Large-Growth Stocks to Watch

Large-cap growth stocks--which Morningstar defines as large-cap stocks with growth rates above the rest of the market as measured by forward earnings, historical earnings, book value, cash flow, and sales--have been sorely out of favor in recent years. While small-cap value stocks have surged ahead, big growth stocks suffered from an opposing trend. First they saw their valuations crushed in the bear market, and then they failed to keep pace with small-cap issues when the market recovered. As a result, Morningstar's Large-Growth Index has posted annualized losses of more than 16% per year over the trailing five-year period.

But it would be a mistake to write off this segment of the market. Indeed, while market valuations are relatively steep across the board, prices on the market's biggest names aren't quite as nosebleed-inducing as those on small-cap issues. There's also something to be said for companies that have consistently generated top- and bottom-line growth in a variety of market climates.

For this week's Five-Star Investor, we began by screening for stocks that fall into the large-growth corner of Morningstar's style box. We also looked for companies that have consistently increased both revenues and earnings per share over the past several years. Finally, we threw in some quality screens for return on equity and financial health.

While not all of the stocks that passed are cheap enough to be compelling right now (perennial growth-stock darling Starbucks (SBUX), for example, is still trading well above our fair value estimate), it's worth keeping an eye on this list for the large-growth segment of your portfolio. Here are some of the highlights:

Paychex (PAYX)
Morningstar Rating: 5 Stars
Business Risk: Below Average
From the Analyst Report: "A weak economy with higher unemployment, more business failures, fewer business formations, and lower interest rates can negatively impact Paychex's business, and we think such cyclical issues have depressed Paychex's results for the past few years. But if these macro factors improve as we expect, Paychex's financial results should benefit nicely."

International Game Technology 
Morningstar Rating: 4 Stars
Business Risk: Average
From the Analyst Report: "We expect growth to slow as this accelerated replacement cycle runs it course. IGT still boasts excellent fundamentals, however. Half of its sales come from proprietary gaming systems that the firm leases to customers in exchange for a piece of the action, typically 20% of the net win or 3%-4% of gross wagers. This recurring revenue, combined with robust pricing power and product development, allows IGT to generate stellar returns on capital and free cash flow."

Johnson & Johnson (JNJ)
Morningstar Rating: 4 Stars
Business Risk: Below Average
From the Analyst Report: "We think J&J is an exemplary wide-moat company that's on a roll. Robust sales growth and profit improvement are fueling some of the best results in the pharma group this year. We would gladly buy the shares at a slight discount to our fair value estimate."

Forest Laboratories 
Morningstar Rating: 3 Stars
Business Risk: Average
From the Analyst Report: "Forest's competitive advantage lies in the company's ability to identify and acquire exclusive marketing rights for high-potential products in development stages. For example, Forest obtained Celexa and Lexapro--antidepressants contributing more than 80% of sales--through an alliance with Danish pharmaceutical company Lundbeck. Such alliances and best-in-class products translate into 34% operating margins and returns on invested capital growing from 3% in 1998 to 30% in 2004."

Harley-Davidson 
Morningstar Rating: 3 Stars
Business Risk: Below Average
From the Analyst Report: "We're big believers in strong brands, and any brand that people tattoo on their bodies has something going for it. The Harley-Davidson brand clearly provides a competitive advantage. The firm, the only continuous survivor from the original American motorcycle industry, is more than 100 years old. The brand built over this time has allowed Harley dealers to sell motorcycles at or above manufacturer's suggested retail price for years."

To run this screen and see all the stocks that passed, click here. Note: The stocks mentioned above passed our screen as of Jan. 26. The results of the screen may change due to daily price fluctuations or other factors. After clicking, you can save the search to use later by clicking the "Save Criteria" button in the bottom right-hand corner of the screen. (You will need to be logged in as a Premium Member to view and save the complete screen.)

This article was originally published Feb. 2, 2004. It has been revised and updated.