Big Stocks That Keep Getting Bigger

Kiplinger's Personal Finance Magazine, April, 1999 by Manuel Schiffres, Brian P. Knestout

It's no accident that giant companies dominate today's market. Ten behemoths possess sterling prospects.

Last year marked the first time that Standard & Poor's 500-stock index delivered a 20%-plus gain for a fourth consecutive year--in itself, a remarkable tribute to this nation's can't-shut-me-down economy. Even more notable is that these four years of gains have come mostly from stocks on a short list of gigantic, fast-growing, blue-chip companies. In fact, a mere 15 stocks last year accounted for half of the 28.6% return of the S&P 500. Stocks of large, undervalued companies and of small companies of nearly every sort were pokey by comparison.

You could view this two-tiered stock market with either alarm or enthusiasm. Until recently, many people believed that price run-ups by the likes of Microsoft, Dell Computer and Home Depot were a temporary phenomenon. Jean-Marie Eveillard, manager of SoGen International fund, says that discrepancies between the values of big growth stocks and other categories have gotten so out of kilter that "only the timing of a change is in doubt."

But as long as these giant companies continue to rapidly increase their revenues and profits, the Eveillards of the world will be kept waiting. Lehman Brothers strategist Jeffrey Applegate, a leading proponent of the bigger-is-better theory, says that at least through the end of 1999, big-capitalization growth stocks should continue to lead the market. Among his reasons:

STEADY GAINS. Big companies offer more predictable and stable earnings growth than smaller companies, a trait that is especially desirable in a period of slow worldwide economic growth.

GLOBAL REACH. Big companies can take better advantage of economic globalization. They can move into overseas markets quickly and shift production to low-cost areas.

TIGHT CONTROLS. Big companies have higher profit margins than small ones, primarily because of their consistent ability to reduce their costs.

Applegate could add to his list one other propellant of today's great growth companies: farsighted managements that not only control costs but aggressively work to achieve dominance in their fields.

The hang-up about investing in giant growth stocks is at they are already pricey--some trade at 50 times earnings and up. Valuations of that magnitude bring back not-so-good memories of the Nifty 50--the glamour stocks of the early 1970s that were crushed in the 1973-74 bear market. (The S&P 500 sells at 26 times estimated 1999 profits.)

Applegate argues that you shouldn't be intimidated by the high price-earnings ratios. The dandy double of low inflation and low interest rates permits higher absolute valuations because a dollar's worth of future earnings is more highly prized than it would be if inflation and rates were higher. Plus, notes Applegate, the combination of "globalization and advances in technology has put us in a world that has never existed before." As for big, bluechip growth stocks selling at even higher values than the overall market, "there should be a premium for companies that are leaders in their fields and can withstand really intense competitive pressures," says James Mohz, who runs Deutsche Top 50 U.S. fund.

In any case, what's important is that you own the right companies--those that deliver steady profit gains. The compounding of earnings, says Jim Craig, manager of $27-billion Janus fund, should result in healthy stock appreciation even if P/Es remain stagnant. Adds Spiros Segalas, manager of Harbor Capital Appreciation: "If you're right on the earnings, they'll eventually bail you out."

Ironically, the biggest threat to the steady growers may well be a strengthening global economy. For one thing, that could mean higher inflation and higher interest rates, which would make investors less willing to pay up for future profits. In addition, strong growth is more beneficial to more economically sensitive companies. "When companies like Caterpillar, Deere and General Motors start reporting huge earnings gains, the dollars flow out of the drug companies" and similar growth stocks, says Scott Chapman, co-manager of Founders Growth fund.

With all this in mind, here are ten muscle-flexing stocks that deserve a place in the portfolio of any investor--particularly one willing to hold a stock for five years or longer. All of these stocks have market capitalizations in excess of $40 billion, and all are expected by analysts to generate annual earnings growth of at least 14% a year over the next three to five years.

TECHNOLOGY GOLIATHS

Less than a quarter-century after its founding, Microsoft (symbol MSFT, Nasdaq, recent price $158) has become the most valuable corporation in the world. Its stock, which went public 13 years ago, has since risen 400-fold. Now the government is so fearful of the company's dominance of computer software that it is suing Microsoft for alleged antitrust violations.

Microsoft operating systems are the hearts and lungs of 90% of personal computers, and thanks to an explosion in sales of below-$1,000 computers, the Microsoft juggernaut seems to have shifted into a heretofore unused gear. The company, fondly called Mr. Softee on Wall Street, recently stunned investors when, for the quarter ended December 31, it reported a 75% jump in profits, to $2 billion. Not too shabby for a company with annual revenues of $17 billion, a stock-market capitalization of $450 billion and a cash war chest of $19 billion. "They get the same dollar amount no matter how much the boxes are sold for," notes fund manager Segalas.