Pouring on the Syrup (originally ran in April 1999)

It's not every day that you find a high-quality company experiencing consistent growth and trading at a reasonable price. Even more unusual is learning that this company has been under your nose for years. IHOP Corp., operator of International House of Pancakes restaurants, is just such a company.

While 835 of the company's breakfast palaces (they serve lunch and dinner as well) were open at the end of 1998, only 66 were actually owned and operated by the company. Franchisees and area developers operate the majority of the chain's units. Unlike most other restaurant chains, IHOP franchises most of its restaurants to people who actually work in the establishments, rather than passive investors. IHOP feels these owners provide better management and are more diligent than salaried employees.

The company is successful with this strategy because it finances most new units for new franchisees. After building and equipping a new unit, the company leases it to a new franchisee. Because the restaurant is equipped and ready to go, IHOP is able to charge a higher initial franchise fee than most other restaurant chains. In addition, it earns interest on loans to franchisees as well as ongoing royalty fees.

IHOP has grown its earnings from $15 million in 1994 to $26 million in 1998. Net profit margins hover around 10 percent. With plenty of room to add more units, the company should continue enjoying higher earnings in the years ahead.

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Storing Huge Growth (originally ran in May 1999)

Behind the scenes of the much-ballyhooed Internet revolution is a briskly growing industry that's still fairly unknown. As the number of Internet sites and electronic business transactions proliferate, the amount of data that companies need to store has soared. This has led to rapid growth for high-end storage systems manufacturers, which is expected to continue.

Research firm International Data Corp. projects that the storage market (as measured in capacity shipped) will grow at a compound annual rate of 86 percent between 1998 and 2002. This business is not led by traditional computer powerhouses like IBM, Hewlett-Packard, or Sun Microsystems. Instead, the leader is EMC Corp. with a 35 percent market share that is 13 points ahead of its closest competitor.

Unless you're an information technology professional or stock market follower, you probably have not heard of EMC. Nonetheless, its revenues grew from $1.4 billion in 1994 to $4 billion in 1998. Profits during that period more than tripled from $251 million to $793 million. That growth does not appear to be an aberration, with the company targeting $10 billion in revenues by the year 2001.

EMC's strong earnings performance and outlook led to its designation as the best performing Standard & Poor's 500 company on the New York Stock Exchange last year. While the company's stock is not undiscovered, its industry appears to be just beginning a period of phenomenal growth.

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Pharming It Out (originally ran in June 1999)

Almost all of the major stocks in the drug industry, including stalwarts such as Merck, Pfizer, and Eli Lilly, have declined sharply this year. Sometimes price drops represent opportunities.

A major investor concern is that the government might expand coverage of prescription drugs to Medicare recipients. While this would add millions of new users, many fear decreased profitability for drug companies, as the government would likely pay lower prices.

Before becoming too concerned about this issue, consider the business model of pharmaceutical firms. The manufacturing cost of a drug is usually only a small portion of its price. Activities such as research and development (R&D), marketing, and other functions tend to be much more expensive. Pfizer, for example, spent 16.5 percent of 1998 sales on drug costs, compared to 16.8 percent for R&D and 41.1 percent on marketing and administrative expenses.

If faced with smaller gross margins, R&D and marketing expenditures could be trimmed to maintain profitability levels. Although some initiatives might have to be shelved, these companies should be able to adapt to a new business environment.

Drug stocks have historically traded at price-to-earnings multiples significantly above those of the Standard & Poor's 500 Index because of their strong, consistent earnings growth. Right now, multiples of many companies are equal to or only slightly above the index. If you believe these firms will continue growing, now is a great time to investigate them.