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Jubak's Journal
Recent articles:
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| | Jubak's Journal
3 rules for chasing real growth stocks
It's important, as the bubble's big losers begin to recover, to separate fantasies of earnings growth from the real thing. Here's how.
By Jim Jubak
Theres a tremendous faith in earnings growth in this stock market right now. Not just in a one-time bounce as the economy rebounds, but a sustained acceleration that brings growth rates back to where they were before everything went south.
Take Analog Devices (ADI, news, msgs), for example. The stocks up 60% this year on a spectacular earnings rebound. In the quarter that ended in January, earnings grew 167% from the same period in 2002. Second-quarter earnings increased 375% from the year-earlier quarter.
But the stocks price says there must be much, much more to come. Shares trade at 70 times trailing 12-month earnings.
Is there more? Its the big question for former growth stars that have soared in anticipation of an economic recovery. Stocks such as Cisco Systems (CSCO, news, msgs), up 46% this year so far, Applied Materials (AMAT, news, msgs) up 48%, and Intel (INTC, news, msgs) up 60%, trade at price-to-earnings ratios of 40, 236 and 44, respectively. Investors in Intel, for example, are counting on projected growth of 32% in 2003, 29% in 2004, and 16% on average over the next five years.
And its an even bigger question for the fallen angel stocks of the 2000 bubble that have returned to angel status in the current rally. Broadcom (BRCM, news, msgs) -- remember it? -- is up 51% this year. GlobeSpanVirata (GSPN, news, msgs) is up 56%; Nvidia (NVDA, news, msgs) 83% and Ameritrade (AMTD, news, msgs) 74%.
How I found 7 new names
Before you go plunking your hard-earned cash down on some of these high fliers, its important to know if this faith is warranted or is mere nostalgia.
Unfortunately, as I found out when I started my annual revision of the potential high-growth stocks on the Future Fantastic 50 list, there arent any shortcuts to separate real growth potential from fantasy. In fact, evaluating the growth prospects of these former growth stars is actually harder than starting from scratch with an unfamiliar stock. Thats because these kinds of stocks come with so much emotional baggage for the investors who have ridden these stocks up or down.
So let me run you through a few important steps that I used in revising the Future 50. Youll find the revised list by following the link to the left. Seven new names have been added that I believe will produce above-average growth in earnings and above-average appreciation for investors over the next five years.
Acknowledge that the histories of these stocks make it difficult to think about them objectively. Remember JDS Uniphase (JDSU, news, msgs)? The stock was one of the big stars that burst in the 2000 telecommunications bubble. It went from a couple of bucks a share in the mid-1990s to an all-time high of $147 on March 6, 2000. By October of last year, it was trading for $1.62.
Revenue growth fueled those gains, though the company never did show a profit during this period. Revenue grew by 53% in 1999, 405% in 2000 and 127% in 2001.
Revenue tumbled 66% in 2002 and another 38% in fiscal 2003. For all of fiscal 2003, revenue came in at $676 million, a 79% fall from the peak 2001 revenue of $3.23 billion.
Now, if the stock could get from its current price of $2.75 to something like its old high of $147, investors would make a bundle. If sales climbed back to $3.23 billion, five times current levels, investors would cart away their gains in wheelbarrows. If the company could get revenue growth back to even 50% a year, never mind 130% or 400%, investors would be rolling in profits.
But thats all just wishful thinking. JDSU is a very different company from the one that employed 29,000 workers in 2001. Its shed businesses and shuttered operations; it now employs just 5,500. And restructuring continues. No one is quite sure just what the finished project will look like. The company doesnt know when sales growth will resume, and it just predicted an additional 10% decline in revenue for the first quarter of fiscal 2004. Relying on analyst projections of 20% annual earnings growth for the next five years is an act of faith rather than a logical business decision. And remember that growth rates always look deceptively high when a company is coming off losing quarters. JDSU isnt projected to show an annual profit until the 3 cents a share in earnings expected by analysts for fiscal 2005.
Start from scratch and ask, 'What in the specific situation attracts me to the company?' For my Future 50 and 50 Best Stocks in the World lists, I start with a specific form of that question: Im looking for companies with a sustainable competitive advantage, whether its technology or sales and distribution, or brand name. Whatever your own key question, ask it of the stocks youre studying.
For example, GlobeSpanVirata, a member of the Future 50, has emerged from the horrendous shakeout among DSL suppliers as the leading specialized provider of DSL chipsets. (The company does face intense competition from more board-based chip makers such as Texas Instruments (TXN, news, msgs) and Broadcom.) The company was able to acquire competitor Virata in 2001 for just about cash value. That size balances the companys focus on the DSL technology to give GlobeSpan a solid sales argument that lets the company push in the Chinese and Japanese markets. Each now represents about 30% of its revenue. With the domestic phone companies pushing DSL as a way to compete with cable companies, Globespan can count on solid, if often lumpy, growth in the United States. Morgan Stanley forecasts that DSL chip sales will grow by 35% in 2003.
