Great stocks on sale – suggested stocks to purchase

Great stocks on sale – suggested stocks to purchase – Cover Story

Manuel Schiffres

Opportunities to invest in terrific companies at distress prices don’t come often.

Painful as it is in most respects, the first bear market in eight years is a long-awaited blessing for people who would like to make long-term investments in great companies at reasonable prices. Thanks to the bloodletting, many outstanding companies with terrific futures have seen their share prices cut 30%, 40% or even more in just a few months. In short, the great growth stocks of the next millennium are now on sale–a sale you shouldn’t pass up.

The key phrase here is “long term.” Stocks deliver superior returns over the long haul, but over the short term anything can happen, as recent events bear witness. But if you pick good companies–those that deliver solid and consistent earnings growth–your investments should prosper over time.

But just which stocks should you buy for the year 2000 and beyond? We spoke with two dozen portfolio managers and analysts to identify great growth stocks for years to come. The final cut includes companies from a variety of industries, although those related to health care and technology are the most widely represented. In size, they range from tiny to large. We excluded immense companies because their present size could preclude the magnitude of profit growth we sought. Nine of these 11 companies are currently profitable, and of those, analysts expect long-term earnings to grow by at least 20% annually over the next few years.

One common thread that binds these companies is that their share prices are significantly below their recent highs. If the overall stock market declines and, as is its custom, punishes the best companies along with the worst, take advantage of this rare (and perhaps fleeting) opportunity to scoop them up at even lower prices.

HEALTH CARE PIONEERS

The same imperatives that drove health care stocks in the 1990s should remain operative in the new millennium: an aging global population, major innovations in technology, and a growing worldwide demand for Western medicines and medical devices. A company that should benefit mightily from these long-term trends is Guidant, a maker of devices for treating heart disease.

Shares of Guidant (317-971-2000) haven’t exactly gone unrecognized since the company was spun off in 1994 by drug maker Eli Lilly & Co. The stock went public at a split-adjusted price of $7.25 per share, and soared to a high of $90 earlier this year. Its retreat to a recent $75 has stemmed from the stock-market rout and from investor concern over the impending entrance of rival Boston Scientific into the huge, $1.7-billion market for coronary stents–the metal tubes or coils used in angioplasty procedures to keep arteries open. But Guidant is expected to get approval soon for its new Multi-Link Duet stent, which analysts say should allow the company to maintain its leading position.

Guidant’s other major product is pacemakers, devices that control heart rhythms. Some of its pacemakers treat slow or irregular heartbeats, while others can be implanted to treat potentially fatal fast heart rhythms with electrical charges. Guidant recently introduced its new Meridian and Discovery pacemakers, and has agreed to buy the cardiovascular-device unit of Switzerland’s Sulzer Medica. The pending deal would more than double Guidant’s pacemaker business and make it the second-largest competitor in the industry, behind only Medtronic.

An array of new products will drive Guidant’s growth in the new millennium, says John Schroer, manager of Invesco Health Sciences fund. In particular, Guidant is testing a device for treating congestive heart failure. Congestive heart failure has a high mortality rate, and any therapy that would allow bedridden patients to live longer and improve the quality of their lives would be a blockbuster, says Schroer. He expects Guidant to win approval for the product in Europe in 1999 and in the U.S. by 2000 or 2001.

Guidant should experience earnings growth of 21% annually over the next three to five years, according to the consensus of analysts surveyed by First Call (the source of all earnings estimates in this article). Guidant is expected to earn $2.35 per share this year and $2.65 in 1999. One of only two companies among those featured here to pay a dividend, Guidant disburses 5 cents per share annually.

In the old west, surgery was sometimes performed on a dusty saloon bar, using cheap whiskey as both disinfectant and anesthetic. Techniques in sterilization (not to mention surgery) have come a long way, and Steris Corp. (440-354-2600) is at the forefront of this burgeoning field.

Steris was founded in 1987 to commercialize a chemical sterilization process for surgical and diagnostic devices. A year later, it launched its flagship System 1, a low-temperature desktop sterilizer that is sold to hospitals and physicians’ offices around the world.

