could hit $76 in 12 months.

PEP BOYS (PBY) NYSE, $36 Projected '95 return: 20%

To car owners in 29 states ranging from California to Massachusetts, Manny, Moe and Jack (the founders of the Pep Boys auto-parts and repair empire) are as ubiquitous as Pavarotti, Domingo and Carreras. The $1.3 billion Philadelphia-based company operates some 408 stores and has plans to open nearly 75 more by the end of 1995, including eight major outlets in Puerto Rico, its first move outside the continental U.S. Analysts say these new stores can help drive the company's earnings up as much as 30% a year over the next five years.

"Buying Pep Boys now is like buying Toys R Us before it became Toys R Us," says analyst John Casesa of Wertheim Schroder in New York City. Why? The $160 billion annual market for auto parts and service is currently fragmented among thousands of tiny local garages, with a few specialized national chains like Midas and Jiffy Lube thrown in. The Pep Boys strategy is to consolidate market share by offering a broad range of repairs (everything but transmission and bodywork) at a price that is 30% to 50% less than neighborhood shops charge. To serve working families, Pep Boys centers stay open seven days a week for a total of 86 hours. Adds Casesa: "Pep Boys fills a gaping need, now that big chains like Sears and Montgomery Ward have reduced auto service." Because auto parts and repair are Pep Boys' sole focus, Casesa says, there's less risk that the company will suffer from the corporate neglect and misjudgments that felled department stores' auto-repair businesses. He thinks that the stock, which yields 0.4% and trades at a P/E of 22.6, could fetch $43 by the end of 1995.

For Money's rankings of all 500 stocks in Standard & Poor's index, please turn the page.

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BEST IDEA 1995

Lowe's: Nailing down growth

Lowe's, a $5.3 billion retailer of home improvement products, is taking on industry giant Home Depot--and winning. Over the past 2 1/2 years, the North Wilkesboro, N.C. company's same-store sales have grown 29.4% annually, nearly three times Home Depot's 10.7% rate, and earnings have ballooned 50.6% a year, compared with HD's 30.5%. Though analysts think that there is plenty of room in the fast-growing $120 billion home improvement market for both companies, the betting is that the challenger will win the race in 1995.

"Lowe's success began when it stopped imitating Home Depot and asked what its customers wanted," says Montgomery Securities analyst Bo Cheadle. No great surprise, it turns out that what do-it-yourself consumers want is low prices, a huge selection of products and knowledgeable advice. Lowe's caters to this demand in 327 stores, located in 20 states from Pennsylvania to Texas. Salespeople are trained to make sure customers leave the store with everything they need to complete a particular project, so do-it-yourselfers never have to visit their corner hardware store, even for the odd paint roller or wood screw. "Lowe's has found a concept that consumers love, and they're able to roll it out into new stores quickly and efficiently," says Cheadle. Soon the retailer will expand into the lucrative home-office market by selling computers, fax machines and cellular phones. The company trades at a reasonable P/E of 23.7, less than 80% of its expected five-year growth rate of 30% to 35%. Recently the stock sold for $39.75 on the New York Stock Exchange. Cheadle's 12-month target price for the shares, which yield 0.4%, is $60. That works out to a satisfying total return of 51%.