| BUSINESSWEEK ONLINE : MARCH 29, 1999 ISSUE | ||||||||
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| COVER STORY
Sifting for Clues Tips for investors of all stripes--from go-go growth to go-slow value--who want to take charge and find some gems It's times like these that can make even the laziest investor look like a genius. After all, the 500 companies in the Standard & Poor's stock index rose a gravity-defying 28.5% in calendar-year 1998--the fourth straight year of 20%-plus gains for the group. But there's less to the market's runup than meets the eye--especially if you are choosing individual stocks, not an index fund. With half of the S&P 500 stocks finishing the year underwater or up by less than 6.6%, skilled stock-picking is more important today than ever. The tables in BUSINESS WEEK's third annual ranking of the S&P 500 companies can make the task easier. Together, our Performance Rankings and Industry Rankings can help you gauge how the stocks you own stack up, identify which of today's superstars have staying power, and find hidden gems. Start with the Performance Rankings, which begin on page 113. There, you'll find reams of information concerning eight key measures of the health and wealth of the S&P's 500 closely watched companies. With an A, B, or C--even the occasional F--you can tell at a glance how a company's fundamental performance stacks up. But savvy investors will want to do more than simply zero in on companies with straight A's and place a buy order. Use the Performance Rankings as a starting place for ideas, then turn to the Industry Rankings found on page 141. They contain a far more detailed portrait of how the S&P 500 companies compare against their closest rivals. SURPRISES. Of course, your own risk tolerance and approach to stock-picking will determine how you can best mine the data. Investors who are fans of hard-charging growth generally focus on rapidly expanding top and bottom lines. But those who like to hunt for bargains place a heavy emphasis on stocks that may be in the early stages of a turnaround, or have fallen out of favor with Wall Street. That means sifting through companies where sales and profit growth is slower, and where current price-earnings ratios are low. And cautious types tend to look for industry leaders with consistent profits and high dividends in addition to reasonable values. So if you're a growth investor, the fast-growing companies that dominate the BW 50 are an ideal launching pad for further research. Start by looking for rapidly expanding sales, with earnings that keep pace. A quick look reveals that 17 companies received straight A's for both sales and earnings growth in our Performance Rankings. To reach that threshold, the companies had to record sales growth of at least 16.7% for one year and a 21.6% annual average for three years, and earnings growth of at least 30.6% for one year and a 23.2% annual average for three years. The growth leaders include high-tech bellwethers Microsoft (MSFT) and America Online (AOL), sure, but also financial-services dynamo Capital One Financial (COF), retail giant Home Depot (HD), and--surprise--aerospace manufacturer B.F. Goodrich. To winnow this field, turn to the Industry Rankings to zero in on prospects with profit margins that are growing and higher than the average for their industries. High margins are an indication that ''perhaps a product has added a little more value than rivals' or a company is a better-run organization,'' says Garrett R. Van Wagoner, president of Van Wagoner Capital Management Inc., whose growth funds focus on small and midsize companies. As you might expect when dealing with straight-A performers, all 17 prospects have above-average margins compared with their rivals. But compare 1998 performance with 1997, and you'll see that four have the flat or declining margins that flash a warning signal to investors. The one member of the group that truly stands out for its margin growth is AOL. The Internet blue chip saw margins more than triple in the past year, rising from a low 2.3% to 7.7%, or slightly more than its industry's average of 6.9%. But just because a company is leaving its rivals in the dust doesn't mean its stock isn't overvalued. One further check used by many growth-style managers: Does a company's rate of profit growth outstrip its p-e ratio? If you look up our 13 remaining growth candidates in the industry rankings tables, you'll find that nine have p-es below or roughly in line with their one- or three-year profit growth rates. The survivors range from Microsoft and AOL to Gap (GPS) and Goodrich (GR). Though none are cheap, by this standard they aren't exorbitant either. A look back at how the 1998 BW 50 performed also supports this formula. For the 52 weeks ended March 12, 1999, the 30 stocks on last year's list that met this criteria returned 23.9%, vs. 21% for the S&P 500. BEATEN DOWN. Because fast-growing tech companies shine the brightest on Wall Street these days, it has been a tough haul for value players who look for unloved stocks likely to rebound. Last year, the S&P 500/BARRA Growth Index--which culls the growth stocks from within the S&P 500--beat its value counterpart by an unusually wide margin of 28 percentage points. The key for value investors is to find stocks that have been overlooked or excessively punished, but are rebounding. That means venturing further down the Performance Rankings. Start by looking at companies that earned a C grade or lower in either one- or three-year total returns. Then narrow the list by keeping only those companies whose grades for one-year sales and earnings growth exceed those they received for the three years. Dozens of companies pass the test, including insurer Chubb (CB), electronics manufacturer Electronic Data Systems (EDS), conglomerate Textron (TXT), and food and beverage giant PepsiCo. Next, turn to the Industry Rankings tables to see which of those prospects are undervalued. You'll want to search for companies whose p-e ratios run below average for their industry, or below the S&P 500, which currently sells for 33.6 times 1998 earnings. That would winnow out picks like Textron, which trades at a premium to its industry. Sometimes, of course, a stock has been beaten down because it deserves To be. To make sure you don't get stuck with a loser, examine how well your prospective investments use their money. Check the performance tables first to see if any have received high grades for return on equity (ROE), the most common yardstick. But because ROE is prOne to manipulation and can disguise a heavy debt load, a fuRther check can be done by looking at return on invested capital, found in the Industry Rankings. Robert J. Sanborn, who steers the Oakmark value-style fund, looks for companies with 10% or more in ROIC, meaning That they have earned at least 10 cents for every dollar invested by stock and long-term bondholders. Among the value-style candidates that meet this criteria: PepsiCo (PEP), Bestfoods (BFO), and Chubb. And for extra insurance, check to see if the Wall Street analysts' earnings-per-share forecasts signal more growth ahead. There, all of our prospects pass with flying colors except for PepsiCo, whose earnings are expected to rise only slightly this year. For investors of all stripes, it is always advisable to factor in several layers of analysis before scooping up--or dumping--a stock. Take, for example, Intel (INTC), a technology bellwether that tumbled from No. 4 to No. 40 on the BW 50 this year. In isolation, that certainly seems grim. But a look at the Performance Rankings shows that the damage was caused by poor grades for one-year sales and earnings growth. Take it a step further, to the Industry Rankings, and sure enough, sales rose a meager 5% last year, and earnings fell 13%. But in the same tables, you see that the chipmaker's rivals are suffering even more. Intel's profit margins and returns on capital are holding up better than most. Rather than fleeing, those willing to stomach some risk might conclude that Intel's current troubles represent a buying opportunity. If all this talk of highfliers and bottom-feeders makes you nervous, you can always stick with steady, proven performers. Start with industry leaders that have strong franchises. You might be willing to give up A-grade sales or profit growth in return for consistency--that is, one-year growth rates that at least match three-year growth. For extra insurance, look on the industry rankings for stocks whose dividend yields are high for their industries. Two straight-B candidates that fit this criteria, for example, are Merck (MRK) and Fannie Mae (FNM). Of course, no formula can insulate your portfolio against an unforeseen collapse in some region of the world or a sudden twitch in the trading herd. But by digging into the grades, rankings, and investment data in the following tables, you should have a leg up when it comes time to dial up a broker or fire up that Internet trading account. By Anne Tergesen in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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