Starting in early 1996, Steris embarked on a shopping spree. It merged with Amsco International, a much larger maker of sterilizer washers, surgical tables and accessories. In short order, Steris bought four other companies, one of which, Isomedix, is a player in the emerging field of preventing harmful bacterial growth in food. As a result of all this consolidation, Steris’s revenues soared from $91 million in the year ended March 31, 1996, to $720 million for the year ended March 31, 1998. During this period, earnings nearly tripled, from 33 cents to 94 cents per share.

Steris is benefiting from two key trends, says Amy Selner, manager of Berger Midcap fund. The rapid growth in minimally invasive surgery boosts the need to sterilize sophisticated reusable devices. And hospitals are turning routine procedures over to stand-alone surgery centers, each of which needs to sterilize its own equipment.

Analysts forecast Steris’s long-term earnings-growth rate at 23%, but Selner says she thinks that profits may grow at a clip of more than 25% per year. Earnings could get a boost, she says, from Isomedix’s expertise in the use of radiation to destroy bacteria in food–a health risk that has received widespread attention as a result of illnesses and deaths involving tainted meat.

Steris’s stock is well off its 52-week high of $36 per share. Analysts expect earnings of $1.08 per share in calendar 1998, and $1.31 in 1999. As a result of the recent price retreat, Steris’s price-earnings ratio, on 1998 earnings estimates, is a reasonable 25.

For the most part, biotech stocks have been duds in recent years. Vital (619-646-1100) has been no exception. After going public five and a half years ago at $5 per share, its shares traded as high as $19 in early June before falling to their current level. With a market value of $166 million, the company is so small as to seem almost invisible on the corporate landscape. Yet some analysts say Vical’s technology could make it a huge financial winner.

Vical has developed technologies that allow direct transfer of genes into cells inside the body to selectively correct or moderate disease conditions. The company is conducting latter-phase human trials for a product to treat melanoma, an aggressive and deadly skin cancer. It is also conducting earlier-stage trials for drugs to treat kidney, prostate, and head and neck cancers.

“Vical’s approach to cancer therapy is kinder and gentler, and basically helps the immune system do what it normally does every day: eliminate cancerous and precancerous cells from the body,” says analyst Peter Freudenthal of the BancBoston Robertson Stephens investment bank. “This approach is much more elegant and potentially more effective than the harsh poisons, radiation and disfiguring surgery currently used to treat cancer.”

In addition to working on cancer cures, Vical has licensed its DNA technology to other companies for the development of vaccines against various infectious diseases, such as influenza, hepatitis and HIV. Vical’s direct gene-transfer technology may also wind up in drugs to treat such metabolic disorders as cystic fibrosis. Vical’s collaborators include leading pharmaceutical companies, such as Merck and Rohne-Poulenc Rorer.

Michael Murphy, editor of the California Technology Stock Letter, says Vical may not be profitable until 2001. He adds, though, that “once you start making money, you make a lot of it.” One way of valuing a currently profitless biotech stock, says Murphy, is to compare its market value with its total expenditures over the years on research and development. The stock, he says, is valued at just 3.3 times R&D expenditures, which is what a venture capitalist might pay for a company with an idea but little in the way of product. Vical, though, has products in human trials, and that means the stock at today’s price could be viewed later as a terrific bargain, says Murphy.

TELECOM TRAILBLAZERS

Deregulation of the phone industry has triggered an explosion of competition. The emergence of new companies and entirely new technologies, coupled with the stunning growth of the Internet, is fueling demand for phone gear. By some accounts, the size of the market for local phone equipment in the U.S. was $5 billion in 1997. That figure could hit $12 billion by 2000. And it is in this rapidly expanding sector of the telecom-equipment industry that ADC Telecommunications is making its mark.

ADC has come a long way since 1935, when it was founded as Audio Development Corp., a maker of jacks and plugs used in phone-company central offices. The company (612-938-8080) now manufactures an array of complex products used mainly by phone carriers to enhance their services. ADC’s products help the phone companies boost the capacity of their networks to allow more efficient delivery of Internet, video, data and even plain old telephone service.

