Sig, here is another good article packed with historical info from today's WSJ...
John
Heard on the Street
Hitting a Wall? Today's Leaders
May Be Tomorrow's Laggards
By KEN BROWN
Staff Reporter of THE WALL STREET JOURNAL
Investors, like generals, always seem to be fighting the last war.
That explains the continued obsession that people have with big-name tech stocks such as Cisco Systems, Oracle and Intel. If history is any guide, the real action in the stock market will be elsewhere, and that shift may last for a long time.
"I suspect that the opportunity to make money on companies is going to rest more with the stocks under the radar screen than the stocks that everyone has been so fixated on for the last six years," says Brian Posner, a managing partner at Hygrove Partners, a New York hedge fund.
No matter how hard investors root for the big-name tech stocks, these companies will have to battle two broad historical trends to regain their prominence in the market. First, the stock market's leaders tend to turn into laggards, and, second, recent research shows when companies hit about $20 billion in annual revenue, overall corporate growth tends to stall.
The last time investors were so absorbed by a narrow slice of big companies was the Nifty 50 era of the late 1960s and early 1970s, when big, fast-growing companies such as Gillette, Minnesota Mining & Manufacturing and McDonald's soared. The brutal 1973-74 bear market put an end to those gains, and the stock market didn't permanently regain its peak until 1982.
Many investors stubbornly stood vigil over the Nifty 50 stocks as they lay comatose for the decade, holding back the major market indexes. But folks who looked elsewhere, including Peter Lynch and Warren Buffett, made a killing on cheap, out-of-favor "value" stocks and smaller companies. "I think that's what can happen here," says Roger Ibbotson, chairman of Ibbotson Associates, a market-research firm, and a professor at the Yale School of Management.
In the five years after the bear market bottomed in 1974, large-company growth stocks, which included the Nifty 50 names, returned 14% a year, according to Ibbotson Associates, while large value stocks returned 24%. But the real winners were small-company stocks. Small-company value stocks returned 38%, and small-company growth stocks returned 33%, according to Ibbotson, which used data compiled by Eugene Fama and Kenneth French, who studied the performance of these sectors.
"You would have made a lot of money in value stocks after the crash of '74; you actually would have made a lot of money on small growth stocks after the crash of '74," Mr. Ibbotson says. "You would have made almost mediocre returns on large growth."
While most investors were waiting for the second coming of Coca-Cola, Mr. Lynch was starting to build his astonishing track record elsewhere. In his January 1978 letter to shareholders of his Fidelity Magellan Fund, Mr. Lynch wrote, "The portfolio is dominated by three categories of companies, special situations, undervalued cyclicals and small and medium-sized growth companies." Certainly not the Nifty 50.
Of course, only the most diehard bears predict a '70s-style stock market this decade. But that doesn't change the fact that investors' faith in certain stocks dies hard. Just ask anyone who bought International Business Machines in 1987 and didn't see a profit for a decade, or investors in Wal-Mart, which went nowhere from 1993 to 1997.
Are things different today? Probably not. People still talk about Dell Computer as a hot stock, but shareholders who invested in mid-1998 still haven't made a dime.
As irrational as the stock market can be, there are usually good reasons why stocks get beaten up. Lately, the main reasons have been slowing growth and lousy prospects for the future -- particularly in the case of the former high-growth stars. So for the Ciscos of the world to bounce back, strong growth would have to resume. A study by the Corporate Executive Board, a Washington organization that does research for its more than 1,700 corporate members, raises serious doubts about whether the happy days will ever return for these companies.
While it isn't news that companies can't keep growing rapidly forever, the research gives investors an idea of when and why the stalls happen. The study found that once a company hits about $20 billion in revenue, the slowdown occurs. The stall level varies a bit, and recently more companies have pushed the $30 billion revenue level before hitting the wall. But when growth resumes, the study says, more than 80% of these companies grow in the low single digits or less for the next decade -- certainly not growth rates that would get investors excited.
"There seems to be this upper boundary of how big a company can get before growth stalls out," says Derek van Bever, chief research officer at the Corporate Executive Board. The researchers focused on revenue growth, which for these companies averaged better than 20% a year during the good times, because they consider it the most important driver of long-term performance. Without growing revenue, the researchers argue, earnings will eventually stall and a company's stock market value will inevitably suffer.
The study also found that companies hit their plateau after their period of fastest growth, the time when investors had the greatest expectations for them. But those investors fled when the companies shifted to neutral. According to the study, 69% of the stalled companies ultimately lost more than half their market values. "What's interesting is how permanent the effects of the stall are," says Mr. van Bever. "We never found an instance where a high-growth company stalled to low or no growth then got back up again to that high-growth trajectory."
The study has been cited by Steven Milunovich, Merrill Lynch's technology strategist, who has been arguing for months that investors have to look beyond the big names. "This is the time you want to be looking forward and identifying the next wave's winners," he says. Among them, he argues, are Juniper Networks, which is taking some business away from Cisco, and Extreme Networks, a networking company.
What companies are at that $20 billion to $30 billion threshold? Many are the very names that investors still can't get off their wish lists. Among them, according to Merrill: Intel, which earned $33.7 billion in its most recent fiscal year; Dell, $30 billion; Ericsson, $29.7 billion; Nortel Networks, $28.5 billion; Microsoft, $23.8 billion; Cisco, $21.5 billion and Sun Microsystems, $19.2 billion. In fact, the slowdown is already evident among some of these big companies. Revenue at Intel grew by just 15% in 2000, and 16% at Ericsson, while it soared 55% for Cisco and 44% for Sun Microsystems.
Of course many companies, tech and others, have grown well beyond $30 billion in revenue, including IBM, which booked $88.4 billion last year, American International Group, $45.97 billion, and Hewlett-Packard, $48.8 billion. But their still-healthy growth rates never hit their old peaks after revenue topped about $20 billion.
There are several reasons why companies stall, but the most common is that innovation slowed, meaning their research-and-development labs stopped generating enough ideas to keep the company growing. Sometimes that happened because R&D became too decentralized. On other occasions, companies slashed their research budgets, generally with painful consequences.
"Typically if you do a post mortem of a revenue stall and you determine that the company missed some development or failed to appreciate some new factor, what you often find is it wasn't that they were unaware of it at the time, it was that they agreed to discount it or ignore it," Mr. van Bever says.
Write to Ken Brown at ken.brown@wsj.com |
