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Jubak's Journal
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| | Jubak's Journal
Where have all the growth stocks gone?
Some have been exposed as impostors. Some are cooling off. Some are simply out of favor. Here's how to see where your stocks fall.
By Jim Jubak
Its a tossup as to whats more depressing to long-term growth investors: the failure of blue-chip growth stocks to hold their ground after the popping of the bubble in 2000 or the way these stocks have underperformed in the rally that began on March 11.
Here are the three-year average annual returns on some classic growth stocks: Coca-Cola (KO, news, msgs), down 7.8% a year on average. Gillette (G, news, msgs), down 8% a year. Wal-Mart (WMT, news, msgs), down 9.5% a year. Microsoft (MSFT, news, msgs), down 23.8% a year. Home Depot (HD, news, msgs), down 29.2% a year. (Microsoft is the parent of MSN Money).
The returns arent any better if you look at just the last year. Coke fell 5.4% in that period, Gillette 7.2%, Wal-Mart 11.7%, Microsoft 22%, and Home Depot 52.6%.
And how have these blue-chip growth stocks performed as the market has rallied? From May 1 through Aug. 15, the Nasdaq Composite ($COMPX) has climbed 15.6%. Microsoft is down 0.7%; Gillettes up just 4.9%. Home Depot has bettered the Nasdaq with a 22% gain. But Coke trails at 11.3% Thats as good as it gets. Wal-Mart is up just 3.9%.
Its enough to make investors throw up their hands and ask, Is this the end of blue-chip growth stocks?
The answer to that, as it is to so many questions in this market, is: It depends. And it depends on which of the four categories of blue-chip growth stocks the stock were talking about falls into.
Is it simply an out-of-favor growth star; a growth star reset; a growth star imposter; or a cooling growth star?
Let me describe each category. Then, Ill assign a few well-known growth stocks to each.
Out-of-favor growth stars
These stocks cycle in and out of favor with investors. For a time, perhaps years, small-company stocks will outperform large-company stocks, and then for a time, large-company stocks will lead the market. Right now, steady growth stocks arent in particular favor with the kinds of investors who dominate the market because stocks with more volatility offer the potential for bigger rewards. Think of it this way: Over the last five years, PepsiCos (PEP, news, msgs) earnings per share have grown 15% a year. That average conceals some volatility, of course. In 2001, earnings per share fell 0.7% from 2000; in 2002, they grew by 25.6%.
But thats mild compared to the volatility in a stock such as Merrill Lynch (MER, news, msgs). Merrill Lynchs 1998 earnings per share dropped 38% from 1997. They fell 86% in 2001. But in 2002, earnings jumped 361%.
Granted, no investor would like to be downhill from that kind of volatility. On the upside, however, a stock that can rebound from a terrible year has considerable earnings leverage that a PepsiCo lacks just because it is so much more consistent. With the stock market rallying on investor hopes for the kind of strong economic recovery that plays into Merrill Lynchs earnings leverage, its not surprising that in that May 1-April 15 period, Merrill shares are up 30.1%, about twice the gain in the Nasdaq. PepsiCo shares are up just 3.4%.
But investors who look not too far out can see a likely changing of the guard in 2004. Wall Street analysts project Merrills earnings will grow 27.6% in 2003 and PepsiCos just 12.4%. Next year, Merrills earnings per share are forecast to grow by just 7.5% and PepsiCos by 11%.
Honestly, theres nothing wrong with these stocks that cant be fixed by the market tilting in their favor next year, as some indicators are now suggesting. Besides PepsiCo, Id put American International Group (AIG, news, msgs), Avon Products (AVP, news, msgs), Dell (DELL, news, msgs), Johnson & Johnson (JNJ, news, msgs), Pfizer (PFE, news, msgs), Sysco (SYY, news, msgs), Procter & Gamble (PG, news, msgs) and Walgreen (WAG, news, msgs) in this camp. All have underperformed in this recent rally. A few even show losses. Talk about out of favor.
