Seeking Value in Large Growth Stocks

Bob Smith says the market is finally moving his way. Smith runs T. Rowe Price Growth Stock (PRGFX), which invests principally in large growth companies, a sector of the market that has been shunned for more than six years. "Even value investors think growth is where the cheapest stocks are now," he says.

Although the markets haven't cooperated with his sector in recent years, his fund, a member of the Kiplinger 25, has posted a fine record. Growth Stock returned 9% annualized in the decade through April 13, beating the average large-cap fund by more than three percentage points per year.

Alas, Smith is moving on just as his bailiwick is showing signs of life. He'll become portfolio manager of T. Rowe Price International Stock, a relative laggard, on October 1. He'll be replaced at the helm of Growth Stock by Robert Bartolo, co-manager of T. Rowe Price Media and Telecommunications, an excellent sector fund. We'll revisit the fund later this year to determine whether it should remain on our recommended list after Smith leaves.

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Smith looks for businesses that can sustain earnings growth of 12% to 15% a year for five years. "Very few companies can grow 15% for five years," he says. Corporations that achieve these numbers are probably expanding unit volumes, raising prices and quite possibly gaining market share. In a slowing economy, such as we have today, the market will often pay a premium for large-cap growth companies such as these that can keep up the pace in a weaker economy. But, Smith stresses, he won't overpay for growth. "Every fundamental investor is a value investor," he says.

So where does he find value in growth stocks these days? His largest position is in Accenture (ACN), the big consulting and information-technology-services outfit that sports a towering return on equity. He's avoiding shares of big drug manufacturers but has large positions in medical insurer UnitedHealth Group (UNH); Medtronic (MDT), the heart pacemaker king; CVS (CVS), the drug-store chain; and Genentech (DNA), a leading biotechnology firm.

Two other growth themes he likes are the Internet -- Google (GOOG) is a top holding -- and telecommunications, Qualcomm (QCOM) and Cisco Systems (CSCO). He's also buying businesses with strong overseas operations, such as AIG, Schlumberger (SLB) and Wynn Resorts (WYNN).