Stocks With 'New Economy' Souls and 'Old Economy' Multiples

We've all read about the divergence in the stock market between "New Economy" and "Old Economy" stocks, between tech and almost everything else. Over the past two years, stocks in the Standard & Poor's technology sector have risen nearly fourfold, while the S&P 500 index has gained just 50%. And without tech, the benchmark would be flat. In January alone, 30% of net inflows into mutual funds went to science and technology funds, vs. just 8.7% into S&P 500 index funds.

There are good reasons for tech's dominance. It's the sector least affected by higher interest rates, for example, because it's financed almost entirely with equity rather than debt. And by some estimates, half the growth of the gross domestic product, or GDP, is tied to tech, so the fact that it accounts for some 30% of the S&P 500 shouldn't be all that surprising.

But it's also true that in today's all-tech, all-the-time environment there are some great businesses going begging, or at least selling substantially off their highs. Stocks with New Economy souls are laboring under Old Economy multiples.

And prices for some old-line firms belie stellar track records and bright prospects. I asked Prudential Securities analyst Ed Keon and portfolio manager Chris Davis of the Davis family of funds -- key thinkers in the mega-growth vs. value debate -- for their best ideas.

Prudential's Keon has a list of what he's dubbed the "new value" stocks. These stocks are expected to turn in 13% to 14% annual earnings growth rates over the next several years -- a pace that might have put them in the growth camp once upon a time, but a far cry from the 50%-plus growth rates expected from the eBays (EBAY) and Amazon.coms (AMZN) of the world.

Still, 14% is nothing to be ashamed of, says Keon, considering that's about double the growth rate of S&P 500 firms over the past 50 years. Here are a few of the "new value" stocks he thinks are well worth investigating (and their Friday closing prices):

• General Electric (GE) ($139 3/8). An old-time Dow stalwart, GE has reinvented itself as an e-business and, as a result, should see revenue growth accelerate from the low to the mid-teens over the next two to three years. Because it has beaten competitors to the Web, GE should profitably take market share in all of its 10 core markets in all regions of the world. And e-selling is cheaper, to boot, shrinking costs by 2% to 3% this year alone. Look for GE, down 16% from its high, to hit $185 a share within the year, says Pru.

• Procter & Gamble (PG) ($88 7/16). The new P&G is more aggressive about getting products from R&D to shelves faster -- no more sitting in test markets while competitors grab market share. Selling and tracking products and supplies electronically will take $1 billion out of P&G's cost structure over the next several years, boosting sales growth to 6% to 8% a year from the old 2% range. Down some 25% this year, P&G is worth $123 per share over the next six to 12 months, says Pru.

• Ralston Purina (RAL) ($27 3/16). If every dog has his day, then it follows... Never mind. In all seriousness, Pru believes that more and bigger dogs, whose masters are working at home and feeding them treats more often, are making pet food the most vibrant food group. Pet food accounts for 69% of Ralston's earnings, and the company owns the category, with leading shares in every major area in which it competes. Pru thinks Ralston is selling for at least 20% less than what it's worth.

Veteran value investor Christopher Davis is the son of value guru Shelby Davis and manager of the Davis (NYVTX)New York Venture, (RPFGX)Financial and (DGIAX)Growth & Income funds. When Davis looks at the market these days he sees plenty of "growth stocks in disguise." Among them:

• Masco (MAS) ($17 5/8). A high-margin home improvement and building products company that trades like a cyclical commodity producer, Masco has increased sales in core businesses in 42 of the last 43 years. Management is shareholder-friendly and has a keen eye for acquisitions. If Home Depot (HD) makes its goal of doubling its store count over the next five years, Masco, a big supplier, will prosper. The irony: Home Depot trades at almost 50 times earnings, while Masco sells for barely 10 times Davis' 2000 estimate of $1.90 a share.

• Golden West Financial (GDW) ($30). Since 1983, this savings and loan has achieved earnings growth of 13% a year, while book value has increased by 19% annually and share price 20%. The low-cost lender controls interest-rate risk by specializing in adjustable-rate mortgages. Credit risk is also minimal, with charge-offs actually at 0% of assets. Davis isn't the only one convinced the shares are a bargain at about nine times estimated 2000 earnings of $3.10. Management is repurchasing 10% of outstanding shares.

• Martin Marietta Materials (MLM) ($37 7/16). The business couldn't be duller -- the company sells gravel, for heaven's sake. But it's hard to argue with the economics. Nationwide, prices have fallen only once in the past 20 years and then, by only 0.5%. Unlike rapidly evolving technology products, gravel doesn't face much risk of obsolescence. Federal spending on highways alone should increase sales by 10% in each of the next five years. And yet at 12 times earnings, the stock trades for less than half the market multiple.

What's the good of prospecting great businesses, however, if you can't get the rest of the market to come around to your thinking? You may not have to. Keon is among those on Wall Street who think '80s-style leveraged buyout firms soon could step in to take advantage of bargains investors are ignoring, thereby commencing a rally.

Keon still recommends overweighting tech and high-growth stocks. But with some of the mega-growth names bound to stumble eventually, it can't hurt to balance the "fire" in your portfolio with a little "ice." Look at it this way, says Keon, "If you buy Ford (F) and Qualcomm (QCOM), you're covered either way."

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