Print-friendly version
Send this to a friend
Posted 4/21/2000
Jubak's Picks
--------------------------------------------------------------------------------
Check out Jim's top stocks for the next 12 months.
50 Best Stocks Today
--------------------------------------------------------------------------------
See Jim's list of the 50 best stocks in the world for the long term.
Future Fantastic 50 Stocks
--------------------------------------------------------------------------------
See Jim's reader-assisted Future Fantastic 50 portfolio.
sponsored link
Jubak's Journal
Don't even think about switching sectors
Not all blue chips are cheap and not all technology is expensive. Try picking stocks instead of trying to guess the identity of the next hot sector.
By Jim Jubak
I know everybody is telling me to get out of technology stocks because they're risky and too expensive. I'm supposed to be buying Old Economy growth stocks, what some market analysts still call blue chips, because they're safer and cheaper.
Well, I've cranked the numbers, and I think that's just dead wrong.
Check out our experts' latest posts
Jim Jubak
Jon Markman
More...
Oh, there are technology stocks that are definitely still too expensive. The stocks of companies without viable business plans, without a product or without the cash -- or the prospects of raising it -- to survive until breaking even. Stocks like these are too expensive now -- as they were before last week's crash. I wouldn't buy them no matter how cheap they get.
But real technology companies like PMC-Sierra (PMCS, news, msgs) or Network Appliance (NTAP, news, msgs)? I don't think they were overvalued before, and I certainly don't think they're overvalued now, especially in relationship to the blue-chip growth stocks. And I think I can prove it.
If I'm right, then I'd say that the advice to shift massive parts of your portfolio from the technology sector to these blue chips is wrong, and it's likely to cost you significant money. If I'm right, it means that instead of trying to pick the next sector with momentum, you should be looking for relative bargains no matter what the sector. To help you do that, I'm going to end this column by listing the 10 stocks among my 50 Best Stocks in the World that I think represent the best buys now, regardless of sector or their membership in the Old or New economies.
It's tough to compare the valuation of stocks with very different growth rates and future prospects, but the good old reliable PEG ratio is a solid place to start. (To build a PEG ratio, you divide a stock's price-to-earnings (P/E) ratio by its growth rate. I like to use the forward P/E ratio -- that is, the current price per share divided by the projected annual earnings per share -- and a projected future growth rate. I think that gives me a better picture when I'm comparing two growth stocks.)
Comparing Coca-Cola and PMC-Sierra
Let's go through this process for Coca-Cola (KO, news, msgs), a blue-chip growth star from years past that reported better-than-expected earnings this week. (Wall Street had expected 21 cents a share; Coca-Cola reported 32 cents.)
On April 14, the Friday that took the Nasdaq Combined Composite Index ($COMPX) down 25% and that resulted in all that weekend advice to buy blue chips, Coca-Cola closed at $47. Adding the most recent earnings surprise into analyst projections results in an earnings estimate of $1.56 a share in 2000. That's a forward P/E ratio of about 30. In its most recent conference call, Coca-Cola's management said that it was targeting 15% growth in earnings per share. That's higher than analysts expect for 2000, but I'll give the stock the benefit of the doubt, since I don't want to be accused of shooting only crippled ducks here. That means Coca-Cola has a forward PEG ratio of 2.
Now let's go through the same process for PMC-Sierra. On April 14, the stock closed at $118.50. The day before, the company had reported earnings per share of 17 cents, a penny above Wall Street estimates. Adding that very modest surprise into analyst projections brings earnings estimates for the full year 2000 to 77 cents. So on April 14, the stock traded with a forward P/E ratio of 154 -- considerably higher than Coca-Cola's forward P/E ratio of 30.
But then PMC-Sierra has been growing earnings much faster than Coca-Cola, and analysts project that it will continue to do so for 2000, 2001 and beyond. Using their 80% earnings per share growth rate projected for 2000 -- a whopping six times the projected growth rate for Coca-Cola -- the PEG ratio for PMC-Sierra comes to a surprisingly modest 1.9. Adjusting for the difference in projected growth rates, this "expensive" technology stock is actually cheaper than the blue-chip growth stock.
Of course, all these calculations use projections. There's no guarantee that any of the numbers Wall Street analysts now expect will actually materialize. That's why I think it's good to risk-adjust, at least approximately, any stock's forward PEG ratio.
In scary and hard-to-read markets like this one, individual stocks tend to become very mispriced, simply because a lot of investors and Wall Street strategists are looking for a quick fix.
