Online Extra: Growth Stocks: Stunted No More
With value stocks ruling the stock market since the dot-com bubble burst in 2000, the past few years have been tough for growth-fund managers. Now, with growth stocks finally starting to rebound, Larry Puglia, manager of the T. Rowe Price Blue Chip Growth Fund, is sitting pretty. Lauren Young, BusinessWeek Personal Business editor, recently spoke with Puglia. Following are edited excerpts of their conversation:
Q: What are the catalysts for growth stocks? A:
Q: What are the catalysts for growth stocks?
A:We look at a number of factors. One would be that large-cap growth has underperformed other sectors of the market by a pretty good margin. The p-e ratios of the top 25 companies in the Standard & Poor's 500-stock index are as cheap as they've been in several decades. The companies in my fund are trading at about 17 times next year's earnings.
I've been saying for about a year that large growth is poised to do better. I was early and wrong. As for other factors, large-cap growth companies have continued to compound earnings, but the prices have gone sideways. There's a much higher percentage of dividend growth in the large-cap area. That has been underappreciated by investors despite the changes in tax law. But that, too, is changing.
One of the things that's absolutely truly consistent is that high-quality companies tend to perform much better when you have slowing S&P 500 growth, and we think earnings growth is slowing more broadly for S&P 500 companies. We've had several consecutive quarters of 20%-plus earnings growth.
Q: Any other factors that help growth companies? A:
Q: Any other factors that help growth companies?
A:Most of the companies in my fund are buying back stock. It's probably above what we typically see. Companies are very cash-rich. One of the things that's not necessarily supportive of growth, but supportive of stocks, is that cash is near record highs for the past couple of decades. Companies are generating lots of cash, and they have lots of flexibility to do acquisitions and repurchase shares. We should see a continued growth in mergers and acquisitions.
Q: Has it been hard to be a growth manager during the past few years? A:
Q: Has it been hard to be a growth manager during the past few years?
A:The only thing anyone wanted to talk about is real estate. I feel much better about things now than I did two months ago -- the irony of it is that we had good relative performance vs. other growth products when the market was performing poorly, but I want the market to do well. I want the sector to do well, too. That said, I'm trying not to get too excited.
Q: So what companies are poised to do well if the market shifts to growth? A:
Q: So what companies are poised to do well if the market shifts to growth?
A:We like State Street Bank, which has had several weeks of good performance. We also like General Electric (GE ). In a better market environment, it would be noticeably higher. The management has executed extraordinarily well. They just had their best qualitative and quantitative quarter in a decade. I like the way that they have changed the emphasis of the company and reallocated capital. They sold low-returning insurance businesses and made major acquisitions in health care and in entertainment.
They are keen on redeploying capital in growing areas. Frankly, it has worked better and sooner than we ever imagined. Look at aviation services -- the jet engine business. There's a big service component there. With that business poised to recover post-9/11, it is likely to stay strong for extended period.
Q: What else do you like? A:
Q: What else do you like?
A:One company where we've established a meaningful position is Kohl's (KSS ), the retailer. This is a much improved company. They've improved inventory-management systems and other systems. They are continuing to grow their square footage pretty rapidly. They also brought a number of brands into their store, including Chaps and Estee Lauder. It's a classic thing with retail: Improve merchandising, and you improve the system.
Q: Is there anything in your portfolio that hasn't moved much yet? A:
Q: Is there anything in your portfolio that hasn't moved much yet?
A:Harrah's (HET ) in the gaming area is one that we own. With the merger of Caesar's and Harrah's, you've got a powerful brand in the gaming and lodging group. Harrah's and Caesar's benefit even if Las Vegas slows down, because they've got significant exposure to Atlantic City.
Harrah's has a very, very powerful customer-loyalty program. They use customer data very well. They can earn as much as $4.40 per share in 2006. And the free cash flow is a lot stronger than the earnings number. That's something we look for. We are buying the company at less than 14 times what free cash flow will be per share.
Q: Any other others? A:
Q: Any other others?
A:One stock that hasn't moved that much is Nokia (NOK ). It's quite cheap. It's trading at about 15 times what we think they'll earn next year. They are much better at rolling products out that meet customers' needs on a timely basis. Initially, they were not good with clamshell phones. Now they have a number of products in that area. They also have a couple of low-end phones for the emerging markets.
They are a lot more effective at returning capital to shareholders. They are buying back stock aggressively. They have a dominant 30% market share.