Oscar Castro, manager of Montgomery Global Communications fund, says ADC will benefit from the “incredible demand” for network capacity. That means strong demand for ADC’s products, not only from existing phone companies but also from a new breed of service providers–known as competitive local exchange carriers–and even from cable-TV companies seeking to break in to the market. “ADC has a very broad product line, and it has established strong relations with customers,” says Castro. “It has products for cable operators to carry telephony and for phone operators to carry data and video.”

Oddly enough, one risk to ADC’s otherwise bright prospects is the merger boom among telecom companies, says analyst Conrad Leifur of the Piper Jaffray brokerage. More than half of ADC’s top 20 customers have recently been bought or are in the process of being acquired, he notes. Those acquisitions may disrupt capital-spending plans in the short term. ADC also expects about one-fourth of its revenues this year to come from foreign markets, with 5% from Southeast Asia.

Analysts expect earnings per share of $1.08 for the fiscal year ending in October. That represents a jump of just 15% over the 1997 figure. But analysts predict much better growth, to $1.36 per share (up 26%) for the October 1999 year, and a longer-term growth rate of 30% a year.

While companies such as ADC provide equipment that plugs into phone lines, the phone lines themselves continue to be a growth business. Although cellular and other forms of wireless communications tend to get most of the attention, the wired world has also seen some exciting growth. Qwest Communications (303-291-1400) has one of the newest and highest-capacity fiber-optic networks.

Qwest got its start in 1988, when the Southern Pacific railroad decided to plant fiber-optic cables along its rights of way. Today routes covering 8,800 miles from Los Angeles to New York City are in place, and by mid 1999 the company will expand its network to 18,400 miles, connecting 130 cities from coast to coast. That’s enough capacity to carry about 80% of domestic long-distance traffic at the speed of light.

Because the cable that Qwest lays is so cutting-edge, costs are tiny compared with those of older networks. Analyst Tom Malley of the Janus mutual funds estimates the cost of using the network at less then 1 cent per minute. That allows Qwest to offer customers big discounts for phone, Internet and data services.

To invest in Qwest requires a leap of faith. The company is expected to lose 12 cents per share this year, but analysts figure that Qwest will be in the black in 1999 to the tune of 32 cents per share. After that, earnings should soar an astonishing 50% per year over the next few years, they say. Revenues are projected to hit $2.2 billion this year and about $3.6 billion in 1999.

What makes analysts so enthusiastic is Qwest’s ability to cash in on the voracious demand for telecom capacity. “We expect data traffic to grow 40% to 50% per year for the next several years,” says Malley. “For the next five years, the sky’s the limit.” Based on that growth, Dick Jodka, manager of State Street Capital fund, says investors can afford to hitch a ride on Qwest’s wagon. “You have to make some larger bets” on these emerging-growth stories, he says.

If the information revolution were a western, the movie might be titled The Quick & the Dead. If you’re not quick–if your products can’t keep up with or lead the revolution in moving data at ever more blistering speeds–you’re dead. One company that won’t be pushing up daisies anytime soon is Vitesse Semiconductor (805-388-3700), which makes semiconductor chips of gallium arsenide, as opposed to the more common and much slower silicon-based circuits.

Makers of telecom equipment are breaking down the doors for Vitesse’s chips. That’s because the need for more and faster data links is expected to double each year over the next five years. Moreover, silicon and other technologies are reaching their speed limits or are expensive relative to gallium arsenide. Vitesse has a huge competitive edge because “it’s extremely difficult” to make such chips in quantity–unless, like Vitesse, you’ve been perfecting the process for 14 years, says Prudential Securities analyst Hans Mosesmann.

Vitesse’s numbers seem to be vaulting as quickly as electronic pulses flow through its chips. Analysts see earnings growing 40% a year over the next three to five years. Sales were expected to hit $173 million for the fiscal year ended September 1998, a 65% increase over the 1997 figure, and earnings per share were expected to reach 66 cents, about double 1997’s figure. The consensus-earnings estimate for 1999 is 83 cents per share.

Vitesse’s lock on the technology and the need of such giant customers as Cisco Systems and Lucent Technologies give it a “near monopoly,” says Jim Goff, manager of Janus Enterprise fund. “I view Vitesse as an arms dealer to some of the most successful companies out there.”

