GROWTH STOCK DILEMMA : FINDING THE NEXT MICROSOFT BECOMES MORE DIFFICULT TASK.

Byline: Floyd Norris The New York Times

Growth stocks - the shares of companies whose profits Wall Street expects to rise rapidly - have been the darlings of the stock market during the 1990s. But they lagged late in 1996, and have recently been downright poor performers.

The best measure of the performance of the stocks that analysts love is a new index, the Montgomery Securities Growth Stock Index, which is based on the 500 stocks for which Wall Street expects the greatest profit growth in the coming five years or so.

The index is new, but Montgomery, a San Francisco-based brokerage firm that specializes in growth stocks, traced it back to the beginning of the 1990s, and found phenomenal performance.

Had you invested $100 in index stocks at the beginning of 1990, it would have risen to $310 at the end of January. In contrast, a similar investment in the Standard & Poor's index of 500 stocks would have been worth $222, and one in the Russell 2000, the best-known index of small stocks, would have risen to just $220. All figures ignore dividends and transaction costs.

But since then, things have not been as friendly for many growth stocks. The index is down 11.7 percent since the end of January, a period in which the S&P 500 is up 2 percent and the Russell 2000 is down 1.5 percent.

The search for growth has been a staple for many investors. Finding the next Xerox or Microsoft - companies that rose from tiny to supreme in an important business - is a dream, and finding one can provide gains to offset a multitude of failures.

But many companies that are expected to grow instead run into problems, whether from competition or changing technology. And such stocks can be vulnerable to concern that the economic environment is turning less friendly.

``Growth investors are looking to the future and paying for future earnings,'' said Michael Moe, Montgomery's director of growth stock research. Federal Reserve Chairman Alan Greenspan has discussed the possibility of ``irrational exuberance'' in the stock market and, some think, sent out warning signals that he may feel required to push up interest rates.

``When you are discounting future earnings, people have a greater fear of interest rates going up,'' Moe said.

Perhaps, but it may also be that as stock prices have been bid up, so too have analysts' expectations. A review of the Montgomery index, and where it stood at the end of each year, shows just how much more pricey growth stocks have become. It also shows that the nature of what Wall Street means by growth has changed.

A few years ago, many investors looked for companies that would grow consistently, whatever the economy, such as Coca-Cola. Now they are often looking for the next Microsoft.

The recent slipping of stocks in the index matches recent performance problems of some mutual funds that have done well in the past by picking growth stocks. The American Century 20th Vista Fund, once a star, has lost more than 8 percent of its value so far in 1997.

The inclusion of companies in the Montgomery growth index is based on the forecasts of analysts collected by IBES, the firm formerly known as Institutional Brokers Estimate Service. While it asks for earnings-per-share figures for coming quarters and years, it also asks for longer-term profit forecasts.

That way, Moe said, Montgomery hopes to capture in its index ``not only yesterday's heroes,'' whose earnings have risen, ``but also tomorrow's stars,'' which may or may not be making money now but are expected to see profits zoom.

To compile the index, Montgomery each year takes the 500 stocks with the highest anticipated long-term growth rates, though it includes only companies with a market capitalization of at least $200 million. By focusing on long-term expectations, it can include stocks that are now losing money, or whose growth is not robust now but is expected to become so.

How much more optimistic have analysts become than they were? At the end of 1990, a company with expected long-term annual earnings growth of 11.6 percent could get into the index.

Now, after several years of economic recovery, joining the select 500 requires that analysts expect earnings to rise 24.2 percent, more than double the rate required six years ago. The figure has risen in every year since 1990.

In the early part of the decade, the list of the 500 stocks for which Wall Street expected the most growth was filled with reliable consumer goods companies that had performed well year after year. At the beginning of 1991, it included venerable names like Procter & Gamble, Coca-Cola, General Electric, Kellogg, Borden and Campbell Soup.

Now, such companies are largely passe to the growth investor, although some have done very well in the stock market. Consumer goods companies make up a dwindling portion of the current list of hot stocks, replaced by a large number of technology companies, and none of the stocks named above is on the 1997 list. Technology companies now make up 40 percent of the 500 stocks, and account for 46 percent of the market value of stocks in the index.

The technology portion would be even greater but for the fact that for the first time, Microsoft no longer makes the cut. Analysts project its long-term growth rate as 23 percent. Not bad, but not enough now to make the top 500.

What companies do make the list? Among the technology names are Netscape Communications, Yahoo, Iomega and Pixar. And while Coca-Cola may no longer be deemed a fast grower, Boston Beer is on the list.

Another way to measure just how speculative the index might be is to see how many companies on it are expected to lose money in the next year, or to make so little that their current price-earnings ratios are more than 60 to 1. Back in 1990, there were 33 such companies.

The next year, scared by the recession, analysts saw hot growth prospects in just 30 companies. The number rose over time, but at the beginning of 1995, it was still just 56, or a bit more than 1 in 10 of the 500 companies about which analysts were the most optimistic.

But at the beginning of 1996, that figure was up to 123, and at the beginning of this year, to 173 companies - or more than one in three. That included 72 that are expected to lose money this year, and 101 that are trading at more than 60 times the consensus earnings forecast for 1997.

More than half the 500 companies are now losing money or trading at price-earnings multiples above 40. At the beginning of 1991, that figure was less than one in 12.

Such companies have room for thrilling moves if things go right. They also have a lot of room for disappointment. Consider the following two lists, each of stocks currently in the index.

The first is Yahoo, Optical Data Systems, Target Therapeutics, Vivus, E-Trade and Playboy Enterprises. The second consists of Citrix SystemsXL Connect Solutions, RTW, Atlas Air, Clintrials Research, Jayhawk Acceptance and Chicago Miniature Lamp. All the stocks in the first list are up at least 50 percent so far this year. The others are down by at least that much.

The first list shows that, even in an environment that has turned at least a bit hostile, there is money to be made in growth stocks. The second one, alas, shows that picking the wrong ones can be disastrous. And so far in 1997, the bad performers have outmatched the good ones.

CAPTION(S):

5 Charts

Chart: (1-5) Growing, Growing, Gone

The Montgomery Securities Growth Stock Index compiles the performance of the 500 stocks for which Wall Street analysts foresee the fastest growth, with the components of the index changed at the beginning of each year. It was a star performer for much of 1990's, but has faltered since the end of January.

(1) ENTRY THRESHOLD

(2) DROPOUT RATE

(3) INDUSTRY SECTORS

(4) HIGHLY SPECULATIVE STOCKS

The New York Times