Is Now the Time to Buy US Silica?

In the past I've written about how frac sand providers could be the best way for long-term investors to profit from America's historic energy bonanza. Recently I explained how US Silica Holdings' (SLCA 1.10%) latest earnings confirmed the company's dominance in its industry and deserved a spot on every investors radar. Indeed, Wall Street seems to have agreed as investors took notice of the company's success and have turned it into one of the hottest stocks of the last year.

In fact, the entire proppant (materials used to prop open cracks in shale) industry, of which frac sand is the dominant variety, has been on a tear. US Silica's competitors Hi-Crush Partners (HCRS.Q) and Emerge Energy Services (NYSE: EMES) have done as well or better. Only CARBO Ceramics (CRR), which manufactures more expensive and more advanced ceramic proppants, and Eagle Materials (EXP -1.73%) haven't at least doubled in price. The reason that Eagle Materials hasn't (yet) soared as high is probably that the construction material and cement manufacture just got into the frac sand game and is lesser known to investors.    

SLCA Total Return Price data by YCharts

Many investors take a look at a chart like this and might wonder if the prices on these stocks aren't too rich to make a good investment. After all, even the best company can make a terrible investment at the wrong price. That is why, when looking at fast growing growth stocks such as proppant makers, it's often best to think in terms of GARP.

Growth at a reasonable price
Some of the most promising companies are also richly valued, yet this is often because they deserve to be. One way to compare such companies is with an investment principle called "growth at a reasonable price," which combines the best of both value and growth investing. 

A simple metric called the PEG (price/earnings/growth) metric can be used as a rule of thumb to see how richly valued a company is relative to its expected growth prospects. Another useful tool is the adjusted P/E ratio, (also called its operating PE, which is useful for MLPs and capital intensive industries such as this) as compared to the historical adjusted P/E ratio.

Sources: Yahoo Finance, S&P Capital IQ, Fastgraphs

For example, in the above table the "premium" column shows how much greater the current adjusted P/E for each proppant maker is relative to its historic norm. With US Silica we can see that the company's valuation is 116% higher than average, and its PEG of 1.29 indicates that the company is overpriced despite its industry best projected 10-year earnings growth rate. Similarly, we see that Hi-Crush Partners, despite an adjusted P/E 76% higher than its historical norm, is actually slightly undervalued based on the PEG ratio.

Not so fast
However, as useful as metrics such as adjusted PE and PEG ratios are, we must never forget that they are merely tools used to make long-term investing decisions. Never forget that stocks are parts of real companies, living, dynamic organisms that must be analyzed at a fundamental level to see if their futures are still worth hitching our hopes of financial independence too. 

For example, if you only look at the historic premium that US Silica is trading at and its PEG ratio, it's easy to dismiss the company as too expensive. Though it's always better to buy on dips and at times of market weakness, that kind of thinking can result in never buying a great company and missing out on spectacular gains.

Consider that since 1873, the S&P 500 has grown at a 9.2% compound annual growth rate (including dividend reinvestment). Four out of the five proppant makers are expected to significantly exceed this growth rate over the next decade. US Silica especially, with its projected 29% 10-year annualized earnings growth rate and 31.65% projected 10-year dividend growth rate looks to be a future dividend growth superstar.

What's an investor to do?
A key Foolish principle of successful investing is "buying in thirds," aka initiating a small, initial position and then adding on dips. By owning a company you're more likely to follow it closely and learn about how it operates.

Another strategy is dollar-cost averaging, a favorite of dividend re-investors, in which you regularly buy a company on a fixed schedule, regardless of the price.

In this way, regardless of how the share price is acting, you steadily build a position in a fundamentally great company, buying more shares when the price is depressed, and sharing in high gains when the price is soaring.

Foolish bottom line 
Though many proppant makers--US Silica most of all--can be called overvalued, that doesn't necessarily mean they won't make excellent, market-beating investments over the long term. Investors worried about valuation should consider buying in thirds or dollar-cost averaging. Both strategies help you get skin in the game but allow you to add more should a more attractive price present itself.