The big challenge for Vitesse now is to spit out enough chips to meet soaring demand. A new plant has started producing 6-inch chips, a much more delicate operation than producing the original 4-inch chips. But so far the new plant is on schedule for full production by the end of 1998. It could provide capacity to boost annual revenues to about $550 million over the next two years.

COMPUTER TRENDSETTERS

In the shaving business, you’re supposed to give away razors and get rich on the blades. The computer business is a little like that. Customers pinch pennies on ever-cheaper and more powerful computers, then end up spending just as much for online services, software and software upgrades. Of course, the key difference between the shaving and computer businesses is that the hardware makers generally aren’t the ones cashing in on the demand for software and services.

One company that clearly benefits from the growing ubiquity of computers and the popularity of the Internet is America Online (703-448-8700). AOL, the leading online information-service company, is hardly a closely guarded secret. With its market value of more than $26 billion, AOL is more than twice the size of the next-largest company among the 11 featured here. A party to this year’s Internet frenzy (see “Inside the Internet Bubble,” on page 112), the stock has increased 70-fold since its initial offering in March 1992. What separates America Online from most other Internet players is that it actually turns a profit–55 cents per share for the fiscal year ended last June (before one-time charges), on revenues of $2.6 billion.

By almost all accounts, AOL dominates its field. Some 40% of all U.S. households that are plugged into the Internet use AOL for their access to cyberspace, a figure 50% greater than AOL’s four nearest rivals combined. During the 1998 fiscal year, the number of AOL subscribers jumped 45%, despite a 10% price hike for unlimited monthly access. AOL recently reported that it has more than 13 million members, and that its system can now accommodate 750,000 users simultaneously, up from just 5,000 five years ago. “AOL plays well in Peoria,” says Kevin Landis, co-manager of Firsthand Technology Value fund. “The company figured out it was important to look at things from the perspective of the end user on Main Street, not just from that of the technogeek.”

About 80% of revenues comes from subscribers drawn to AOL’s proprietary content and its ability to provide access to the Internet. The rest comes largely from advertising and AOL’s cut of transactions made through the service, commonly called e- (for electronic) commerce. Seems Hingorani, an analyst at T. Rowe Price, estimates that AOL can double its take from nonsubscription revenue in fiscal 1999 and continue to post 50% growth in subsequent years. “When AOL takes its subscriber base to an advertiser or retailer, it can say, `Do business with us and we’ll make sure you’ll be seen in the appropriate place on our site,'” she says. “And it’s working.”

What frightens investors about AOL is the stratospheric price of its stock. It trades at 117 times estimated earnings of 87 cents per share in calendar 1998 and 83 times 1999 projections of $1.23. But with analysts predicting robust earnings growth of 55% over the next few years, such lofty P/E ratios may be defensible.

From the relatively straightforward services of AOL, we turn to a software company that operates in the arcane world of component and supplier management (CSM). Aspect Development (650-428-2700) provides software and services that enable companies to find supplies more quickly and buy parts more cheaply. Aspect says that its customers include 125 leading manufacturers–among them Boeing, General Electric and IBM–with combined annual revenues of nearly $1 trillion, and that its tools are saving those customers billions of dollars.

Aspect’s CSM database gives clients, most of which are active in technology-related industries, access to about three million electronic and mechanical devices from nearly 1,000 suppliers worldwide. Analyst George Godfrey of the Raymond James brokerage estimates that the CSM software market will grow to $1.5 billion by 2002, up from $290 million in 1997. He estimates that Aspect had 70% of the market last year. Recently, the company introduced its Morocco database, which offers 1.5 million maintenance and repair parts from more than 3,000 suppliers and 125,000 office products from 1,300 vendors. Morocco may serve an even bigger market, says analyst Brent Wouters of brokerage firm Robinson-Humphrey. “Everybody needs to automate purchasing.”

Sales and profits for Aspect, which was founded in 1990, have been growing at breakneck speed. Revenues, just $4 million in 1993, could approach $90 million in 1998. The company earned 7 cents per share in 1996, its first profitable year, and the consensus of analysts is for 42 cents per share in 1998 and long-term earnings growth of 51% per year. The stock is certainly not cheap, trading at 84 times 1998 estimates.