On the other hand, Human Genome Sciences (HGSI, news, msgs) doesnt pass this test. I added the company to the Future 50 because I believed the companys database of gene sequences gave it a unique advantage in developing new drugs. So far, though, its been much more difficult to turn that database into actual drugs, and, while the company does have eight drug candidates in the pipeline and lots of cash, its record so far just doesnt add up to the kind of competitive advantage I need to see. In short, I dont see a compelling reason to put my money here.
Determine if long-term trends are working in the companys favor. The toughest thing to nail down in the current market is the timing of a recovery. To make up for that uncertainty, an investor should feel comfortable that the long-term trend will eventually deliver the desired result. You should have a reasonable assurance, in other words, that patience will be rewarded.
Oracle (ORCL, news, msgs), for example, doesnt make this cut. Competition in the companys database market is heating up, and, in this round of the contest, the competitors, IBM (IBM, news, msgs) and Microsoft (MSFT, news, msgs), have the staying power and the technology to wage a real fight. (Microsoft publishes MSN Money.) Margins in the database business are under attack, and, if we believe Oracle CEO Larry Ellison, the database market has matured. Oracle sales will probably bounce back at some point, but the long-term trends suggest that the bounce may be smaller and later than now anticipated.
On the other hand, Ameritrade (AMTD, news, msgs) results are clearly dependent on the return of the individual investor to the stock market. The companys most recent quarterly results, while they dont prove that investors are back for good, do show that the companys business model will deliver accelerating earnings growth with any increase in trading volume. With that long-term dynamic, Im willing to be patient.
Heres how these three rules add up for the Future 50 portfolio in this years revision.
7 stocks are out
AstroPower (APWR, news, msgs) has been delisted by Nasdaq for failing to file its annual report and 10K.
Im removing Human Genome Sciences because I dont believe the company now possesses a significant competitive advantage to make up for its substantial risk and uncertain timetable.
Im also removing Oracle because of increasing competition that has eroded the companys competitive advantage.
In addition, Im removing four other stocks: Their relative maturity make them better fits for the 50 Best Stocks in the World portfolio than for the more aggressive Future 50. Ill be considering adding those stocks to the 50 Best list when I revise that portfolio.
7 stocks are in
- AmeriTrade. I choose this company on evidence that its platform for individual investors delivers superior returns of scale to the company as volume increases.
- Ballard Power (BLDP, news, msgs). The company isnt expected to be profitable for another two or three years, but it is arguably the best way to play the developing fuel cell industry.
- PACCAR (PCAR, news, msgs). This companys strong brands (including the Peterbuilt and Kenworth truck lines) and flexible cost structure make it the leading maker of heavy-duty trucks, and PACCAR is aggressively moving into the medium-duty truck market.
- Rio Tinto (RTP, news, msgs). This diversified global mining company has become a key supplier of iron and aluminum to China.
- Talisman Energy (TLM, news, msgs). This Canadian oil and gas producer (48% of production) has huge potential in Southeast Asia.
- Total Systems Services (TSS, news, msgs). A younger First Data, Total Systems specializes in electronic payment processing.
- Trimble Navigation (TRMB, news, msgs). This is a leader in software and hardware for global satellite positioning systems, a technology with major growth trends behind it.
Those are my seven new long-term growth candidates for the Future 50 portfolio. As always, please do your own due diligence. I havent been able to do anything more than wave at these stocks in this column.
My mention here doesnt mean that these stocks are at a good price for a buy. Im holding off on any buy recommendations for this portfolio until I see how August shakes out. And finally, please note that the Future 50 is designed for the riskier edge of any portfolio. These are more speculative growth stocks that should be balanced by a core of blue-chip growth and value picks.
New developments on past columns
One way to invest for four different futures
Its hard to read much into the big numbers in Pfizers (PFE, news, msgs) July 25 earnings report. Yes, earnings per share at 30 cents for the quarter came in a penny above Wall Street expectations, and revenue at $9.9 billion was up 37% from last year, but both figures were heavily influenced by the accounting for Pfizers acquisition of Pharmacia. The revenue number, for example, included results from Pharmacia for much, but not all, of this quarter. Last years revenue for Pfizer didnt. Looking below the top numbers, however, you can see what continues to worry Wall Street about Pfizer: the potential for slowing sales in blockbuster drugs. Lipitor, the best-selling drug in the world, for example, showed revenue growth of 13% for the quarter on a global basis but just 3% growth in the United States. Pfizers future stock price hinges on how well drugs such as Lipitor and Viagra hold up against new competition this year and on how successful the company is in getting the promising drugs in its pipeline to market. On the other hand, Pfizer is trading for just 15.6 times projected 2004 earnings of $2.13 a share. As of July 29, I'm keeping my target price at $42 a share but stretching out the deadline to December. (Full disclosure: I own shares of Pfizer.)
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Applied Materials, Charles Schwab, Microsoft, Performance Food Group, Pfizer, RF Micro Devices, Smithfield Foods and Whole Foods Market. He does not own short positions in any stock mentioned in this column.
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