Going for Growth Three stocks with earnings rising 20% or more a year that can put a little zing in your portfolio without adding a lot of extra risk
(MONEY Magazine) – The recent spate of good news confirms that the U.S. economy is on track for a full recovery. Real gross domestic product expanded at an 8.2% annual rate in the third quarter--the fastest pace in 20 years--and some economists expect growth to reach 5% in the fourth quarter and maintain that rapid pace in 2004. In addition, unemployment is finally starting to come down. First-time claims for benefits in November dropped to the lowest level in three years.
Investors may still be worrying about how long the good times will last, but the inflation outlook is signaling a major bull market. Historically, when inflation has run less than 3.5%, stocks have provided above-average returns over periods lasting at least five years. And general price increases seem likely to remain below that mark for the next several years. Core inflation has increased only 1.1% over the past 12 months, the lowest rate since 1966.
As ever, individual investors should be well diversified and should build their portfolios around a group of blue chips offering earnings growth of 12% to 16% a year. It's worthwhile, however, to include a few faster-growing stocks to boost the overall growth rate of your portfolio. That generally means considering smaller companies and accepting greater volatility.
Those risks are minimal if you include a few aggressive stocks in a portfolio that is well balanced overall. Here are three companies with annual revenue between $3 billion and $7 billion that are leaders in their industries. Each is projected to increase its earnings at a compound annual rate of at least 20% over the next five years.
Applied Materials is the leading producer of chipmaking equipment for the semiconductor industry, with about half the market. The business is extremely cyclical, and Applied Materials stock is capable of sudden dips as well as big gains. The share price has roughly doubled within the past year, but could still rise significantly as computer sales rebound. When economic times are tough, chipmakers postpone purchasing capital equipment for as long as they can. But when demand recovers, the chipmakers have to upgrade their equipment or they will fall behind their rivals. Thanks to the improving economy, that process seems to be under way. Spending on computer equipment grew at an annual rate of 18.4% in the third quarter of 2003. New orders for chipmaking equipment are coming in faster than they can be filled. As a result, the industry is enjoying rising order backlogs, the basis for future revenue. Industry analysts say that's the sign of a fundamental turning point. And although the stock is vulnerable to a short-term correction simply because the share price has risen so rapidly, the long-term outlook is impressive. At a current price of $22, the stock trades at more than 40 times depressed earnings. But as with other extremely cyclical stocks, Applied Materials' P/E always looks high right before profits soar. Enormous percentage gains in earnings are expected this year and next, followed by growth averaging about 20% annually for several years thereafter.
InterActiveCorp is an exceptional collection of e-commerce businesses assembled by CEO Barry Diller. I don't normally like Internet stocks, since they're often risky and overvalued. But if I wanted to take a flier on a real aggressive growth stock, InterActive would be one of my top picks. The company has a great mix of businesses, a legendary CEO and, best of all, real earnings. When Vivendi Universal began to unravel, Diller was one of the few insiders to get out in good shape. Essentially, he walked away with the foundering media company's online businesses and has since added to them. Currently, InterActive includes the HSN home shopping network, Hotels.com, the Expedia travel site, Ticketmaster, online dating service Match.com and more. There are plenty of caveats with a stock like this: Competition from sites like Orbitz and Travelocity is fierce; earnings, although real, are hard to pin down; and all Internet stocks are wildly volatile. On the plus side, though, InterActive's divisions have real profit-making business plans. And Diller has an impressive record of shrewd dealmaking. Over the past year, the stock has swung from $21 to $42. At a recent $34, InterActive trades at about 35 times estimated earnings for 2004, and profits are projected to grow at a 27% compound annual rate over the next five years.
Teva Pharmaceutical Industries is the world's largest maker of generic drugs. Generics already represent more than half of all prescriptions dispensed, up from a third 10 years ago. And the new Medicare drug benefit is expected to boost demand further. Generics producers spend relatively little on research and development--mostly, they wait until hot products become available for generic use. And now, analysts say, the pipeline of drugs soon to come off patent is actually more attractive than the pipeline of newly developed drugs awaiting approval. Teva markets around 140 products in more than 400 versions (different dosages, for example) in the United States and an even larger variety in Europe. And though it's based in Israel, which is a possible risk factor, Teva has been in business for nearly 60 years and has most of its production facilities in the United States and Europe. Earnings are projected to grow at an impressive 24% rate over the next five years. At $56, the shares trade at 23 times 2004 earnings.