Seven Stocks To Bet On

(FORTUNE Magazine) – Fast and dangerous is always sexy. No wonder, then, that investors are drawn to our annual list of growers. For every Dell (up 18,000% since it debuted on the list in 1991), there's at least one aaiPharma (No. 19 in 2003, it's down 89% in the past year). To steer clear of this year's bad seeds, we paid careful attention to valuation, grilled industry experts, and found a handful of stocks that should blossom. BY ABRAHM LUSTGARTEN AND OLIVER RYAN


It's an ugly truth about medicine: many common ailments, like acne, can only be treated, not cured. That's good news for a company like Bradley Pharmaceuticals (BDY, $23), which markets niche dermatology and gastrointestinal medications.

Bradley is a pharma small fry, with just $91 million in revenues and a $354 million market cap. But its CEO, Daniel Glassman, has carved out a strategy with big potential. The company acquires prescription brands that lack blockbuster promise from industry leaders like Pfizer, repackages them, and sells them at a premium. The strategy has worked wonders with products like prescription skin moisturizer Carmol. Bradley has also had success with treatments developed internally, like acne medicine Zoderm. Its profit margins are close to 25%. "They've shown their ability to create value through marketing," says Michael Krensavage of Raymond James.

And Bradley's future growth prospects appear bright too. The company has launched a half-dozen new products in the past year, including three new versions of the successful Zoderm line and a variation on topical acne treatment Rosula, which already garners about 7,700 prescriptions a month. In June the company began marketing Keralac, the first prescription moisturizer to hit the market in ten years, and took in $4.3 million in sales in its first quarter. "I don't think the Street has come to grasp how successful a launch Keralac has been," Krensavage says. In early August, Bradley closed its $188 million acquisition of Bioglan Pharmaceuticals, adding three new products, including Solaraze, a patent-protected topical treatment for precancerous skin conditions.

While it may be seen as a buyout candidate for larger companies that covet its strong marketing and sales force, Bradley looks to be a bargain even on its own. Its closest competitor, Medicis, has a $2 billion market cap and a P/E of 118. Bradley, meanwhile, trades at just 16 times its trailing earnings.

Online Security SYMANTEC /No. 24

Here are a few simple predictions about the future of computing: Networks will be bigger and more numerous, and many more viruses will plague the lot. There are now nearly a billion Internet users and, according to CERT, Carnegie Mellon's cybersecurity clearinghouse, security "incidents" increased by an average of 85% a year from 2000 to 2003. (In 2004, CERT stopped tracking incident reports because they became too commonplace to be meaningful.) Here's another prediction: There will be more spam. eMarketer Inc. estimates that 1.6 trillion e-mail messages were sent in the U.S. in 2003 and suggests that the volume will grow by about 15% per year through 2007. According to a variety of studies, 60% to 75% of that e-mail is, to put it politely, "unsolicited."

If you are an investor in Symantec (SYMC, $45), the dominant global provider of antivirus software and now the leading provider of spam-filtering software to businesses, those grim trends are not entirely unwelcome. According to IDC, the market for "information security, services, and enterprise administration" was $16 billion in 2003 and will grow 19% a year to reach $32 billion in 2007.

There are, to be sure, a couple of valid reasons to eye shares of Symantec skeptically. First, they trade at a lofty price/earnings multiple of 34. Then there's the specter of Microsoft. Many industry experts expect the Redmond, Wash., giant to offer its own consumer antivirus product soon. That could undermine Symantec's Norton AntiVirus franchise, which boasts a 64% market share. (For more on the company, see the following story.)

But Symantec CEO John Thompson has been anticipating the Microsoft threat for some time. He has had success moving Norton customers to a subscription model, making them less likely to switch to competitors. Thompson has also pushed the company in the direction of enterprise security, a market Gates & Co. are less likely to crash. In June, Symantec bought Brightmail, a San Francisco firm that makes antispam software for businesses. Brightmail, in fact, was the 17th spam-or security-related acquisition made by the company since Thompson's arrival in spring 1999.

Given Symantec's 85% gross margins, $2.3 billion in cash, and leading market position, we think its future earnings prospects are more than bright enough to justify its current valuation. The company estimates that the consumer market for its antivirus products is only 50% penetrated. And it's not getting smaller.

