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| There are probably as many methods of investing for growth as there are experts who think they know how to do it. The BusinessWeek 50 focuses on the best of the biggest -- large-capitalization companies in the Standard & Poor's 500 Index. The wisdom in sticking to the S&P 500 is that these companies represent a benchmark of performance for the market as a whole -- and, generally, aren't as volatile as stocks in the suddenly notorious Nasdaq.
Looking for growth stocks by limiting yourself to the BusinessWeek 50 can have its drawbacks, however -- among them that you're looking primarily at past performance and that you're ignoring literally thousands of companies. Granted, there's not much doubt about what happened last year. But when you're buying a stock, you're doing so based on how much money it can make you in the future. And last year's numbers aren't always a good indication of that.
Trying to guess the future has weaknesses, too: For instance, who would have predicted the fizzle in wireless growth last year? Or the resurgence of biotech? Investing based on predictions of analysts and others is a gamble, but perhaps no riskier than trying to extrapolate from the past. So if you've been looking for a way to crank future performance into your stock-picking calculations, you might want to consider the 12 criteria for growth companies that I came up with as an adjunct of sorts to the BW 50.
I translated my criteria into a list of values (see Twelve Steps to Finding Growth Stocks) that can be plugged into BusinessWeek Online's Advanced Stock Search to produce a list of potential growth companies not only from the S&P 500 but also from the entire universe of companies that are traded on the three major U.S. exchanges -- the New York Stock Exchange, American Stock Exchange, and the Nasdaq. My initial screen, on Mar. 19, turned up 76 companies -- four of which also among the BW 50. The list will obviously change by the week, sometimes even daily. To chart who's hot, who's not, and who comes and goes, simply rerun the screen each day.
My explanation of the thinking behind these growth criteria needs no further elaboration (see "Investing for Growth"). However, here are a few observations on how the BW 50 and my list diverge.
The Universe. The BW 50 is based on the usually safe and sane S&P 500. My universe of growth stocks includes all publicly traded companies in the U.S., including mid-and-small-cap stocks. Why? Because the bigger a company gets, the harder it is to grow fast -- and vice versa. And because, in the words of portfolio manager Foster Friess of Brandywine Fund, "industry leaders are so widely recognized and popular that their price-to-earnings ratios tend to get outrageous." That's another way of saying these stocks are often fully valued, whereas -- except in a dot-com bubble -- a lot of smaller stocks may not be.
History vs. Projections. As I was just saying, the BW50 uses only historical earnings and revenue numbers. Objective, verifiable stuff. But not necessarily prescient.
Ideally, investors use a combination of past and projected growth to find a future highflier. Trying to do so presents the challenge of separating hallucinatory projections -- the kind that created the dot-com bubble -- from accurate ones. I've tried to find a middle ground: Pick a growth rate for the future -- for earnings, cash flow, and revenue -- that seems sustainable for a growth company. Based on my conversations with money managers, I like 15%.
Valuation. The BW 50 rests heavily on the appreciation in a company's stock price. Such a momentum-driven strategy worked exceedingly well in the 1990s. But in normal times, investors would be wiser to take into account a more sophisticated indicator of value -- the price-to-earnings-to-growth (PEG) ratio. Typically, a PEG ratio uses forward earnings and an estimate of average future growth over five years. One note of caution: PEG is a concept most dot-coms were never acqainted with -- since, of course, they had no earnings.
Generally, however, the idea is to not simply to check to see that a stock is going up. Make sure that the company's business fundamentals justify the increase. Now, it's true that a PEG ratio is an easy thing to get wrong: Just ask anyone who forecasted dot-com earnings growth a year ago. My solution is to use the PEG, but make sure the ratio is low. I go by this rule of thumb: Never pay more than one times the future growth rate of any company.
To borrow from my magazine story on this subject, look at ADC Telecommunications for how to calculate a PEG ratio. The company has a 19.3 price-earnings ratio and estimated (by analysts) long-term earnings growth of 27.2% a year. So its PEG is 19.3 divided by 27.2. That's a ratio of 0.7. And that means that ADC's stock is 30% undervalued relative to its expected growth rate.
Momentum. The BW50 uses long-term momentum -- one- and three-year total return -- as a stock-picking criterion. Personally, I favor short-term momentum -- defined as the relative performance of a stock, compared with its peers, over the course of the most recent week. Look for a company whose stock is appreciating faster than that of its peers -- and of the overall market.
So what kind of companies come up using all these criteria? Plenty of beaten-down techs with high long-term growth prospects and low valuations. As of my most recent screen, on Mar. 19, semiconductor-equipment maker Electroglas (EGLS
) popped up. It has a PEG ratio of only 0.4, meaning that it's selling at a 60% discount to its estimated-earnings-growth rate. The company also has very little debt, which makes it a good bet for weathering tough times. Other bargain tech names that turn up with this approach include SanDisk (SNDK
), AVX (AVX
), Novellus Systems (NVLS
), Cypress Semiconductor (CY
), and Teradyne (TER
).
Compare such a list to the BW 50, and you'll find that the 50 has a much smaller tech component, and greater diversity. For instance, this year's BW 50 has a large concentration of stocks in industries with strong earnings fundamentals, such as oil-and-gas production and exploration, power generation, and banking. Such stocks have held up better in the downturn. But they may not yield the same capital appreciation as the undervalued tech stocks you'd get if you used my 12 criteria for investing in growth. |
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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