NEW YORK (MONEY Magazine) -
As you scan the names of the top stocks of the past 30 years, one thing becomes clear: Trying to predict which companies will make that list three decades from now is a fool's errand.
Who knows what new technologies or demographic trends will shape the investing landscape of 2032? No one's crystal ball is that good. That said, investors won't go wrong looking for companies that share many characteristics with our 30-year champions (see the full list here), including outstanding earnings quality, focused strategies and smart use of technology. MONEY set out to find some of those stocks for you.
| *P/E based on estimates for 2003. Growth rate is 5-year projected earnings. | | Source: First Call |
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We started by keying in on companies in relatively early stages of growth, limiting our search to those with a market capitalization (stock price times number of shares outstanding) of $1 billion to $5 billion. That restriction led us to many unfamiliar names, but then, who had heard much about Southwest Airlines or Wal-Mart in 1972?
We sought companies that are well run and operate in industries with healthy growth prospects (but aren't faddish). Mindful of the importance of earnings integrity, we then narrowed our list to companies that shun earnings-boosting accounting gimmicks. We also excluded companies that try to disguise bad decisions by taking frequent write-offs.
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We looked for companies with improving profit margins and return on capital, indicators that managers allocate capital wisely and care about improving operational efficiency. Finally, we tossed out companies with high debt loads (more than 40 percent of total capital) that could hamper their ability to grow.
That winnowing left us with 7 highly promising companies in industries ranging from food distribution to medical testing. All have solid foundations and excellent positions in growing industries, but as small stocks, all are inherently risky propositions. Even so, we are confident that these 7 have the potential to reward investors over the next several years.
BJ Services
Despite what you may remember from the opening credits of The Beverly Hillbillies, oil doesn't just bubble up out of the ground. In the real world, both oil and gas production must be stimulated inside a well by cracking rocks and pumping in extraction fluids, in a process known as oilfield pressure pumping. Enter BJ Services (BJS: Research, Estimates), which has thrived in this niche of the energy sector.
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Spun off by Baker Hughes in 1990, BJ Services is the largest independent player in the $8 billion pressure-pumping market, and third-biggest behind diversified giants Halliburton and Schlumberger. The key to BJ Services' success: its management. The team of former Baker executives that has run the company for the past decade has a reputation for relentless attention to detail. Every 90 days, BJ Services managers create a comprehensive 12-month forecast that tracks pricing, market share and industry outlook for every piece of its business. Such obsessive scrutiny, which helps BJ Services make swift pricing and resource allocation decisions, has widened operating margins from 2.2 percent to 10.1 percent over the past three years.
Industry trends also favor the company. The Bush administration has issued a mandate to increase domestic energy production. BJ Services, which derives about 70 percent of its revenue from the North American market, is well positioned to capitalize on the accelerated pace of oil and gas exploration in the U.S., asserts Tim Parker, an analyst at long-time BJ Services shareholder T. Rowe Price. Furthermore, he notes that while Halliburton is mired in asbestos lawsuits and Schlumberger is digesting an acquisition, "BJ is solely focused on pressure pumping."
Not that BJ Services is sheltered from industry volatility. Last year, sales slumped because of the economic slowdown and bad weather in Canada; that, plus the possibility of a price war between OPEC and Russia, has knocked the stock 35 percent off its 52-week high. But that makes BJ Services a sweet deal as well as a great company. Icon Energy fund manager J.C. Waller calculates that the stock, which recently traded at $26, is worth $48.60 a share. Parker, meanwhile, expects the stock to reach $50 within three years. back to top
Career Education
In less than a decade, Career Education (CECO: Research, Estimates) has blossomed from an itty-bitty start-up into the No. 2 for-profit provider of post-secondary education in the U.S. Its game plan: To buy small, poorly run schools with decent reputations and improve them by fixing up campuses, expanding curriculums and centralizing back-office tasks like accounting and human resources.
The result: Since its 1998 IPO, sales and profits have risen on average 50 and 60 percent, respectively, each year. The company has also beaten Wall Street estimates for 17 consecutive quarters. Says Cliff Greenberg, whose Baron Small Cap fund has a 3.3 percent stake, "It's unusual for me to find a company growing this fast."