Fun and Games ELECTRONIC ARTS /No. 30

What do you call a company with $3 billion in annual sales, almost 60% gross margins, earnings growth over the past three years of 254% annually, the dominant market share position in a growing global market with high barriers to entry, fanatically loyal customers, little direct competitive threat, $2.4 billion in cash, and, oh yeah, no debt?

We call it a buy. Electronic Arts (ERTS, $49), the global leader in videogames, makes its debut on our list this year as the second-ranked company in earnings growth. Last year the company released 27 titles that sold over one million copies on its way to recording almost $3 billion in sales. Particularly strong in sports games, EA owns the No. 1 titles in baseball, football, and soccer. Its role-playing franchise, The Sims, is the No. 1 PC game of all time, and it has also had great success with games tied to Hollywood hits like the Harry Potter series. (For more on how the company replicates its success, see the following story.) EA gets just over half its sales in international markets and makes products across all the current game platforms--from Xbox and PlayStation to PCs and handhelds. EA's is also the leading online gaming site.

Despite EA's strengths, its stock has had a bumpy ride this year. After hitting a 52-week high of $55.36 in early April, shares have slid 12%. The videogame industry is notorious for its boom-and-bust cycles, driven largely by the lifespan of game platforms. And with new consoles from Microsoft and Sony not due until late '05 and '06, respectively, investors should not expect an immediate payoff. "In the next six to 12 months, EA can be a little risky," says Deutsche Bank analyst Jeetil Patel. "But beyond that, it's going to be a phenomenal performer. It's a core holding."

Road Warriors THOR INDUSTRIES /No. 49

America's most numerous and financially powerful demographic category--yes, the baby-boomers--is easing into retirement with a well-documented demand for cruise vacations, high-end barbecues, and financial advice. And also, as it happens, recreational vehicles.

The average age of a new RV owner in the U.S. is 49, and the business is, well, booming. According to the Recreational Vehicle Association of America, RV unit shipments have increased an average of 11% per year since 2001. Meanwhile, across the country, park officials have quietly overhauled America's campgrounds, adding more wide-body parking spots, power hookups, and curbside water sources.

All that is a boon to Thor Industries (THO, $27), the largest RV manufacturer in America. Thor is the creation of New York City--based entrepreneurs Wade Thompson and Peter Orthwein, who bought the now uber-hip--then struggling--Airstream in 1980. Since then they've acquired ten more RV manufacturers, cobbling together an empire of established brands and imbuing it with an aggressive, cost-conscious corporate culture. Today Thor is the market share leader in "towables," and last year's purchase of manufacturer Damon helped push it into the No. 3 position in motor homes, competing head-to-head with industry stalwarts Winnebago and Fleetwood.

Thor's financial discipline has given it a big advantage over most of its rivals. Building RVs is a low-margin, capital-intensive business in which raw materials represent as much as 60% of total costs. By centralizing purchasing across its subsidiaries, Thor has cut materials costs significantly, allowing its portfolio of brands to win sales on price while at the same time delivering operating margins of 7.4%, vs. an industry average of about 5%.

Thor's stock fell 14% in the first couple of weeks of August, prompted perhaps in part by concerns about high oil prices. But industry veterans contend that RV demand is only very lightly correlated with the price of fuel. Sector analyst Kathryn Thompson at BB&T Capital Markets argues that a doubling of the price of gas would increase the cost of a typical family RV outing by 10% or less.

Thor has made little secret of the fact that it aims to get bigger, and there is plenty of opportunity for consolidation in this still fragmented industry. With no debt, more than $100 million in cash, an impressive track record, and the boomers behind them, Thompson, Orthwein, and crew are positioned for a long, successful ride.


As oil continues on its trajectory tOward $50 a barrel, just about any petro stock might seem a good investment. Not true, of course. But there are a barrelful of reasons we like explorer Encore Acquisitions (EAC, $27).

The pint-sized driller specializes in finding and extracting oil and natural gas in patches the bigger companies have left behind, buying predrilled properties as they enter the last quarter of their lifespan. Encore thus widens its profit margins by spending less on exploration. Led by CEO Jon Brumley, a 40-year industry veteran, Encore has demonstrated that it has excellent judgment in property acquisition. "[Brumley] is a proven oil finder, and a company under his stewardship is one to look at," says KeyBanc Capital Markets analyst Kim Pacanovsky. Starting later this year, it should begin using an innovative high-pressure air-injection technology to reach underground and literally squeeze every last drop from the farthest recesses. Encore believes the technique could increase its yields by more than 100%.