But Andrew Lanyi, a broker and analyst at CIBC Oppenheimer, compares Aspect to a work by Rembrandt, asserting that the stock is worth the money because the company has practically no competition. Moreover, says Lanyi, Aspect enjoys repeat business. “As long as you save people money, they come back every day.” Finally, a company like Aspect could be counter-cyclical, meaning it would prosper in a recession because companies would be more motivated to trim costs.

Compared with AOL and Aspect, Sterling Commerce looks like bargain-basement material. Shares of the company (214-981-1100), which provides software and services to facilitate the electronic exchange of documents among businesses, trade at just 29 times estimated earnings of $1.26 per share for 1998. This isn’t an unreasonable WE ratio for a company whose earnings are expected to compound at a 30% annual rate.

Sterling Commerce, which was spun off to the public in early 1996 by Sterling Software, is a major player in the burgeoning field of e-commerce. It operates a private network that businesses use for transmitting purchase orders, invoices and other sensitive documents. It also sells software that enables businesses to create electronic purchase orders, and that lets businesses exchange large files of data over both private networks and the Internet.

Businesses are willing to pay for Sterling’s services (rather than use the Internet for transmitting important papers) because Sterling makes sure those papers get to their intended destinations. “They can monitor every document and make sure it’s gotten to the right place at the right time,” says T. Rowe Price analyst Hingorani.

The growth of the Internet also offers opportunities for Sterling. For example, Sterling performs electronic-fulfillment functions for Amazon.com, the Internet-based book retailer. “A huge shift of capital is under way from traditional commerce channels, such as bookstores and music stores, to the Internet,” says Robert Loest, manager of the IPS Millennium fund. “Sterling provides the gateway through which all those sales flow, so it ought to do pretty well.”

Analyst Bill Burnham of Credit Suisse First Boston cautions, though, that the rising popularity of the Internet also poses risks for a company that provides its services primarily through private networks. “Investing in Sterling comes down to having confidence that the company will be able to leverage its strong sales force, rock-solid operations and blue-chip customer base to grow its business no matter what the winds of technology hold,” says Burnham, who rates the stock a buy. Sterling will likely respond to the challenge by offering “value-added” services over the Internet. Sterling has also been on a shopping spree since going public: It has acquired eight companies, including six that have beefed up its presence overseas.

SERVICE LEADERS

One of the overriding themes of the late 20th century is the transformation of the United States from a manufacturing economy to one dominated by services. There’s nothing on the horizon to suggest that the trend will abate in the new millennium. That’s a plus for Apollo Group, one of the nation’s largest private providers of higher education for working adults. Apollo (602-966-5394) helps its clients to improve their position in the service economy.

By some estimates, adults with higher education are paid 70% to 95% more than those who lack a college degree. Workers who seek to bridge the pay gap may enroll in one of Apollo’s facilities, such as the University of Phoenix, the Institute for Professional Development or Western International University. The schools provide accredited bachelor’s and master’s programs, including business administration, information technology, education, nursing and management. In all, Apollo serves nearly 67,000 students at 112 campuses and learning centers in 32 states, Puerto Rico and Great Britain.

Apollo’s schools are targeted to the one-third of post-secondary students who are also working adults. Students take one six-week course at a time so that they can balance study with a full-time job. New courses begin each month. Classes are small and taught by faculty who have both advanced degrees and significant experience in their fields. Leased facilities help to trim overhead.

Growth is being fueled by steady jumps in enrollment–an increase of nearly 30% in the quarter ended May 31 over the same period in 1997–and tuition increases of 4% to 5% per year. Moreover, Apollo recently received approval to open schools in Maryland, Oklahoma and British Columbia and is seeking permission to enter the New Jersey and New York markets. It has also begun offering programs via the Internet. “Apollo’s evolving brand name will drive its growth,” says analyst Howard Block of BancBoston Robertson Stephens.

