Stocks That Grow in Any Climate

Companies that achieve profit growth during a recession are hard to come by. That's why those that do while everyone else is just scraping by look especially attractive right now.

Growth stocks -- that is, stocks known for their earnings power rather than for bargain prices -- have performed well this year. Through August 7, the Russell 3000 Growth index trounced its Value index counterpart, 21% to 9%. Granted, that performance gap came mainly in the first quarter; the second quarter was virtually a tie. But over the long term, owning a great growth stock can be very rewarding. Google, for example, has provided shareholders with a 36% annualized return since its initial stock offering in 2004.

What makes a growth stock great is a company's ability to increase profits consistently over the long haul regardless of economic conditions. Usually a company is successful because it has a head start on its competitors, a strategy or technology that's hard to duplicate, or some other built-in advantage that keeps customers coming back.

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All seven stocks profiled below have an edge over their rivals as well as a solid record of consistent profit growth that should persist. None comes cheap, at least by value-stock standards. But over time, we think these stocks will fulfill the expectations built into their prices.

School star

At first glance, Strayer Education (symbol STRA) may seem to be a defensive play rather than a growth stock. After all, laid-off workers tend to flock to school during a recession. But chief executive Robert Silberman insists that Strayer's profits are unrelated to the economic cycle, and the numbers bear him out: Its profit growth, an annualized 19% over the past nine years, is closely tied to the opening of new campuses.

This year the Arlington, Va., firm will open 11 campuses (plus a second operations center to serve online students). Since Silberman took over in 2001, Strayer has expanded from 12 campuses in three states to 67 sites in 15 states, primarily in the Southeast, plus the District of Columbia. There's plenty of room for more growth in Silberman's plan to put a campus in every metropolitan area with a population of 300,000 or more.

Strayer has no debt, and it has generated enough cash to buy back 12% of its shares over the past eight years as well as pay a dividend, currently $2 per share. It also has the pricing power to raise tuition by 5% annually. Those factors, plus enrollment growth at new and existing campuses, should provide steady, low-risk growth for years to come.

Still, the shares fell from $240 last year to $150 in March on fears that Strayer's corporate partners, which provide 20% of revenues in exchange for specially tailored training and educational programs, would cut back. So far, they haven't.

Another concern, that the private student-loan market would dry up, also proved to be unfounded. Strayer's tuition -- $14,000 a year for a full-time bachelor's-degree program -- is low enough to qualify for federally subsidized loans, which remain plentiful. The shares have since rebounded to $216, or about 29 times this year's expected earnings. That's not cheap, but as the U.S. shifts away from a manufacturing-based economy, investing in a more knowledgeable workforce looks like a smart thing to do.

Detection specialist

Think of FLIR Systems (FLIR) as one of the earliest "green" stocks. The maker of infrared detection systems was founded in 1978 to sniff out energy waste in buildings. The technology quickly expanded into other areas -- particularly the military, where, eventually, "everything that moves is going to have an infrared camera," says CEO Earl Lewis.

Government agencies in the U.S. and elsewhere use FLIR's infrared cameras and laser devices for early-warning systems, weapons-targeting systems, surveillance and reconnaissance. The Wilsonville, Ore., firm's government-systems division accounts for 53% of revenues and the lion's share of the $598-million backlog of products expected to be delivered over the next 12 months.

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But the biggest opportunity for growth lies in the technology's commercial applications. Thermography, which combines imaging with heat measurement, is used to detect energy waste in malfunctioning mechanical equipment as well as in buildings (problems show up as hot spots). Night-vision systems are used on boats, trucks and, since 2005, as an option on BMW automobiles.

Revenues have expanded at an annualized 28% over the past five years, though analysts see growth slowing to 5% this year as businesses and the military cut back on new orders. But the economic-stimulus program passed by Congress directs billions of dollars to energy-efficiency and law-enforcement programs that could benefit from FLIR's technology.

Meanwhile, the shares are $22, down by more than half from their 2008 peak. They trade for just 15 times this year's expected earnings, even though analysts expect 19% annual profit growth over the next three to five years.

Biotech giant

The recession has had little impact on profits at Gilead Sciences (GILD), the biotech firm that dominates the field of HIV pharmaceuticals. The treatment of life-threatening infectious diseases, after all, is not something that can be put off. Second-quarter 2009 profits were 31% higher than in the same period a year ago, thanks largely to two once-a-day HIV treatments, Truvada and Atripla. The two drugs accounted for $3.7 billion in sales last year, or about 72% of Gilead's $5 billion in total product sales.

Based in Foster City, Cal., Gilead owns a 71% share of the U.S. market for HIV drugs. Sales should grow further as Atripla, launched in the U.S. in 2006, is approved for use in more European markets.

More important, Gilead has taken steps to diversify beyond HIV treatments. It acquired CV Therapeutics, the maker of Ranexa, a treatment for chronic angina, earlier this year, and it bought Myogen, maker of hypertension treatment Letairis, in 2006. These acquisitions together give the company a foothold in the market for cardiovascular drugs. Gilead also sells a widely used hepatitis B drug, Hepsera.

Even after this year's mostly cash, $1.4-billion purchase of CV Therapeutics, Gilead still has $2.9 billion in cash, which it can use to further diversify its product lineup. It also has several promising treatments in its development pipeline, and none of its patents will expire in the near term. At $46, shares of this developing pharmaceutical giant are 17% below their price one year ago. They change hands for about 18 times this year's expected earnings.