Greenberg is even more excited about Career Education's strengthening position in a thriving industry. Analysts predict that spending on post-secondary schooling will climb steadily from $277 billion in 2001 to $320 billion by 2011, driven by a growing number of high school graduates and a continued rise in jobs demanding higher education.
To be sure, this is an industry rife with competition; Career Education not only contends with other for-profits like Apollo Group but with thousands of private and state-sponsored colleges and universities. Nevertheless, proponents argue that Career has a more diversified curriculum than many for-profits, offering degrees in areas like information technology, business, culinary arts, and design and visual communications -- unlike, say, rival DeVry, which focuses mostly on tech-related careers.
Under CEO John Larson, who has guided the company since its inception, it plans to open two schools and buy two to three campuses annually for the next several years. (It has only 43 campuses, in 16 of the 50 largest U.S. metropolitan areas.) The company is also in the early stages of an online degree program, which it hopes will generate as much as $300 million in sales by 2005.
At a recent $47, shares of Career Education trade at 28 times next year's earnings, a big discount to industry leader Apollo Group. Greenberg pegs earnings growth at 30 percent annually for at least the next few years. Says Kenneth Turek, manager of Northern Mid Cap Growth: "These guys will continue to be successful because they're focused only on this business they know and do well." back to top
C.H. Robinson Worldwide
Think of C.H. Robinson as travel agents -- but not for people. When companies need to ship goods -- from potatoes to electronics -- they often call a logistics company such as C.H. Robinson (CHRW: Research, Estimates) to arrange the pickup, transport and delivery of their products. It may not sound sexy, but Robinson's business model (and the steady profits it generates) gets investors excited.
Unlike most of its competitors, Robinson doesn't own fleets of trucks, trains, planes or ships, so when times are tough, it isn't saddled with expensive equipment sitting idle. Nor does it have to continually plow cash into upgrading or expanding these fleets. Although sales growth slowed in 2001 -- up 7 percent to $3.1 billion after a 27 percent gain in 2000 -- Robinson's cost of doing business declined even faster. As demand slackens, truckers aggressively discount rates to get any available freight, which means the cost of transport falls faster than the company's sales.
And because the shipping industry is very fragmented, Robinson, the juggernaut in trucking transport, has a distinct edge: It can command the best rates and use the savings to attract more customers. This allowed the company to maintain 15 percent gross margins in 2001, despite the slowdown. Analysts also believe that this asset-less approach buffers Robinson from the boom/bust cycles that other transportation companies suffer.
Investors also love the work ethic that pervades the organization. It's got a pay-for-performance culture that is the envy of the industry. Recently, new CEO John Wiehoff, who had been the CFO since 1998, was given a one-time grant of $5 million in stock. Rather than providing an immediate payday, the grant vests over 15 years. And he can't sell any shares while he's still employed at the company.
"That's almost unprecedented," notes Ken Broad, co-manager of Transamerica Premier Growth Opportunities, who has owned the stock for 4 years and recently boosted his holdings to 5 percent of his portfolio. "He's handcuffed to the business. And that restricted stock gets expensed and doesn't inflate earnings like options."
Another strength: Its management knows how to buy and integrate other companies. Since going public in 1997, it has swallowed 1 large and 6 smaller logistics companies that, like Robinson, don't own transport assets. Opportunities to expand the business are ample, say analysts, who estimate the overall market for truck-based shipping alone in the tens of billions of dollars.
What's Robinson's piece of the pie? Less than 5 percent. Since going public in 1997, this 97-year-old company has pounded out annual earnings gains of 12 to 29 percent, and investors have noticed. The stock trades at 22 times estimated 2003 earnings vs. 16 for the S&P 500. It gets a premium partly because of its streak of five years of double-digit profit growth. Transamerica's Broad lists three compelling reasons to own Robinson: "exceptional management, great return on capital and open-ended growth opportunity." back to top
Fair Isaac
For nearly 50 years, data cruncher Fair Isaac (FIC: Research, Estimates) -- started by a mathematician and an engineer with an investment of $400 each -- has produced analysis that helps banks and other lenders decide whether people are creditworthy.
