With so much attention on European debt and fiscal cliffs and LIBOR scandals, many investors have overlooked an important occurrence in the stock market over the past year or so.
While small, beaten-down value stocks led the market's upward surge for much of the first couple years of the bull run that began in March 2009, a significant shift in leadership has occurred since then, with large growth stocks now leading the way.
So far in 2012 (through Aug. 2), large-cap growth has been the strongest performing style-box category, according to Morningstar, returning nearly 15%; the closely-related large-cap core is second with 11.3%. The bottom three: small-cap core (4.9%), small-cap growth (5.4%), and small-cap value (6.1%).
Top strategist and Forbes columnist Kenneth Fisher expects the shift to continue. Fisher says in a recent column for Interactive Investor that it's typical for bulls to be led by small-cap value at the start, and then have leadership shift to large-cap growth.
That's because small-cap value picks are more economically sensitive and get pounded when fears crescendo at the end of bear markets; then they bounce back strong when fears subside and the bulls start running. "Later, after the bull market’s early phases, a new phase starts, where people are less myopic,” Fisher writes. “They aren’t quite so fearful and start thinking a bit longer term. Those small, economically sensitive cyclical firms don’t have long-term growth prospects, no long-term vision. But big, growth-oriented firms do. Quality and growth. They have vision, deep product pipelines, quality management. That’s what investors want then--so they move away from small value to the polar opposite--and large growth takes over leadership.”
Fisher says the change often takes time to play out. But once large-cap growth takes over, he says, its outperformance can be huge and last for quite a while. He thinks the current bull still has a ways to run, and recommends focusing on growth stocks with market caps in the $100 billion or more range. “There aren’t many stocks there to pick from; but do it,” he says. “The longer the bull market runs, the bigger you should go.”
Fisher's logic--and excellent track record--make this advice well worth listening to. So I used my Guru Strategies (which are each based on the approaches of such investing greats as Warren Buffett, Benjamin Graham, and Fisher himself) to find some of the market's most attractive high-quality large-cap growth plays.
As Fisher noted, there aren't all that many stocks big enough to fill his $100 billion or so market cap recommendation--only about four dozen or so trading in the U.S. Many of those are better classified as value stocks, so in order to find enough large-cap growth picks that my strategies like I looked for stocks with market caps of $75 billion or more. Here's what I found.
Intel (INTC): The California-based computer-chip giant has a$130 billion market cap, and has grown EPS at a 26.3% rate over the long term. (I use an average of the three-, four-, and five-year EPS figures to determine a long-term rate.) It gets strong interest from two of my models. My Peter Lynch strategy considers Intel a "fast-grower"--Lynch's favorite type of investment--because of that impressive growth rate.Lynch famously used the P/E/Growth ratio to find bargain-priced growth stocks, and when we divide Intel's 11.0 price/earnings ratio by its long-term growth rate, we get a P/E/G of 0.42. That falls into this model's best-case category (below 0.5).
While Intel has produced strong growth, my James O'Shaughnessy-based approach actually considers it a value play. It targets large firms with solid cash flows and strong yields when looking for value stocks. Intel's size, $3.83 in cash flow per share (nearly three times the market mean), and solid 3.5% yield all make the grade.
Apple (AAPL): Apple's recent quarterly results disappointed many, but the $580-billion-market-cap behemoth still gets decent scores from some of my models. My Lynch-based approach has some interest in the firm, which has grown EPS at a staggering 62.3% over the long term. Despite that growth, its shares trade for a very reasonable 14.3 P/E ratio, making for a stellar 0.23 P/E/G. What's more, the firm has no long-term debt.
The only thing the Lynch approach doesn't like about Apple is that its growth is too high. Lynch found that firms with long-term growth above 50% could have trouble continuing to sustain such growth, so Apple actually loses some points from this strategy for its 62.3% long-term rate.
SAP AG (SAP): The largest enterprise application software firm in the world, Germany-based SAP ($77 billion market cap) offers a variety of I/T products and services to more than 190,000 customers around the globe. It's another favorite of my Lynch-based model.
The firm has grown EPS at a 17.6% rate over the long-term, making it a "stalwart" according to this approach--the kind of large, steady firm that Lynch found offered protection during downturns or recessions. For these firms, Lynch adjusted the "growth" portion of the P/E/G equation to include dividend yield, since they often pay solid dividends; yield-adjusted P/E/Gs below 1.0 are acceptable to this model, and SAP's comes in at 0.90, a good sign. SAP also has a very reasonable debt/equity ratio of about 24%, another reason the Lynch model likes it.
SAP also gets high marks from my Warren Buffett-based approach. While Buffett is usually thought of as a value investor, the strategy I base on his approach has a big growth component, looking for firms that have decade-long histories of increasing EPS with few annual declines. SAP's earnings have dipped just twice in the past decade, a good sign. Two more reasons the Buffett approach likes the stock: SAP could pay off its $1.9 billion in debt in less than a year, if it wanted to, given its $4.3 billion in annual earnings, and its 10-year average return on equity is an impressive 25.2%.
CNOOC Limited (CEO): The Chinese National Offshore Oil Corp. is an $89-billion-market-cap oil and natural gas operations firm that has grown EPS at a 17% rate over the long term. That and its 0.39 yield-adjusted P/E/G are big reasons that it's another stalwart that gets strong interest from my Lynch-based model, which also likes its 14.5% debt/equity ratio.
My Buffett-based model also likes CNOOC, whose EPS have declined in just one year of the past decade. In addition, the firm's debt is about a quarter of its annual earnings, and its 10-year ROE is a stellar 26.1%, two more reasons the Buffett strategy likes it so much.
Wal-Mart Stores (WMT): This Arkansas-based retail giant has some 10,000 stores across 28 countries. The $250-billion-market-cap firm gets strong interest from my O'Shaughnessy-based growth model, which looks for firms that have increased EPS in each year of the past five-year period, and which have a key combination of qualities: a high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Wal-Mart has indeed upped EPS in each year of the past half-decade, and it has a red-hot relative strength of 92. Its shares trade for just 0.55 times trailing 12-month sales, well below this model's 1.5 upper limit, though, making it a bargain.
I'm long WMT, SAP, CEO, and INTC.
