Shooting Stocks

Follow the clues growth managers look for to pick stocks that are ready to soar

S&P Barra Value Index up 9.74% compared with growth’s 3.57% tally. And, as most professional investors will tell you, over the long haul, value’s record outstrips growth by a slender margin (“Revenge of the Value Investors,” August 1999). In the meantime, some of growth’s stalwarts have stumbled. Pharmaceutical stocks have rebounded since a government proposal that could have sent drug prices soaring was dead on arrival in Congress in late June. At the same time, some investors have grown wary of tech stocks, many of which are selling at incredible valuations.

To understand just how growth managers could possibly find the going rough after boom times, first consider how Wall Street values stocks. When investment pros examine stock prices and how much a company and its shares are worth, they tend to use the price-to-earnings multiple or P/E. Take a company’s share price, divide it by profits per share, or earnings, and you get a multiple, or a number indicating how shareholders value those earnings or profits.

Juggle the same equation and you’ll see how Wall Street’s appreciation for a stock might go up or down. A little math will show you that the product of a company’s earnings and its multiple equals its share price.

Portfolio managers will tell you that the growth school centers on the earnings side of that equation and just how quickly the executives in the boardroom can keep the bottom line rising or “growing.” Keep a company’s multiple fixed, raise earnings 10% a year, and it follows that the stock market will likely lift the corporation’s share price 10% annually as well. And to ensure that a stock will really get some attention, growth managers want companies that can outdo the market. With the S&P00 predicted to grow earnings an average of 7.5% over the next five years, according to estimates from Zacks Investment Research, staunch growth managers will tell you that they’re scouting for companies capable of growing profits-or the bottom line in industry parlance-10% or more annually.

There’s a second part to the growth manager’s credo, one which focuses on the “multiple” portion of the equation. When investment professionals consider what kind of multiple a company deserves, they look at several factors. First, there’s the industry and what kind of multiple competitors in the same business now get. A second factor is just how dependable earnings are. Wall Street has a fondness for companies that grow earnings year in and year out, so much so, growth managers say, that investors are willing to pay a premium or a higher multiple for that predictability.

Growth managers, however, still have some concerns. For one, the P/E for the broader stock market is perched at perhaps its highest elevation ever. Currently, the S&P 500 fetches about 27 times projected 1999 earnings. For growth managers, that could well be an indication that investors have already piled onto every stock with great possibilities around, which would limit the prospects for any given growth stock.

For growth managers, coping

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