The company takes bits of data -- such as a history of late bill payment and how much money a person owes -- and applies its proprietary algorithms to produce a single score. This analysis is used by lenders to quickly make decisions, like whether to give someone a mortgage and how much interest to charge. Fair Isaac dominates this area with 70 percent market share.
Now the digital age ushers in new vistas. With the recent acquisition of HNC Software, a provider of business analytic software (such as fraud-management and predictive software), the combined $630-million-in-revenue company is pushing to market its expertise in new ways to different types of customers.
One promising market is selling their own credit scores to consumers, allowing them to gauge their prospects for securing a new-car loan or home-equity line of credit, or to figure out how to improve their credit so that they're eligible for lower interest rates.
You can go online to its www.myfico.com and buy your credit report and credit score. Fair Isaac shares proceeds with its partner Equifax, a credit bureau that supplies the data. Retail sales are expected to bring in revenue of $20 million to Fair Isaac next year, and the company hopes that can quickly grow into a $100 million-plus business.
Selling directly to consumers is much more profitable than selling to institutions, because corporate clients pay a few pennies per score, while retail customers pay $12.95 apiece. Considering that the company makes a cushy operating margin of nearly 50 percent on the institutional side, the possibilities for the retail business over time are, in a word, great, says Andrew Peck, vice president at Baron Capital, which owns about 1.3 million shares spread over several funds.
Adds Peck: "They have all the good parts and none of the bad of a tech stock. They're reselling this proprietary algorithm that they've invented, and their cost to provide it is, effectively, nothing."
Better still, Fair Isaac's business can thrive whether the economy does or not. Banks and other lending institutions need to make credit checks whether they are marketing to new customers or trying to detect bad risks in existing loans that they hold. "In a good economy, a bank might need to check customers' credit scores once a year," says Tony Wible, an analyst at Salomon Smith Barney. "But in a bad economy, the bank might check them three times a year to try to detect risks sooner."
Fears that Fair Isaac might have trouble absorbing HNC have dampened the stock by 18 percent this year. The company says the merger is going smoothly and should save $35 million in costs. The stock at around $30 is now an exceptionally good value, particularly when you consider Fair Isaac's dominant position in a highly lucrative and seemingly recession-proof business. back to top
Laboratory Corp. of America
Back in December 2001, the American College of Obstetricians and Gynecologists recommended that couples considering pregnancy be offered DNA screening for cystic fibrosis, a debilitating genetic disease. That was just the latest bit of good news for Laboratory Corp. of America (LH: Research, Estimates), which has a nationwide network of clinical testing labs that perform cystic fibrosis screens, among other tests.
Rising demand for such tests explains why earnings per share at the country's No. 2 lab chain (behind Quest Diagnostics) exploded 61 percent last year. Scientific advances are producing an array of ever more sophisticated tests for genetic and infectious diseases.
Editor's note: On Oct. 4, after the Fall 2002 issue of MONEY Magazine went to press, Lab Corp. announced that third-quarter revenue would be shy of estimates. Read MONEY's updated opinion.
At Lab Corp., the number of high-end screenings has nearly doubled in the past two years; they now make up 23 percent of revenue. In addition, its core business of routine blood and urine testing is seeing solid single-digit growth, driven by the large aging population and a heightened focus on early detection of disease.
As one of just two national lab chains, Lab Corp. has a size and breadth that helps the company win contracts with large insurers and avoid price wars with competitors. That advantage shows up in improved financial results: Since 1999, profit margins have more than tripled to 21 percent and return on total capital has skyrocketed from 9 percent in 1999 to 21 percent last year. The company has paid off most of its debt, and in March Standard & Poor's upped its credit rating for the second time in just over a year.
Lab Corp. is a favorite of investment firms like Janus, where four funds count the company as a top 10 holding. Despite the fact that it's not exactly undiscovered, the stock remains surprisingly cheap. The shares trade at 13 times next year's earnings, which analysts expect to be up 26 percent. Sure, that pace will be hard to sustain, but T. Rowe Price health-care analyst Chris Leonard believes that the company can be "a nice, steady 15 to 20 percent bottom-line grower." back to top
Michaels Stores
What was one of the most resilient retail sectors during the past year? Arts and crafts. Since September of last year, more families seem to have been passing the time at home, making picture frames, crocheting sweaters, casting figurines.