Domestic outsourcer

Investors don't seem to be bothered by the fact that Cognizant Technology Solutions (CTSH) will see little growth this year in the 45% of its technology-outsourcing business that depends on the financial-services industry. The shares have more than doubled since December, to $34, and trade at 20 times expected 2009 profits. But even at that price, there is plenty to like.

The business is characterized by long-term contracts, fairly stable revenues, low debt and high cash flow. And even though many customers are putting off new projects, ongoing maintenance services account for more than half of revenues. Once the economy recovers, Cognizant is sure to start winning more new business. Analysts expect a 16% rise in profits this year, and they predict annual profit growth of 17% over the next three to five years.

Like competing outsourcing businesses, Cognizant can provide offshore software design and perform development and maintenance chores for less than it would cost its customers to keep those functions in-house. The Teaneck, N.J., firm also targets a handful of industries, including financial services, health care, manufacturing and retail, which gives it a leg up on less-specialized competitors.

Cognizant has no debt and $1.1 billion in cash. It aims for operating profit margins of 19% to 20%, and any profits that exceed the target get pumped back into the business. That healthy reinvestment policy leaves Cognizant well positioned to gain a greater share of a global-outsourcing market that is expected to grow for many years to come.

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Medical record keeper

The $787-billion economic-stimulus plan, which directs $29 billion toward improving health-care technology, has set off a gold rush in shares of medical-records firms. Interest in the shares of Quality Systems (QSII), one of our favorites, has risen since the bill was signed in February.

We still like the shares, even though, at $52, they trade at a lofty 29 times expected profits for the fiscal year ending next March. If you've been to a doctor's office lately and seen the stacks of patient files still kept in manila folders, you know how much work remains to be done in digitizing medical records.

Quality Systems, based in Irvine, Cal., is one of the more established players in a fragmented industry. It is in a good position to capture a large share of the business that will come from the federal government's push to cut medical costs by increasing the use of technology.

The company is in great shape financially, providing a key advantage in coming battles for market share. It is already one of the most profitable firms in the field, with pretax profit margins exceeding 30%. It has no debt and $78 million in cash, some of which is earmarked for a $1.20 annual dividend (resulting, at the current share price, in a 2.3% yield). Analysts expect profit growth of 11% this year and 30% next year, even though the stimulus money won't begin flowing in earnest until next year.

Robo-surgery supplier

For Intuitive Surgical (ISRG), robotic surgery is not a futuristic concept; it's an $875-million-a-year business. The Silicon Valley-based firm's da Vinci Surgical System allows a doctor to operate by precisely manipulating robotic arms while seated at a control console. Doctors can perform surgery with much smaller incisions than in traditional open surgeries. That means less patient trauma, shorter recovery times and lower costs.

At $230, shares of Intuitive Surgical have nearly tripled from their March lows. They had fallen sharply, to $85, because of fears that hospitals will be reluctant to spend $1 million to $1.7 million for a da Vinci system during a recession. Nevertheless, second-quarter profits were a healthy 22% higher than they were a year earlier.

Intuitive acquired its only competitor in 2003. New rivals will no doubt emerge, but when they do, Intuitive will retain a huge first-mover advantage. Meanwhile, its de facto monopoly status gives it a lot of pricing flexibility. Today, its systems are used primarily for prostectomies and hysterectomies; such surgeries accounted for almost 80% of the 136,000 procedures performed with da Vinci systems last year. As other types of procedures are added to the da Vinci repertoire, the company's market value will only grow.

Meanwhile, the existing base of more than 1,100 systems generates loads of cash for Intuitive. Instruments and accessories must be purchased and replaced, generating recurring revenue of $100,000 to $150,000 per machine annually. Almost half of Intuitive's revenue in 2008 was recurring, and the company says the percentage continues to rise. It should be no surprise, then, that the company is in good financial shape, with no debt and $902 million in cash.

Expanding exchange

Owning shares of an exchange is a great way to profit from growth in securities trading. Most exchanges are electronic nowadays, so it costs little more to process a billion trades than it does to process a half-billion. Such economies of scale can create huge profits. IntercontinentalExchange (ICE), one of our favorites, had a pretax profit margin in the second quarter of 2009 of 54%. What's more, established exchanges benefit from a networking effect: If buyers and sellers of a contract know that most transactions happen at a given exchange, they have little motivation to go elsewhere.

IntercontinentalExchange, or ICE, began as an energy-focused marketplace in 2000. Through acquisitions and smart moves, it has become one of the world's largest marketplaces for crude oil and other energy futures, as well as for sugar, cotton and other agricultural products. It also has an exclusive license for trading futures based on the Russell stock indexes. ICE does its own clearing -- it guarantees the performance of contracts traded on its exchanges -- giving it more flexibility and profitability than rivals that rely on others to clear trades.

The crackdown on unregulated trading of credit-default swaps should be a boon for ICE. In concert with nine leading banks, it has launched an exchange for trading these instruments where they can be more easily monitored and regulated. Credit-default swaps are essentially insurance policies on bonds. Trillions of dollars' worth used to trade in unregulated markets, and ICE can potentially generate big profits by drawing that business to its platform. Analysts expect profits to rise only slightly this year, then climb 17% next year. At $94, the shares are down 23% from their June peak and trade at 21 times 2009 earnings.

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