Industry analysts think that Encore has found a long-term profit center in the Cedar Creek Anticline, a large deposit in the Williston Basin of Montana and South Dakota that the company bought from Shell in 1999. The company has already upped production by 79% over Shell's output. And the new technology should boost that figure even further. Continental Resources, a company with property adjacent to the Cedar Creek, employed the same method and grew from 1,000 barrels per day to more than 2,400 over an eight-year period, according to Pacanovsky.

Encore can afford to take chances on new exploration down the road because it has accumulated a healthy backlog of supply. Its current known reserves could last the company more than 15 years, as opposed to nine to ten years for its competitors, estimates Pacanovsky. "Other companies don't have as many verifiable long-term opportunities," adds Deutsche Bank analyst John Bailey. "They're just depleting their drilling prospects."


So far 2004 has been a pretty tough year for Forest Labs (FRX, $47). Its blockbuster antidepressant Celexa lost patent protection in January, and the company hasn't been able to convert patients to its replacement drug, Lexapro, as efficiently as Wall Street had hoped. That has opened the door for generic competitors. On top of all that, in June Eliot Spitzer began a probe into the way Forest marketed Celexa. The result? Shares of Forest have fallen 40% from their 52-week high. For investors who don't mind a bit of risk, the stock's big dip is a great opportunity to buy into a proven company.

Founded in 1954, Forest is a midsized drugmaker that has been able to bring a number of big drugs to market, including Celexa, hypertension treatment Benicar, and a promising new Alzheimer's treatment, Namenda. Despite its problems, Forest netted $736 million in profits in its most recent fiscal year--double its 2002 total. And, no small feat, it's making its fifth straight appearance on our Fastest-Growing list.

Behind the headlines, there's still plenty of good news at Forest. Lexapro actually brought in $1 billion in sales last year, and analysts are expecting that figure to increase by 55% in 2005. The antidepressant was also No. 1 in new-patient market share, a key indicator for future gains, according to Morgan Stanley analyst Marc Goodman. Namenda, which was approved for late-stage Alzheimer's treatment last October, had sales of $45 million in fiscal 2004 and is on track to bring in $360 million this year--a 696% gain. The company is hoping to get FDA approval for use of Namenda as a treatment for Alzheimer's patients in the middle stages of the disease--the greatest portion of the 4.5 million Americans who have been diagnosed. And in July the FDA approved Merck's Campral, the first new treatment introduced since the 1970s to help recovering alcoholics stay on the wagon. Forest is licensed to sell the drug in North America, to a potential market of more than 14 million people. That should make the next couple of years much better for Forest's investors.

Picket Fences PULTE HOMES /No. 78

A quick look at this year's list makes two things clear immediately: Real estate has been exceptionally hot, and the stock market seems convinced that the good times fueled by low interest rates are over. Of our 100 fast growers, 18 are directly tied in to the housing and mortgage boom. And, almost without exception, those companies are the most steeply discounted in terms of P/E multiples. With interest rates beginning to creep up slowly, caution regarding real estate stocks makes good sense. But when it comes to homebuilders, the market may be underestimating the potential for further growth. Our favorite, Pulte Homes (PHM, $59), recently said its order backlog had climbed 31%, to $6.3 billion.

In the past three years the six builders on our list have seen their stock prices appreciate an average of almost 62% per year. That's a lot, but thanks to a nearly 40% annual increase in earnings over the same period, they are currently trading at an average trailing P/E of only 8.21. At that level, they're "priced for disaster," says Jack Kasprzak, managing director of BB&T Capital Markets. Rather than merely an artifact of low rates, Kasprzak argues, the recent growth in the national homebuilders is a "longer-term structural phenomenon" driven by both sustained population growth and an ongoing transformation of the building market.

Once the province of local construction outfits, the homebuilding sector has undergone a wave of consolidation in recent years, giving rise to some very large regional and national players. "Today the top ten builders control 22% of the industry," says Kasprzak. "Ten years ago it was 10%." With the cost of land and the complexity of getting permits increasing in the most attractive markets, the nationals' competitive advantages have only increased. The situation favors scale, and that's one reason we like Pulte, which operates in 44 markets.

Another is the company's Del Webb division, which specializes in developing communities for "active adults," those 55 and over. It's the industry's fastest-growing segment and one that tends to be far less rate-sensitive. Pulte trades at a slight premium over its competitors, but at these prices you shouldn't hesitate to buy the best.