All told, analysts expect earnings growth of 30% annually over the next three to five years. Analysts expected profits of 58 cents per share for the year ended August 31, 1998, and 75 cents for the following year. The stock was clipped 25% on September 17 after the Wall Street Journal reported concerns about rising accounts receivable and a Department of Education audit of the University of Phoenix’s handling of financial-aid programs. Analyst Block says that the argument about rising accounts receivable is based on inaccurate data and “is not alarming.” The Journal quoted the president of Apollo, Todd Nelson, as saying he expected favorable resolution of the DOE audit. Still, even with the big drop in Apollo’s stock, more-cautious investors might want to stand aside until the DOE review is resolved.

Harte-Hanks is a company that has remade itself. Last year, it sold its newspapers and TV stations, mostly in the Southwest, for $790 million. It still publishes weekly advertising “shoppers” in California and Florida, but two-thirds of revenues now come from providing sales assistance to businesses. And in a few years, suggests Prudential Securities analyst James Dougherty, Harte-Hanks (210-829-9000) may well leave the shopper business behind to concentrate exclusively on its fastgrowing, direct-marketing services.

Behind Harte-Hanks’s transformation was the realization that corporate expenditures on direct marketing are growing much faster than spending on mass media. Harte-Hanks’s direct marketing consists of three segments. First, it builds customized databases that allow clients to easily target their best customers and prospects. Second, it helps clients target their sales efforts by providing creative input as well as printing and mailing services. Finally, Harte-Hanks Response Management processes responses that clients, Such as IBM and NationsBank, receive from their sales efforts via toll-free phone numbers, faxes and Web sites.

In fact, Harte-Hanks’s Web efforts have some investors drooling. In the second quarter of 1998, response management handled 1.5 million Internet transactions, double the number in the second quarter of 1997. “Every time somebody goes on the Internet to buy something or to respond to a direct marketer, someone has to manage the response to the customer,” says Beth Dater, manager of Warburg Pincus Emerging Growth fund. Harte-Hanks, she adds, is a play on the “enormous phenomenon” of the Internet.

Harte-Hanks is sitting on a war chest of $200 million, which analysts expect it to use to make acquisitions in the fragmented direct-marketing industry. The company also regularly buys back its shares and pays a yearly dividend of 6 cents per share, one of only two companies among the 11 featured here–the other being Guidant–to pay a dividend. “They are very disciplined about what they will pay for acquisitions,” says Prudential’s Dougherty. “The company has a greater devotion to shareholder value than most companies I know.” Analysts expect long-term earnings growth of 20% per year. Harte-Hanks is expected to earn 86 cents per share in 1998 and $1.03 next year.

GUIDANT

GDT (NYSE) Recent price: $75 12-month high: $90 Market value: $11.3 billion www.guidant.com

STERIS CORP.

STRL (Nasdaq) Recent price: $24 12-month high: $36 Market value: $1.6 billion

VICAL

VICL (Nasdaq) Recent price: $11 12-month high: $19 Market value: $166 million

ADC TELECOM

ADCT (Nasdaq) Recent price: $27 12-month high: $44 Market value: $3.6 billion www.adc.com

QWEST

QWST (Nasdaq) Recent price: $33 12-month high: $48 Market value: $11.4 billion www.qwest.com

VITESSE

VTSS (Nasdaq) Recent price: $23 12-month high: $37 Market value: $1.8 billion www.vitesse.com

AOL

AOL (NYSE) Recent price: $102 12-month high: $140 Market value: $26.5 billion www.aol.com

ASPECT DEVELOPMENT

ASDV (Nasdaq) Recent price: $35 12-month high: $43 Market value: $1.2 billion www.aspectdv.com

STERLING COMMERCE

SE (NYSE) Recent price: $37 12-month high: $50 Market value: $3.5 billion www.sterlingcommerce.com

APOLLO GROUP

APOL (Nasdaq) Recent price: $30 12-month high: $43 Market value: $2.4 billion www.apollogrp.com

HARTE-HANKS

HHS (NYSE) Recent price: $23 12-month high: $26 Market value: $1.8 billion www.harte-hanks.com

COPYRIGHT 1998 The Kiplinger Washington Editors, Inc.

COPYRIGHT 2000 Gale Group