Growth-star resets
A lot of companies with amazing records of consecutive years of earnings growth have seen those streaks end. In most cases, the ends didnt have much to do with the recently concluded recession but more to do with efforts to take advantage of the temporary weakness of competitors.
State Street (STT, news, msgs) has grown earnings per share every year but one in the past 10 years. But 2003 is clearly going to be a very different story, with earnings per share already running a whopping 86 cents a share behind the $3.10 earned in 2002. The short-term pain is the result of the costs of State Streets acquisition of Deutsche Banks (DEUCF, news, msgs) huge global custody business. The deal has made State Street the largest custodian of financial assets in the world. Over the long run, the deal should bring even more growth to State Street. But 2003 definitely marks a reset year in the companys growth record. Other stocks Id put in this group include BP (BP, news, msgs) and Schlumberger (SLB, news, msgs).
Growth-star impostors
AOL Time Warner (AOL, news, msgs) is this categorys poster child. Not because the online business is slowing and not because the company allowed its technology to grow old. And not even because America Online faces huge challenges from broadband Internet providers to its bread and butter dial-up business. (Any of these would be a significant challenge for any growth company.) Rather, its an impostor because, as recent accounting news has revealed, just about everything the companys critics have said through the years about how it used gimmicks to pump up its growth rate was absolutely true. The organic growth (that is, the internal growth from existing business lines) was never as robust as investors, including this one, believed.
AOL Time Warner isnt alone. Id include Amazon.com (AMZN, news, msgs), which continues to use accounting that masks the true cost of acquisitions; IBM (IBM, news, msgs), which used pension fund gains and other tricks to bolster growth, and Boeing (BA, news, msgs), which used acquisitions to make it appear its core business was growing.
Cooling growth stars
What growth rate can investors expect out of Cisco Systems (CSCO, news, msgs), one of the 1990s great growth stories? Right now, Wall Street estimates that Cisco will average earnings per share growth of 14.9% a year over the next five years. Thats impressive enough to put the company in a class with PepsiCo and Pfizer.
But its small potatoes compared to the companys past growth rates. In 2000, the companys earnings per share growth rate for the previous five years stood at 33.6%.
So which is it? Will Cisco grow like PepsiCo or Pfizer over the next five years ahead? Or will it resume the growth of its heyday? The market is clearly pricing the stock for the latter possibility. PepsiCo trades at 22.7 times trailing-12-month earnings and 20.9 times projected 2004 earnings per share and Pfizer at 29.1 times current earnings and 18.8 times forward earnings. Cisco Systems is trading at 36 times trailing 12-month earnings and 27.8 times fiscal 2004 earnings.
The problem with Cisco isnt that 14.9% annual earnings growth is shabby. If the company delivers that growth rate, Id class it with the other great blue-chip growth stocks. But the stock isnt priced for that kind of growth. Instead its priced for a resumption of past growth rates of growth. And Id say thats extremely unlikely.
Intel (INTC, news, msgs), Microsoft and Texas Instruments (TXN, news, msgs) are three stocks that trade as if old growth rates are right around the corner.
The problem isnt limited to technology. Whats the likely future growth rate for Coca-Cola, Gillette, McDonalds (MCD, news, msgs) and Walt Disney (DIS, news, msgs)? I think these companies are likely to better their recent sluggish performances, but I certainly wouldnt buy them at prices that assume a return to past growth rates.
These stocks may have to go through an extended period of below-market performance to work off the premium, based on past growth rates, thats still in the stocks.
Thats my backward look at the challenges and problems facing the blue chip growth stocks that investors have come to rely on. In my next column, Ill be taking a forward look as I revise the 50 Best Stocks in the World portfolio and go looking for unfamiliar but established growth stars.
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: American International Group, Microsoft, PepsiCo, Pfizer and Sysco. He does not own short positions in any stock mentioned in this column.
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