Finding Hidden Value in Financial Growth Stocks

In a recent report to clients, Goldman Sachs researchers have found that, in general, stocks with high growth prospects are currently priced at P/E multiples in line with comparable stocks with lower growth prospects. The theory goes that this presents a fantastic opportunity to buy high potential growth stocks on the cheap.

The report found that the dispersion of P/E multiples across the S&P 500 (SNPINDEX: ^GSPC  )  varied not only from sector to sector, but also company to company. The findings are worth a look, but this method of stock picking still falls short of a long-term value investing approach.

High growth vs. low growth in the insurance space
We can use MetLife (NYSE: MET  ) as a typical low-growth player and Lincoln National Corporation (NYSE: LNC  ) as the contrasting high-growth player. In the chart below showing the forward P/E ratios for each company, its clear to see they are being valued very similarly between 8.5 and 9 times forward earnings.

MET Forward PE Ratio Chart

MET Forward P/E Ratio data by YCharts.

Despite being valued so closely, Goldman forecasts 10% earnings-per-share growth at Lincoln, considerably outpacing the 3% forecast for MetLife.

Great in theory, but the method doesn't always work
Goldman's research here is essentially an advanced statistical analysis, seeking to find hidden, undervalued growth stocks. It's important for long-term value investors to remember this and review the methodology for what it is (and nothing more).

We still have to do our homework, and sometimes it's worth paying a little premium to buy a premium company.

Take the example of Community Bank System Inc (NYSE: CBU  ) . Company management is forecasting a long-term 9.9% annual earnings growth rate, the balance sheet appears strong in terms of capital and credit quality, and the company is beating analyst estimates quarter after quarter. By all accounts, this company is poised to perform well above average for the very long term. Yet it would not show up in Goldman's screen because its forward P/E ratio has been increasing, appropriately, relative to the banking industry average. 

CBU Forward PE Ratio Chart

CBU Forward P/E Ratio data by YCharts.

At the end of the day, using methods such as the one Goldman recently published can be useful and can uncover some fantastic long-term buys. As an investor, this is another tool in your toolbox to help you in your quest to find and own companies for the long term.

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