US - The next-generation blue chip

published 31 October 2005

"It doesn't take an investing genius to pick Microsoft out of a crowd," say Stephen Gandel and Lisa Gibbs in Money. Establishing which fledgling company could be the next Microsoft, however, is "exceedingly difficult". Most of the firms touted as future blue chips stumble as their success spurs competition and they find that managing an expanding operation is too complex. Nonetheless, getting it right means "fatter returns" than usual, so it's well worth trying to identify potential titans. To this end, MoneyWeek has screened the market for stocks popular with fund managers who specialise in medium-sized growth companies (the sector most likely to contain tomorrow's blue chips). Candidates also had to display regular annual earnings growth of at least 15% and sales growth of at least 10%. Of the 20 firms that made the cut, the following look "attractively valued" with 2004 p/e ratios at, or below, their anticipated earnings growth rate. Studies show that growth stocks with a price to earnings growth (PEG) ratio of 1 or below tend to outperform the market.

Affiliated Computer Services (ACS) "has turned paper-pushing into an earnings machine". The group has reeled in "scores of corporate customers" - including Motorola and General Motors - and a number of state governments thanks to its ability to handle back-office operations (such as processing insurance claims, loan documents and human resources forms) "on the cheap". Annual revenue growth has averaged 17% since 1998 and should continue at this clip as cost-conscious firms and cash-strapped local governments keep seeking ways to trim costs and slash paperwork, and as ACS enters new markets, such as toll collection. Earnings should expand by an annual average of 20% over the next five years, yet the stock is on a 2004 p/e of 17.

The main strengths of oil services group BJ Services (BJS) are its "great niche and great management". It specialises in pressure pumping, a highly efficient method of extracting oil and gas, while the "scrupulous attention to detail" of the team of veteran oil service executives in charge of the group has boosted operating margins from last year's 10% to 14%. Furthermore, it has a strong presence in North American natural gas drilling - which is up 30% so far this year - and caters largely to independent producers, who have been more active in increasing oil exploration than the energy giants. BJ Services is set to post the strongest annual profit growth of all the mid-sized oil service firms, and should continue to benefit from the drive to boost US energy production. The stock is "worth more" than its current 2004 p/e of 18 and PEG of 0.3.