Many of the giant companies that used to be emblems of quality, reliability and consistency are no longer the best bets when it comes to so-called blue chip stocks.
Instead, a new breed of blue chips is emerging now—big companies that should thrive for many years despite what will remain a slow-growth global economy.
That’s the belief that is shaping the investment strategy of Larry J. Puglia, manager of the T. Rowe Price Blue Chip Growth Fund, which has outperformed the Standard & Poor’s 500 stock index over the past three-, five-, 10- and 15-year periods. He points out that in recent years, even legendary investor Warren Buffett has invested in several “growthier” blue chips.
Bottom Line/Personal asked Puglia why this shift is taking place and how it should affect our readers’ investment decisions…
Most investors haven’t worried too much about the anemic growth of the US economy over the past several years because the stock market has kept rising, fueled by low interest rates. But weak economic growth eventually makes it harder for many companies to improve their earnings year after year. And in the long run, earnings growth is the main driver for higher stock prices.
Many traditional blue chips, ranging from Coca-Cola to General Electric, have lagged the returns of the broad market over the past five years. And investors should expect the subpar performance to continue.
Although the new blue chips have many of the same characteristics as the traditional ones—dominant market share, seasoned management teams and sustainable advantages over the competition (such as a proprietary technology or a trusted brand name)—I also require the following before I invest…
Durable growth. I seek companies that can increase their earnings per share at rates above the industry average regardless of the ups and downs in the economy. Typically, I expect them to have annualized earnings growth of 12% or more over the next five years.
Exposure to long-term positive trends. These trends often are driven by technology, the environment, culture and/or demographics. The trends range from advances in medical technology to global demand for fresh water. It is important that the trends aren’t held back by what the economy is doing and they provide the opportunity for enormous growth.
The following large-cap stocks fit all my criteria and have outperformed the S&P 500 and the Dow Jones Industrial Average over the past five years…
• Biogen Idec (BIIB) is only about half as large as its better-known competitor Gilead Sciences, but it has achieved blue chip status with a deep pipeline of new drugs under development in the fields of immunology and neurology, as well as industry-leading multiple sclerosis drugs such as Tysabri. Its drugs generate nearly $10 billion in annual revenue. In late 2014, the company entered late-stage clinical trials for an Alzheimer’s drug that had a “statistically significant effect” on cognition after 54 weeks of treatment, according to the company’s research chief. If successful, the drug could be worth tens of billions of dollars annually. Performance: 44.7%.* Recent share price: $342.34.
• Danaher Corp. (DHR) is one of the best-run industrial companies that you may never have heard of, with robust earnings growth in several market niches. For example, its environmental services division treats water for more than one billion people in 102 countries, including treating 2.24 billion gallons a day of drinking water for New York City. And about half the company’s earnings now come from its fast-growing health-care division, which makes diagnostic tests and instruments used in hospitals and laboratories around the world. These businesses generate enough cash flow to allow Danaher to spend an average of $2 billion a year acquiring smaller competitors, increasing its market share and pricing power. Over the past 15 years, its stock has beaten the S&P 500 by an average of 10 percentage points a year. Performance: 18%. Recent share price: $85.53.
• McKesson Corp. (MCK) is the leading US drug distributor, buying prescription medications wholesale and selling them to the health-care industry. The company, which was started in 1833, distributes one-third of all prescription drugs used in North America…serves more than 50% of US hospitals and 20% of physicians…and is the main supplier to large pharmacy outlets including CVS Caremark, Rite Aid and Walmart. This extensive network gives McKesson the leverage to negotiate much better deals with big drugmakers than its competitors are able to. It is expanding its software division, which sells programs for storing medical records and software used to manage hospitals and private doctor practices. McKesson also is expanding its presence overseas with the purchase of Celesio, one of the largest medical-distribution companies in Europe and Brazil. Performance: 27.6%. Recent share price: $216.67.
• Starbucks Corp. (SBUX), the world’s largest coffee shop chain, has more than 14,000 US stores, about 50% more than its closest rival, and accounts for one-third of all the cups of coffee sold at retail. Sheer size and its upscale reputation earn Starbucks blue chip status. The company is able to negotiate much lower prices on the 400 million pounds of unroasted coffee beans it purchases annually and often has its pick of marquee locations in malls and shopping districts. The company, which dropped the word “coffee” from its logo, has been beefing up its lunch menu and expanding its evening food fare. One out of three Starbucks purchases in the US already include a food item. And the recent purchase of La Boulange bakery will vastly improve the variety and quality of the food it serves. I expect Starbucks to double its sales from its food business in the US within the next five years. Overseas, Starbucks’ growth potential is even stronger. The company has a presence in more than 65 foreign countries but only about 7,200 stores. Performance: 30%. Recent share price: $79.79.
• The Sherwin-Williams Company (SHW), which was started one year after the Civil War ended, has enormous brand power and far-reaching distribution. The paint giant operates more than 4,000 stores in North America, more than all of its competitors combined, and it has sales in about 100 foreign countries, including nearly 300 stores in Latin America. Its high-quality paints and service allow it to charge premium prices and grab a big share of the market among contractors and home owners. And it recently signed a deal to supply a house-brand paint called HGTV Home to the Lowe’s home-improvement retail chain. While Sherwin-Williams has been a direct beneficiary of the recovery in housing since the recession, the company earns its blue chip status because it derives most of its revenue from maintenance painting not tied to new construction or home sales. The company’s cash flow has been so consistent that its stock dividend has increased annually for 35 years straight. Performance: 34.5%. Recent share price: $274.42.
*Performance figures in this article are annualized returns for the five years through December 31, 2014.
