STOCK WATCH


Where the Growth Is

These five companies should generate profit gains this year.



Earnings growth might seem like something from a bygone era, along the lines of Friendster or Uggs -- so 2007. But even in this severe recession, some companies are able to increase profits, albeit not at the levels they did a few years back. "The environment is so challenging that it's hard to find as many companies that can show double-digit growth," says Larry Puglia, manager of the T. Rowe Price Blue Chip Growth fund. "That makes the remaining companies that much more valuable."

In that spirit, we set out to identify companies that are capable of generating profit gains this year. Below are five in five different sectors that fit the bill.

For the first time in decades, Americans, especially young people, are reading more. That's good news for Amazon.com (symbol AMZN) because books (along with CDs and DVDs) remain its core business. But the online retailer is also generating revenue growth in the other goods it discounts, such as apparel and jewelry. Circuit City's decision to liquidate could boost Amazon's electronics sales as well, says Puglia.

Amazon is certainly not immune to the recession. This past holiday season was the Seattle retailer's best ever, but higher sales were the result of deep discounts. Amazon's earnings grew 148% in 2007, but analysts expect that profits jumped only 22%, to $1.37 per share, in 2008 (Amazon is scheduled to report fourth-quarter results on January 29). For 2009, they see profits declining in the first two quarters, then improving in the second half, for a total gain of 5%, to $1.44 per share.

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"Amazon's economic proposition is quite powerful," says Puglia. "It can adjust its inventory to the changing market much more rapidly than a brick-and-mortar retailer, and its cost of capital is lower."

Despite falling 43% since last August, Amazon shares are not cheap. At the January 23 close of $50.63, the shares trade at 35 times 2009 profit forecasts. It's probably best to hold off buying Amazon's shares until the stock trades at a more reasonable valuation.

Some companies can thrive in lean times. Consider O'Reilly Automotive (ORLY), a purveyor of auto parts. Cars are staying on the road much longer -- an average of 9.5 years. As credit remains tight and the unemployment rate continues to climb, new cars aren't leaving dealers' lots with the frequency they used to. "Cars are going to run longer, and they're going to need more fixing," says Ajay Krishnan, manager of the Wasatch Ultra Growth fund.

Through its purchase of Phoenix-based CSK Auto last April, O'Reilly, which is headquartered in Springfield, Mo., is expanding its geographic reach just as the recession deepens. Based on stronger demand for its products, Krishnan believes that O'Reilly can generate profit growth of 15% a year over the next three years.

Analysts estimate that O'Reilly's profits fell slightly, to $1.56 per share, in 2008. But they predict that earnings will leap by 17%, to $1.83, in '09. The stock held up better than most in 2008, falling just 5%. At $29.02, it trades at 16 times this year's estimated profits.

You may not be feeling flush enough to dine at a celebrity chef's four-star restaurant, but plunking down a few dollars for a Chipotle BBQ Snack Wrap, a Fruit 'n Yogurt Parfait and a Coke at your local McDonald's (MCD) is an affordable luxury.

The Oak Brook, Ill., company is still moving hamburgers, sandwiches and now specialty-coffee drinks at a good clip. On January 26, McDonald's reported what it called "very strong" results for the fourth quarter and all of 2008.

Global comparable-store sales (sales at restaurants open at least one year) rose 7.2% in the fourth quarter. The company earned 87 cents a share, which was down from the $1.06 it earned in the fourth quarter of 2007, but that figure was inflated by tax benefits of 33 cents per share. "The company has done a good job of publicizing its value menus, so it's less affected by people cooking more," says Morningstar analyst R.J. Hottovy. "McDonald's is still a solid concept even in a recession."

For all of 2008, McDonald's earned $3.76 per share from continuing operations. Before the January 26 earnings release, analysts estimated that the company would earn $3.83 per share in 2009. That represents an increase of only 2% from the 2008 figure, but analysts may well boost those estimates in the aftermath of the upbeat fourth-quarter report.

McDonald's stock climbed 8.5% in 2008, making it one of only two in the Dow Jones industrial average to advance last year. The stock, which closed at $58.02 on January 23, trades at 15 times 2009 profit estimates.

Recessions and advertising generally don't go together -- unless the advertising is being done on Google (GOOG). The search-engine giant continues to attract ads at the expense of television and print outlets. Writes Argus Research analyst Wendy Walker: "We believe that the Internet will continue to gain share from traditional media, and that search -- dominated by Google -- will continue to gain share from display ads as consumers comparison-shop and advertisers move to maximize their return on marketing dollars spent."

As Google matures, its growth is slowing and the Mountain View, Cal., company is putting greater emphasis on controlling costs. "Google is getting its headcount lower and getting a better grip on costs," says Chris McHugh, manager of the Turner Midcap Growth fund.

Although fourth-quarter profits tumbled, revenues rose 18% in the period. For all of 2008, profits climbed TK%, to $19.49 per share. Analysts expect earnings of $21.24 per share in 2009, an increase of 9%. At its January 23 close of $324.70, down 56% from Google's record high in November 2007, the stock trades at a modest 13 times estimated '09 earnings.

Looking for growth names in a recession naturally leads to the health-care sector. But drug makers have disappointed because of patent expirations, paltry new-product pipelines and concerns about the impact of health-care reform. Medical-equipment makers have also experienced a slowdown as hospital spending has declined.

Then there's Gilead Sciences (GILD), a biotechnology company whose main products are easy-to-use drug-cocktail therapies for treating HIV. About 50,000 new HIV cases are reported each year, according to the Centers for Disease Control and Prevention. The Forest City, Cal., biotech could benefit if some of the 250,000 people who have HIV but have not yet reported it were to begin using the company's drugs. Gilead is also looking beyond its HIV franchise with its recent purchase of Myogen, which has a healthy pipeline of cardiovascular drugs, including a drug for treating hypertension.

Analysts expect earnings of 55 cents a share when Gilead reports fourth-quarter results on January 27. The $2.04 per share they estimate for all of '08 represents a 21% gain from the $1.68 that Gilead earned in '07. And they're looking for $2.41 per share in '09, which would be an increase of 18% from '08 -- pretty heady stuff in this economy. Gilead's stock, which rose 11% in 2008, trades at 20 times '09 earnings forecasts.



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