Stocks in 2001: Which Strategy Will Prevail?

After two spectacular years, “growth” stocks suffered a deep dive in 2000, thanks largely to the technology sector’s crash.

But growth’s adherents say investors who worry that the death knell has sounded for growth investing should ask themselves a simple question: Why would the market permanently turn its back on the companies posting the fastest sales and earnings gains?

Because stock prices ultimately follow earnings, it’s natural that investors should be drawn, long term, to the economy’s most vibrant sectors--which is why growth stocks always command premium prices.

What last year demonstrated, of course, is that growth investors can push their stocks’ prices to extreme premiums relative to earnings and other valuation measures. The penalty for overdoing it can be severe, as the “dot-com” bust showed.

Yet even as tech shares plunged last year, gains in other kinds of growth stocks reminded investors that growth is wherever you find it. Specialty staffing firms, medical device makers, restaurant chains and up-and-coming young energy companies were among the non-tech growth sectors that produced winners last year.

While large-stock growth mutual funds fell 14.1%, on average, in 2000, declines in growth funds that target smaller shares were more muted.

Now, with the Federal Reserve cutting interest rates, growth-stock fans note that many growth sectors have done well historically against a backdrop of falling rates.

Even so, it’s true that growth-stock investing can take a back seat to “value” investing for extended periods. And in the very long run, academic studies contend that value investing beats growth. In the 70-year span from 1930 through 1999, value stocks produced an average annual gain of 13.5%, versus 10.3% for growth stocks, according to Ibbotson Associates of Chicago.

In the ‘90s, however, growth stocks dominated, returning an annualized 19.6% versus 14.7% for value stocks. But the two sectors repeatedly traded the lead.

Because the market’s style tilt can change abruptly, many analysts say investors should always hold both growth and value stocks in a well-diversified portfolio. And if you follow the “buy low, sell high” philosophy, the best time to buy growth funds for the long haul should be when they’re down.

Growth-oriented money managers say there are plenty of good pickings in this market, but they emphasize that investors should be finicky and patient: The fierce price momentum that propelled tech stocks in 1999 and early 2000 is unlikely to return soon, and concern over high stock price-to-earnings ratios appears to be back in the center of the investing public’s collective consciousness.

Indeed, because valuations on many tech stocks, in particular, remain relatively high despite the slide in the stocks, the risk is that buyers could be too early--especially in a weakening economy.

Still, for those who can take a long-term view, this may be a good time to focus on the industries that are likely to boast robust growth in this decade. Among them:

* Health care. The aging population should benefit many hospitals, drugstore chains, companies providing outpatient services such as oxygen, and providers of pharmacy services to nursing homes and assisted-living facilities, said Brian Berghuis, manager of T. Rowe Price Mid-Cap Growth fund, which gained 7.4% last year.

Robert Gardiner, manager of the Wasatch Micro Cap fund, up 37.5% last year, likes San Clemente-based ICU Medical (ticker symbol: ICUI), which makes needle-less intravenous systems.

Meanwhile, though the fruits of the human genome project aren’t expected until the latter half of the decade, many biotechnology firms already have “truly revolutionary” drugs in late development or coming to market, Berghuis noted.

Kenneth W. Corba, manager of the PIMCO Growth fund and chief investment officer of the firm’s equity division in New York, said PIMCO continues to own several of the more-established names in biotech, including Genentech (DNA) and Amgen (AMGN), both of which are well off their peaks of last year. Corba’s fund lost 14.2% in 2000 after soaring 41% in 1999.

* Financial services. Many value managers claim financial stocks for their own, but the fastest-growing financial firms naturally attract growth investors.

“We’re looking at financials that have a global presence--asset gatherers with recurring income and strong brand names,” said Corba. “They can benefit from two major trends: aging demographics and continuing globalization.”

Names he likes include insurance titan American International Group (AIG), American Express (AXP) and Citigroup (C).

The average financial services stock mutual fund surged 26.6% last year, in large part because value investors bid up such sectors as insurance and regional banks.

But “the [financial] group tends to do well in an environment of easing interest rates, which is what everyone expects in 2001,” said Erik P. Gustafson, manager of Liberty Growth Stock (down 11.8% last year) and Liberty-Stein Roe Young Investor (down 10%) funds.

* Energy. A few years ago, most investors wouldn’t have expected electricity to become a fast-growth industry. But up-and-coming power companies are thriving in a deregulated environment and tight power markets. “In the long term, there is clearly a great need for cleaner and more-efficient distribution of energy,” said Gustafson, who said Calpine (CPN) and AES (AES) are two of the better-run power providers. Both stocks have tumbled recently.

* Technology. The plunge in the tech sector has been brutal as many companies have warned in recent months about slowing sales and earnings growth. But many growth managers say it’s impossible to imagine that the tech sector won’t continue to produce great growth stories in this decade.

Kevin Landis, whose Firsthand Technology Value fund leaped 190% in 1999 before easing a relatively mild 10% last year, said he continues to like firms facilitating e-commerce behind the scenes, especially those working with Fortune 500 companies.

“I’m interested in some of the software companies like BEA Systems [BEAS], whose ‘middle-ware’ allows you to tie everything together--develop a cool Web site linked right into your inventory systems,” he said.

In the optical networking area, Landis likes Ciena (CIEN), whose technology sends multiple signals down a single fiber. The stock is down 51% from its peak.

And in the optical component area, Landis likes the little-known No. 3 player, Furukawa Electric (FUWAF). The Japanese firm is slowly gaining market share and trades at a slightly more modest valuation than No. 1 JDS Uniphase (JDSU) and No. 2 Corning (GLW). As a bonus, Furukawa owns 11% of JDS, Landis said.

Robert “Reg” Gipson, head of Alpha Analytics, a Los Angeles-based money manager, said he favors tech infrastructure companies making fiber-optic components, switches and other products, including SDL (SDLI), Emulex (EMLX) and Applied Micro Circuits (AMCC).

He also likes companies whose products address the need for speed, including Vitesse Semiconductor (VTSS), the high-speed chip component maker, and Rambus (RMBS), which develops and licenses high-speed chip-to-chip interface technology.

What’s more, data storage firms such as EMC (EMC) should benefit from the continuing trend of digitizing information, Gipson said.

Gustafson agreed: “In the second wave of the information age, companies that can sort and distribute information will be huge winners.” Along with EMC, he likes Network Appliance (NTAP).

“The dot-coms may be toast but there are still a lot of attractive [tech] businesses,” he said.

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Staff writer Josh Friedman can be reached at [email protected].