Are Growth Stocks Still a Growth Experience?

“There is no such thing as a growth stock,� mutual fund sage William Berger is fond of saying. “There are only companies in growth phases.�

Berger’s view may seem counterintuitive at first--given how generously the term “growth stock� has been applied on Wall Street--but of course he’s right.

Ideally, most long-term investors would like to own “worry-free� portfolios filled only with high-quality growth stocks: Companies offering great products or services, continually above-average earnings and dividend growth, a superior return on assets and, most important, dependable and rich share-price appreciation.

Looking back over the last 30 years, many U.S. companies have met all or most of those requirements for certain periods. Indeed, the growth-stock club has at various times included such industries as airlines, steel, specialty retailing and even electric utilities.

But few industries or individual companies enjoy longevity in the growth-stock category--which is Berger’s point.

That is why the plunge in Wal-Mart Stores shares last week was a bitter pill for Wall Street. For much of the last 20 years, Wal-Mart has been the ultimate growth company, expanding relentlessly, continually grabbing market share yet never compromising quality or service--or earnings growth.

The stock soared from $2 in 1984 to a peak of $34 in 1993. Earnings have risen for 99 straight quarters.

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But that earnings streak apparently ended with the fourth quarter. As Wal-Mart announced last week, it expects to report a fourth-quarter profit decline of as much as 11%, reflecting in part miserable holiday retail sales.

Naturally, there is no greater sin for a growth company than to stop growing. Wal-Mart’s warning caused its stock to plummet more than 10% for the week, ending at $19.875, a level it last saw in 1991.

If the premier discount retailer in America can’t lay claim to being a dependable growth stock, one might suspect that it’s tougher in general to find such stocks these days--even though the near-record level of the U.S. market as a whole implies that investors have high opinions of plenty of firms.

Don Yacktman, manager of the $600-million Yacktman stock mutual fund in Chicago and a veteran growth-stock investor, believes that the pickings for classic growth investors are definitely slimmer today than in years past. As Yacktman sees it there are two glaring problems with most of the stocks investors widely consider to be “must-own� growth issues now.

First, “Most people think of growth stocks as companies with [high] top-line growth,� meaning soaring sales, he says. “But a lot of them turn out to be ‘Roman candles,’ � burning brightly because of a hot product that quickly fades or is usurped, Yacktman says.

“You’re going to see that in spades with technology stocks�--Wall Street’s current hot growth-industry bet--�over the next year,� he contends.

Second, Yacktman says, many of the true, buy-’em-and-put-’em-away growth stocks of the era, such as Coca-Cola and Johnson & Johnson, are simply too expensive today relative to earnings, after huge 1995 price gains. A great stock-picker, he notes, knows not only what to buy--but when.

Wal-Mart offers a good lesson about the risks of overpaying. Even before it tumbled last week, the firm’s stock had been in a general decline since early-1993. The market was sounding a warning for those who would listen.

Investors who were still buying the stock above $30 in 1993 were paying more than 30 times Wal-Mart’s expected earnings a share that year. Yet the firm’s annual earnings growth rate was already in a marked decline from the 25%-plus of the early-’90s.

A general rule among veteran growth-stock investors is never to pay a price-to-earnings multiple, or P-E, higher than the company’s current growth rate, unless you expect that growth rate to surge.

In Wal-Mart’s case, by 1994 the evidence strongly suggested that earnings growth would more likely decelerate further than accelerate, as retail competition toughened and Wal-Mart’s already extensive coverage of the U.S. landscape limited expansion possibilities.

With last week’s plunge Wal-Mart shares are now priced at about 15 times the low end of analysts’ calendar 1996 earnings estimates (about $1.30 a share). That P-E is just under the 16% annual rate of profit growth the company believes it can still attain in the years ahead, the fourth quarter notwithstanding.

Some pros believe that Wal-Mart at a 15 P-E is a terrific bargain. “I think this is a buying opportunity,� says Arnold Kaufman, editor of Standard & Poor’s Outlook stock letter in New York. “Wal-Mart is going to come out of this [retail slump] stronger than ever,� he argues, because it has the staying power smaller rivals lack.

In fact, recent history includes several extended periods when certain big-name growth firms hit potholes in the earnings-growth fast lane, saw their stocks slump and were forced to restructure their businesses to restore growth.

Major drug stocks, for example, suffered deep declines in 1992 and 1993 as the federal health-care reform threat shook the industry. And when Philip Morris slashed cigarette prices in mid-’93 in a bid to steal market share, some analysts declared that brand names in general had lost their cachet, and that with it went the brand companies’ dependable growth rates.

Yet by 1995, many of the brand-name growth stocks were again the market leaders, hitting record highs as they delivered above-average earnings growth. In retrospect, the sell-off in the stocks in 1992-93 was a great time to buy.

“A lot of growth-stock managers are people who just look at [short-term] earnings momentum,� says Michael Sandler, co-manager of the Beverly Hills-based Clipper stock fund. His fund, he says, takes a much longer-term view in judging what constitutes a true growth company: “We buy with the idea that if the stock market shut down tomorrow we’d be happy to hold the business for 10 years.�

Clipper’s holdings include McDonald’s, PepsiCo, Federal National Mortgage Assn. and, in a recent addition, Wal-Mart. Sandler says all of the firms share a strong desire to raise market share and the cash flow with which to do so.

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Yacktman, however, isn’t so sure that Wal-Mart can quickly reverse its earnings-growth deceleration. As he notes, in the retail industry “everybody’s a discounter now,� and the industry shakeout is only beginning.

Instead, Yacktman’s favorite growth stocks include Philip Morris, Reebok, RJR Nabisco and Bristol-Myers. But as share prices in general continue to rise, he says, his “buy� list gets ever shorter.

John Tilson, co-manager of Pasadena Growth fund in Pasadena, has the same misgivings as Yacktman about Wal-Mart’s true growth prospects and about the retail business overall. The aging population trend is working against many retailers, he points out.

At the same time, Tilson believes that population and business trends have made long-term growth stocks of information-processing and -management firms such as First Data and General Motors’ EDS.

In the stock market, Tilson notes, “Earnings eventually win.� So the challenge for investors never changes: “You have to look out and ask, ‘Where is the real growth going to be?’ �

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Wal-Mart: Investors Saw It Coming

Wal-Mart shares plunged 11% last week after the retailer said its streak of consecutive quarterly earnings gains was ending--after 90 quarters. But a down-trending stock price since 1992 shows that investors have been suspicious about Wal-Mart’s growth prospects for several years. Quarterly closing prices on the NYSE, and latest:

Friday: $19.875

Source: Bloomberg Business News