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On Top of Its Games

For Electronic Arts (ERTS), the party may have only begun. Shares of the No. 1 maker of game software have zoomed 40% this year--hitting a 52-week-high of 59 on Apr. 18--but there's still room to play, say some pros.

The electronic-game industry, which produced the likes of Mario and Myst, is "on the cusp of a five-year cycle that is potentially enormous--and Electronic Arts dominates," says equity analyst Edward Williams of Gerard Klauer Mattison. EA's new generation of games will hit the $20 billion worldwide retail market just as Microsoft, Nintendo, and Sony roll out new versions of the GameCube and PlayStation consoles on which games are played. And the market is expanding: Better graphics have boosted the base of users from just children to adults. "It's more of a mass market now," says Williams.

Not that there aren't volatility problems. Case in point: A news item--speculating whether Microsoft might stall the launch of its Xbox video game console--pushed EA down 9% in one day. It quickly recovered, but the rumor revealed a sore spot: potential console shortages. That's "the kind of problem you want to have," says Williams. "We're not suffering from a demand issue here." The Electronic Entertainment Expo (E3) in May could fuel stock gyrations before EA settles in a trading range. That could provide a buying opportunity before the holiday season heats up, says Heath Terry of Credit Suisse First Boston: 75% of game sales are made in the fourth quarter. Terry's yearend target is 70. He expects earnings to grow from 17 cents a share last year to 50 cents this year and $1.60 in 2002. "The big year is next year," Terry says. Patents on drugs that currently produce a massive $34 billion in sales will expire soon, starting this year with premier names such as Prozac and the diabetes drug Glucophase. That's more than twice the amount that has come off patent in the past 10 years--and good news for distributors such as Cardinal Health (CAH). While Cardinal also distributes brand-name drugs to retail chains and hospitals--CVS, Walgreen, and the Mayo Clinic, for example--it makes more gross profit from generics. Anticipating the boom, investors have bid up Cardinal's stock, which has doubled in a year. It trades at 96--down from 105 in December. But "the best times are still ahead," says analyst Leonard Yaffe of Banc of America Securities. He has rated Cardinal a "strong buy" since 1995 and has a one-year price target of 130. Jonathan Green at Dresdner Kleinwort Wasserstein reiterated his "buy" rating on Apr. 12; his 12-month target is 120.

A strong balance sheet and revenue growth account for the upbeat forecasts. Cardinal's distribution business, which accounts for 80% of revenues, is growing at twice the industry average of 12%, as it continues to snatch market share from such rivals as McKesson. It also operates higher-margin services, including Pyxis, an automated drug-delivery system--rather like an ATM. "That mix can sustain a 23% earnings growth rate," says Yaffe. Merrill Lynch's analyst Owen Hughes notes that Cardinal's price-earnings ratio is 28, based on 2001 earnings per share of $3.40, and 23, based on next year's expected $4.07--a ratio 10% less than most large-cap drug stocks. Energy stocks: Been there, done that? Not so fast. "Most people believe it's over and done with," says Susan Byrne, money manager for Westwood Management, which oversees $4 billion. "But we're expecting a much longer period of growth and profitability." Why? Because demand will spike and supply won't cover the needs.

That's where astute energy producers such as Apache (APA) come in, says Byrne. Westwood holds the stock in most accounts, including the $250 million Gabelli Westwood Equity Fund. For years, the Houston outfit has been building up its natural-gas and coal reserves, funding acquisitions with equity offerings. Analysts say it got the reserves for a song, compared with the cost of building them from scratch. The result: "very strong positive earnings surprises," says Byrne. First Call's consensus estimate for first-quarter 2001 earnings (to be released Apr. 26) is $2.12 per share and $7.20 for the year 2001. Byrne's own forecast is $2.50 for the quarter and $8.25 for the year.

The stock, trading at 62, sells at a price-earnings ratio of only 7.5, based on Byrne's estimate for this year's earnings: her near-term target is 80. Christopher Wolfe, equity strategist at J.P. Morgan Chase, has a 12-month target of 90.

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