5 Cheap Growth Stocks

Hi, my name is Tim, and I'm a growth investor who doesn't like expensive stocks.

Huh?
Surprised? I can understand that. I am, after all, the guy who selected Akamai (Nasdaq: AKAM  ) as a Motley Fool Rule Breakers recommendation when its P/E ratio was still in the triple digits. Most rational human beings would call that expensive.

But I look at "expensive" differently. And not in a "it depends on what the definition of 'is' is" sort of way. What I mean is that all valuations are relative. In Akamai's case, several factors led me to conclude that the stock was still cheap:

  • A commanding market share
  • Leadership in a massive growth industry
  • High barriers to entry in that industry
  • Accelerating sales and margins
  • Significant insider ownership and little institutional coverage

Moreover, Akamai was trading for roughly five times sales when I first profiled the company in late 2003. Surely that seemed high to some. But those who passed the stock by probably didn't consider that at exactly the same time, Microsoft (Nasdaq: MSFT  ) , itself a study in slowing growth, was trading for more than seven times revenue.

One screen, no rules
See what I mean? Value is relative, and growth on sale can absolutely rock your portfolio if you let it. (Akamai, for example, is up more than 140% since its selection in Rule Breakers.) So it's worth asking: What are the best cheap growth stories in today's market? I ran a screen to find out. Here are the criteria:

  • Market capitalization of at least $100 million
  • Sales growth averaging at least 30% annually over the past three years
  • Gross margin greater than 50%
  • Institutional ownership of less than 50%
  • CEO ownership of at least 2%

The next band of rebels?
Capital IQ returned 32 companies from that screen. Some look very intriguing. Here are the five that most caught my eye:

Company

Share price
as of 6/8/06

3-year
sales CAGR

Gross margin

Institutional
ownership

CEO ownership

Garmin (Nasdaq: GRMN  )

$91.65

33.4%

51.4%

35.3%

21.6%

Sycamore Networks
(Nasdaq: SCMR  )

$4.22

35.6%

55.2%

47.0%

15.4%

TASER International
(Nasdaq: TASR  )

$9.11

67.8%

65.4%

41.5%

3.2%

Utek (AMEX: UTK  )

$15.90

106.8%

79.2%

3.8%

22.0%

Vascular Solutions
(Nasdaq: VASC  )

$8.31

42.5%

70.3%

9.4%

2.0%

Source: Capital IQ, a division of Standard & Poor's

Pretty interesting, eh? TASER is a Rule Breakers recommendation, and Garmin is a Motley Fool Stock Advisor selection. Both could still make for excellent additions to a Foolish portfolio. But it's Utek that I find most enticing.

I'd never heard of this so-called technology transfer firm. As its website describes, Utek helps publicly traded firms to acquire new technologies from university researchers. All told, it has completed more than 60 deals and, like a venture capitalist, owns stakes in more than 50 publicly traded firms. Mix in heavy insider ownership, a meager dividend yield (0.1% as I write), and a 4.9 P/S ratio, and you can color me intrigued.

Get ahead on the cheap
No screen is perfect, of course, even this one. Take Medifast (AMEX: MED  ) , which professes to be like fast-growing NutriSystem. That's great, till you realize that the CEO recently dumped 25% of his shares on the open market.

Still, my point stands: Cheap stocks are the best foundation for any portfolio. And cheap growth stocks offer a wonderful way to pummel the market. Just remember that there is no rule of thumb when it comes to defining what cheap is. That's why David Gardner revels in flouting investing convention. Instead, his Rule Breakers team seeks great businesses with durable advantages that have been mispriced by the market.

Thus far we've found four that have become multibaggers, including Akamai. Want the skinny on the other three? Get an all-access pass to the Rule Breakers service by clicking here. It's free for 30 days, and there's absolutely no obligation to buy.

Fool contributorTim Beyersonly breaks the rules in his portfolio. Wimp. Tim owns shares of Akamai. You can find out what else is in his portfolio by checking Tim's Foolprofile. Microsoft is an Inside Value recommendation. The Motley Fool has an ironcladdisclosure policy.


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