While the market was in nearly nonstop rally mode for most of the past six years, investors didn't need to look far to uncover an abundance of growth stocks. But not all growth stocks are created equal. While some look poised to deliver extraordinary gains going forward, the recent market turbulence has crushed some that were overvalued, burdening their shareholders with hefty losses.
What exactly is a growth stock? I'll define it as any company forecast to grow profits by an average of 10% or more annually during the next five years -- although that's an arbitrary number. To gauge what's "cheap," I'll use the PEG ratio, which compares a company's price-to-earnings ratio to its forecast future growth rate. A PEG of around 1 or less could signal a cheap stock.
Here are three companies that fit that bill.
Hertz Global Holdings
The first cheap growth stock that investors may want to take for a spin is rental car giant Hertz Global (NYSE:HTZ).
The biggest knock against a company like Hertz is that it's cyclical. Hertz, along with its important subsidiaries Dollar and Thrifty, relies on a growing economy and discretionary spending to drive growth. If the economy is contracting, or growth is sluggish, the consumer is less likely to take a vacation, which can hurt car rental revenue and profits. Additionally, car rental companies freely use debt to bolster their fleets and keep them new, which means investors need to closely monitor debt levels to ensure they don't become a problem, as they did for the industry in 2009.
While Hertz has risks like every other company you can buy on a major stock exchange, it also has plenty of reasons for investors to be excited about the future. Front and center on that list is the continued low interest rate environment offered by the U.S. Federal Reserve and other developed countries around the world. Low lending rates have two positive effects for Hertz. Firstly, they allow Hertz to expand its fleet using debt at a relatively low cost, historically. Secondly, low lending rates are designed to entice the consumer to spend (among other things), which can lead to more vacations and more rentals. With seemingly no end in sight to below-average interest rates, Hertz should be able to take advantage of this environment.
Hertz has also benefited from inorganic growth. In 2012, it acquired Dollar Thrifty Automotive, which greatly expanded its rental offerings to include more cost-conscious consumers. In 2011, it also acquired Donlen, a provider of long-term car, truck, and equipment leasing, for $930 million. Hertz isn't afraid to pull the trigger on a deal when it sees good value. Since these deals were closed, Hertz has expanded its top line from about $7.6 billion annually to $10.5 billion in 2015, all while maintaining its gross margin in the mid-40% range.
Hertz is currently valued at a PEG of just 0.5 and a forward P/E of less than 10. Even with global economic uncertainties coming into view, Hertz looks like a downright cheap growth stock worth looking into.
FCB Financial Holdings
Next, I'd suggest cheap growth stock hunters hone in on FCB Financial Holdings (NYSE:FCB), which is short for Florida Community Bank. FCB is the third-largest independent Florida bank, with $7.8 billion in assets and 47 full-service banking centers.
The biggest risk with any bank stock at the moment is low lending rates (essentially the opposite of Hertz above). Banks benefit from rising rates, as they allow them to net more money off of their interest-based assets, so a precipitously low interest rate can make it tough to expand their bottom line. The state of Florida was also hard hit during the mortgage meltdown, which hasn't necessarily made things easy for FCB -- or any Florida-based bank, for that matter. Nonetheless, you'll find plenty to like with FCB Financial if you want cheap growth.
We can start with the bread and butter of banking activity: loans and deposits. In its most recent quarterly report, FCB announced new loan funding of $512.1 million -- ahead of its own expectations, with deposit growth of $472 million. FCB's loan portfolio totaled $5.6 billion at the end of Q1 2016, a 52% increase from Q1 2015, whereas total deposits rose by 40% to $5.9 billion from the prior-year quarter. All the while, its provision for loan losses stood at just 0.52%, and its nonperforming new loan ratio was just -- get this -- 0.02%! In plainer English, FCB's credit quality is solid.
FCB Financial Holdings has also been growing by acquisition. In 2014, it acquired Great Florida Bank for $42.5 million in cash, or roughly 85% of the bank's book value. FCB was able to add about $1 billion in total assets at a discount because of its disciplined execution and strong credit quality that made the deal possible. Also, FCB's sole focus on Florida has allowed it to grow at a more rapid pace organically and inorganically compared to its peers, since many of its larger peers are focused on other states in the Southeast outside of Florida.
It's not common to find a bank with double-digit EPS growth potential, but that's exactly what FCB offers over the next three to five years. With a PEG ratio below 0.6, this could be a regional bank to consider buying.
Lastly, growth investors looking for a cheap stock would be wise to pay attention to Orbotech (NASDAQ:ORBK) in the technology sector. Orbotech provides a wide array of production solutions and yield enhancements for the electronics industry.
What investors in Orbotech will need to be aware of is that -- like nearly all technology companies -- its business is cyclical. This means Orbotech needs an expanding economy and people to be spending in order for its enterprise customers to come through with orders. We all know that no bull market lasts forever, but the solace here is that economic expansion often lasts far longer than periods of contraction or stagnation.
What investors will like about Orbotech is its well-balanced business that consists of three main segments: its printed circuit board (PCB) business, flat panel display segment, and semiconductor device (SD) operations. Each of these three segments is expected to contribute relatively equally moving forward, even though the first quarter showed that its SD and PCB businesses were notably larger than its flat panel display segment.
But the real star is likely to be organic growth in organic light-emitting diode (OLED) demand, which can be found in televisions, smartphones, and laptops. According to MarketsandMarkets, the OLED market is expected to grow to nearly $44 billion by 2020 and is projected to grow by 16% per year between 2014 and 2020. This all bodes well for Orbotech's up-and-coming flat panel display segment.
Following a recent common stock offering that diluted shareholders but boosted its cash position in order to repay a portion of its outstanding debt, Orbotech is now valued at just nine times forward earnings and a PEG of less than 0.6. Long-term growth investors could certainly do a lot worse in the tech sector.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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