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6 stocks for a second-half growth rally
Growth investors have been losing badly to value investors for some time, but many feel the tide is about to turn. I'm not convinced just yet -- but here are 6 stocks to watch just in case.
By Jim Jubak
It's been value over growth for so long now that it's a wonder that more growth stock investors haven't thrown in the towel.
For 2005, through the end of the June quarter, value stocks were up 1.7% and growth stocks were down 1.9%. That's not just a case of isolated outperformance, either. Value stocks, according to index manager Frank Russell Co., show a one-year return of 14.1% -- vs. 9% for growth stocks. The last two years? It's 18.1% average annual for value stocks vs. 10% for growth stocks. Three years? It's 11.2% for value stocks and 7.56% for growth stocks.
But growth-stock investors are a hardy group, and they now see signs that the year's second half will belong to them.
Growth rally? Let's wait and see
I'm not totally convinced. At least not yet. But with growth stocks priced at the lowest valuation premium to value stocks in 15 years, according to State Street Global Markets, it's worth weighing the arguments for a growth stock rally. In this column, I'll even give you a list of growth stocks to research so you'll be ready to move if and when you're convinced.
Growth and value are relative and subjective terms. But the trend in the stock market over the last few years has been real -- and profitable, if you've been on the right side.
Growth stocks such as Microsoft (MSFT, news, msgs) and IBM (IBM, news, msgs) have done dismally. The companies show double-digit annual earnings growth (22% and 24% annually on average over the last 10 years), pay almost nothing in regular dividends and show above-average volatility (betas of 1.6 and 1.4, respectively, vs. the stock market average of 1). In the last three years, Microsoft is up 2% and IBM 4%. That's total return for the entire period, mind you, and not an annual average.
Value stocks such as Exxon Mobil (XOM, news, msgs), Burlington Northern Santa Fe (BNI, news, msgs) and utility FPL (FPL, news, msgs) have rocked, meanwhile. They boast single-digit annual earnings growth (5%, 7% and 6%, respectively), pay sizeable regular dividends and show lower-than-average volatility (betas of 0.48, 0.52 and 0.14, respectively). Exxon Mobil is up 60% in the last three years, Burlington Northern 65% and FPL 66%.
After lagging so badly, growth investors are inclined to clutch at any straw of evidence of a comeback for their investing style. This is why the recently concluded June quarter has given them hope: The Russell 3000 Growth Index ($RAG.X) returned 2.6%, beating the 2% return on the Russell 3000 Value Index ($RAV.X).
Related news and commentary on MSN Money
One quarter of outperformance isn't enough to convince me that the trend has turned. Value has lost to growth before in the last 18 months, but that didn't stop the value style from outperforming growth in four of the last six quarters.
But the case for a growth rally isn't built on the June quarter alone.
The case for a growth rally
For one thing, there's recent economic evidence indicating that growth may have started to rebound from a slowdown in March and April. Factory orders, for example, rose in May (by 2.9%) for the third straight month. The Institute for Supply Management reported that its manufacturing-activity index rebounded to 53.8 in June from 51.4 in May, the first increase since November 2004. The ISM service activity index rebounded to 62.2 in June, reversing a decline from 63.1 in March (any reading above 50 indicates expansion). Business investment climbed 8% in the second quarter, according to J.P. Morgan Chase, after growing by just 4% in the first quarter of 2005.
Then there's the valuation evidence. The stock market began the year's second half almost exactly where it was at the beginning of the year, with the Standard & Poor's 500 ($INX) at 1,202 on Jan. 3 and at 1,191on June 30. In those six months, however, trailing 12-month operating earnings on S&P 500 stocks climbed to $71.05 from $67.68, a 5% increase. With the index stuck near the same price at the beginning and end of the period, the earnings increase has been enough to drive the price-to-earnings ratio down to 16.8 from 17.6. With the yield on the benchmark 10-year Treasury note actually lower than it was six months ago, stocks are cheaper relatively and reasonably priced historically, at least at current interest rates.
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