What ever happened to growth stocks?
Unpleasant memories and some legitimate but short-term worries are keeping share prices down
(MONEY Magazine) -- For a while now, I've been saying that big growth stocks are unduly depressed and look like smart choices for bargain hunters. Other market watchers are also singing this song, and savvy money managers such as Bill Nygren and Ron Muhlenkamp have been buying of late.
It's not hard to see why. As a group, the earnings of America's largest companies are rising faster than the rest of the market, yet the giants' shares trade at lower price/earnings ratios than those of smaller companies.
And among the biggest stocks, those that increase their earnings at double-digit annual rates are now the cheapest they've been in more than 30 years relative to the slower growers.
Yet growth stocks show no signs of a big move up. What gives?
In part, investors still feel burned by the growth-stock bust that began in 2000. The two-year rise in interest rates has also been a wet blanket, and recent financial headlines aren't helping either. Falling home values and oil prices are signs that economic growth is slowing.
Forecasters project that the economy may not really pick up again until mid-2007, and the anticipation of a few slow quarters is enough for Wall Street analysts to start marking down their five-year earnings growth projections.
Play the Rebound
The outlook isn't entirely downbeat, however. The majority of forecasters don't expect a recession, just a slowdown. And recent all-time highs for the Dow show that investors are looking across the valley to brighter prospects. A year from now, earnings projections could turn up sharply, giving growth-stock prices a strong boost. To me this suggests current weakness is not cause for concern but, rather, the sign of a buying opportunity.
I don't mean to say that all growth stocks look good in this environment. That became clear as I reviewed the Sivy 70 list, as I do each quarter, to see if it needs revision. Generally, I try to make as few changes as possible. My goal is to provide a focused list of big growth stocks to track. I use my column here and on CNNMoney.com to spotlight those that look like compelling bargains.
But recently a dozen of the 70 failed to meet one or more of the benchmarks I use to evaluate a stock. Those criteria include revenue and market caps of at least $5 billion, strong finances and potential total returns of at least 12% a year, including both capital appreciation and dividends.
The large number of stocks failing to clear all the hurdles suggests to me that the group is at the kind of trough that occurs once a decade or so. Therefore, I've kept stocks on the list if I believe their growth potential is understated by analysts or the companies seem likely to overcome their current problems--especially when they offer important diversification. Nonetheless, there are three stocks I want to replace.
Old Media, No; Finance, Yes
Boston Scientific (BSX) continues to have problems with its cardiovascular products, and the acquisition of Guidant has made matters worse. Radio broadcaster Clear Channel Communications (CCU) and Gannett (GCI), publisher of USA Today and 89 other daily newspapers, will both likely suffer in today's tough market for traditional media.
To replace them, I've selected three companies that look like worthwhile long-term holdings.
Banking giant Wells Fargo (WFC) offers 10% annual earnings growth and a 3.1% yield, and it trades at just over 13 times next year's projected earnings.
Mutual fund management company T. Rowe Price (TROW) looks expensive, with a 22 P/E that's nearly double its 12% projected growth rate. But after six years of up-and-down performance, the stock market is due for a sustained advance at some point. When that happens, fund companies' earnings should have big upswings.
I'm also adding Caterpillar (CAT). With 12% projected growth and a 1.8% yield, Cat is one of the few old-fashioned capital-goods makers that meet the list's total-return criteria.
The addition of these stocks shouldn't be interpreted as a recommendation to go out and buy them immediately - of the three, only Wells Fargo is timely. T. Rowe and Cat could suffer in the short run if worries about the economy escalate. That would be the time to consider them. Successful portfolio building, after all, comes not simply from recognizing good stocks. It comes from adding those stocks at good prices.