But even before that the industry was on a roll. Knitting came back in vogue thanks to actresses like Cameron Diaz and Sarah Jessica Parker, both fans of the hobby. And Martha Stewart and Oprah have been helping the sales of home decorating, painting and crocheting supplies balloon from $10.2 billion six years ago to nearly $30 billion today.
The chief beneficiary of that growth has been Michaels Stores (MIK: Research, Estimates), the nation's largest arts and crafts retailer. "It's become the destination store for crafts projects," says Jill Grueninger, whose Mason Street Asset Allocation Fund bought Michaels stock back in 1997. Lured by Michaels' strong return on capital, she recently added to her stake.
Michaels started winning fans on Wall Street in 1996 when Michael Rouleau, a former vice president at home improvement chain Lowe's, was named CEO. (Rouleau's appointment led Money 100 member Bob Rodriguez of First Pacific Advisors to buy Michaels stock in 1996. Today it is his top holding.) Rouleau, a seasoned merchandiser, annually relocates about 20 stores from tired locations to higher-volume areas. He has also automated Michaels' outmoded inventory systems. As a result, operating margins rose from 4.7 percent in 1997 to 7.4 percent in 2001. Rouleau expects margins to hit 10 percent as average sales per store, currently $3.7 million, hit the $5 million mark.
Michaels, with 742 stores in 48 states, plans to open 70 stores a year until it has about 1,100 across the country. Store openings, plus the anticipated increase in sales per store, will fuel Michaels earnings at an annual clip of 15 to 20 percent over the next several years.
The stock price has run up over the past year as more investors have discovered the category killer in the arts and crafts arena. Yet Michaels' shares still trade for less than 20 times estimated 2003 earnings. That's a very attractive valuation for an industry leader that boasts a well-regarded CEO and that has consistently surpassed Wall Street's earnings expectations for the past three years. back to top
Performance Food Group
Performance Food Group (PFGC: Research, Estimates) is the nation's No. 3 food distributor (behind Sysco and Royal Ahold's US Foodservice), serving 46,000 restaurants, supermarkets, hospitals and schools. Although it is one-fifth the size of Sysco (sales of $4 billion vs. Sysco's $23 billion), Eric Larson, an analyst at US Bancorp, believes it is well positioned to mimic the success of that dynamo. "It's like Sysco 20 years ago," he asserts.
Performance Food seems ideally positioned to benefit from key industry trends. For starters, it services 33,000 restaurants, and even in this sluggish economy Americans are eating more meals outside the home (an estimated 4.2 meals a week, up from 3.75 meals in 1985).
When folks do shop for groceries, they're looking for convenient, easy-to-prepare meals, and Performance is one of two leading providers of prepackaged produce. Finally, the industry is in the early stages of consolidation -- the top five companies command just 27 percent of the market -- giving the company lots of room to increase market share or expand by making the same smart acquisitions for which it's known.
Indeed, Performance has goosed profits at a 22 percent annual rate over the past five years and gained market share, mainly by purchasing smaller food distributors. One recent coup: the 2001 acquisition of Fresh Express, which made Performance one of the largest suppliers of fresh-cut produce (think prepackaged salads) to some 9,000 Albertsons, Safeway and Wal-Mart stores.
The fresh-cut-produce unit, which now accounts for 20 percent of sales, boasts 8 percent operating profit margins vs. an average of 2 percent for Performance's other businesses. The expansion of this division should help augment Performance's overall growth rate, reasons David Kalis, manager of the Segall Bryant & Hamill Mid Cap fund, who has about 3 percent of his portfolio in Performance's shares. "The real thing that's going to drive the stock is the move to fresh-cut vegetables," says Kalis. "The margins are higher, the growth is faster and returns will be much higher."
Performance's top managers, who together own 5 percent of the company's stock, have all been with the company since its inception in 1987. Original CEO Robert Sledd passed the reins to Michael Gray in 2001; Sledd remains chairman of the board.
Best of all, the stock has room to run. It's trading at 18 times estimated 2003 profits, while earnings are expected to grow 45 percent this year and 19 percent in 2003. Its combination of strong management, strategic acquisitions and new product lines makes it a great way to invest in an indispensable industry. back to top
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