What are the chances, for example, that Coca-Cola won't make the 15% target for earnings growth that the company promised to deliver? Pretty high, I'd say. In the most recent quarter, worldwide unit volume rose only 2% (on a comparable basis). To get that 15% earnings growth, Coca-Cola's management is looking for 7% to 8% unit growth. Not an impossible number to reach, but not a slam-dunk, either. Increasing unit growth from 2% to 8% takes very aggressive marketing and more than a bit of luck.
What are the chances that PMC-Sierra won't hit the 80% growth rate that Wall Street has estimated? Pretty low, I'd say. The company shows one of my favorite earnings patterns -- accelerating earnings growth, quarter by quarter. (In the old days, we called this momentum; now, it's better to call it earnings momentum to distinguish it from the recently more-popular price momentum.) In the most recent quarter, the company grew earnings per share by 183% over the same quarter in 1999. In the previous quarter, the fourth quarter of 1999, the company grew earnings by 107% over the same quarter a year earlier. Companies showing accelerating earnings growth like this are better than average bets to make or surpass projected earnings for at least the next two or three quarters. Once a technology company's products are on a roll -- with the company racking up design wins that result in more customers using its product -- the good news goes on for quite a while. That makes it relatively likely that PMC-Sierra will make analyst projections over the next year. Its forward PEG ratio actually includes less risk than Coca-Cola's does.
Hunt stocks, not sectors
Now, does this mean that all technology stocks are cheap and all blue chips expensive? Of course not. And it's not a call on my part for anyone to shift a big part of any portfolio from one sector to another.
In fact, I think of this as a kind of anti-sector call. In scary and hard-to-read markets like this one, individual stocks tend to become very mispriced, simply because a lot of investors and Wall Street strategists are looking for a quick fix. The quickest fix is to dump on one sector of the market and to wave the flag for another sector. That leads to a lot of great stocks getting unjustly trashed, and a lot of bad stocks getting unjustly recommended.
In time, and once the panic passes, investors will start to discriminate within sectors. Earnings stories, management and product cycles will all start to count on the upside and the downside. We'll stop hearing silly blanket statements such as "Technology stocks are too expensive" or "Buy the blue chip names; they're cheap and safe." And we'll start to pick individual stocks again.
If you can skip over the stage of silly sector calls and go right to analyzing and picking individual stocks, you'll be doing your portfolio a favor.
Jubak's Archive
--------------------------------------------------------------------------------
Recent Jubak articles:
? It's time to learn the bear necessities, 4/18/00
? Is tech investing dead?, 4/14/00
? How to handicap B2B winners amid the chaos, 4/11/00
More?
And now, 10 best buys
In my "10 best buys now" recommendations from the 50 Best Stocks in the World, I've looked for either:
Stocks that are really cheap -- true value stocks -- where I can see a short-term catalyst that could get the stock price moving. Mattel (MAT, news, msgs) is a good example of this kind of stock. It's certainly cheap. You can buy all the company's public stock for just $5 billion, which is not bad for the dominant global toy company. And if the company can just manage to hire a competent chief executive officer to fill that now-empty slot, the stock should move up.
Or, stocks that are cheap relative to their growth stories. Applied Materials (AMAT, news, msgs) is a good example of this kind of stock. At a recent price of $96 a share, the stock traded at a forward P/E ratio of 45 on projected earnings for the fiscal year that ends in October 2000. That's not expensive at all for a stock projected to grow earnings by 123% in 2000. (That's a PEG ratio of 0.36.) And I don't think the growth projection takes account of the full acceleration in capital spending in the semiconductor industry. Intel (INTC, news, msgs), after all, just announced that it would spend $6 billion this year on new plants and equipment, a stunning 20% jump from the company's plans to spend just $5 billion this year.
By those standards, here are my "10 best buys now" recommendations: Applied Materials, Avon Products (AVP, news, msgs), Dell Computer (DELL, news, msgs), Home Depot (HD, news, msgs), Lear (LEA, news, msgs), Mattel, Pfizer (PFE, news, msgs), Sealed Air (SEE, news, msgs), Texas Instruments (TXN, news, msgs) and MCI WorldCom (WCOM, news, msgs).
One final word on timing. For a long-term investor, I don't think it's important to hit the absolute bottom in this market when you're buying any of these stocks. So don't panic on the first rally and buy into them before you're comfortable. It's OK to wait until the dust clears and we can see where this market is headed. And if you're a true long-term investor, I'd recommend dollar-cost averaging during a period of turmoil like this. The strategy of buying a fixed dollar amount of a specific stock every month guarantees that you'll buy fewer shares when it's expensive and more when the stock is cheap. That's a good way to cope with any volatile market.
|
