Good growth stocks are inextricably linked to value, despite their usually being thought of as being from different worlds. And like any other investment, it's the business beneath the label that is of utmost importance, regardless of how you classify it.
Yet it's still hard to identify the very best growth stocks, so we asked three Motley Fool contributors to discuss a growth stock they think investors should love today. Read on to learn why they believe Axon Enterprise (NASDAQ:AAXN), A.O. Smith (NYSE:AOS), and Callaway Golf (NYSE:ELY) fit the bill.
The surprise cloud growth play
Travis Hoium (Axon Enterprise): Body cameras are becoming a standard piece of equipment for law enforcement in the U.S. and around the world, and Axon is the clear leader in the industry. The company was really built on the back of Tasers, but made the transition to body cameras in a big way the last few years. You can see below that the growth engine has been firing on all cylinders.
The beautiful thing about the body camera business is that it's very long-term in nature. Agencies normally sign contracts for cloud-based video storage, lasting up to five years, when they get cameras. Plus, the camera business should be fairly sticky, leading to contract renewals. And Axon has been investing in wireless data offloading and intelligent data analysis so that its capabilities will stay ahead of competitors'. In fact, Axon is so confident in the long-term value of its services that it's offered free cameras to law enforcement agencies.
Financially, the services business margin hovers around 80% to 90%. So, Axon is locking up long-term contracts at high margins, and as it adds customers around the world, it'll be stacking contracted revenue and profit up year after year. This is a growth stock every investor should love.
Growth in the most unlikely of places
Tyler Crowe (A.O. Smith): All too often, I think, investors fall into the trap of thinking that the term "growth" has to come from some new emerging technology or medical breakthrough. More often than not, you can find companies that post spectacular growth rates in those dull, slow-growing markets that are often ignored. One such company is water and air treatment equipment manufacturer A.O. Smith.
What makes A.O. Smith such an intriguing stock for investors is that it has two unique markets that serve completely separate purposes. Its North American business is a stable one, in which the company owns 40% and 50% shares of the residential and commercial water heater markets, respectively. This side of the business consistently churns out high operating margins and operational cash flow, giving the company the financial support needed to pursue the real growth opportunity: The middle class of China and India.
In China, A.O. Smith's water heater line has been growing revenue at a 22% annual rate over the past 10 years and has moved ahead of its competitors to own the largest market share in the country -- about 25%. What's even more interesting is that A.O. Smith's management identified some tangential markets that are growing even faster. Its water treatment and air purification equipment sales grew 50% and 80% year over year, respectively. While it's still in the early innings in India, A.O. Smith believes it can achieve similar results in that market as well.
These two businesses have translated into an earnings engine that's growing at a fast clip while still generating high returns on capital invested. It's no wonder, then, that A.O. Smith's stock has gained more than 800% over the past 10 years.
A.O. Smith's business may not fit the traditional mold of a growth stock, but its performance and future market opportunities suggest it is very much a growth stock to consider for your portfolio.
Going for the green
Rich Duprey (Callaway Golf): With the fairways increasingly to itself, Callaway Golf looks like it might be one stock investors will want to take a swing at -- even after its earnings beat sent shares higher.
The golf business isn't as smooth and level as a green, and harbors plenty of sand traps to catch those unaware. For example, golf-oriented retailer Golfsmith declared bankruptcy last year and both Adidas and Nike have pulled out of the market for making golf clubs, balls, and more. It indicates the difficulty surrounding the golf-equipment business even as the selling of golf apparel remains a bright spot for those two.
Dick's Sporting Goods' (NYSE: DKS), meanwhile, bought Golfsmith, but has said it is a "challenging business" and it will be dedicating less space in its own stores to the sport. Callaway, while a more premium brand than the equipment formerly made by either Adidas or Nike, ought to benefit from the shelf space that will be made available by their exit.
It's true the golf industry has had difficulty attracting younger players, and without a galvanizing star like Tiger Woods, the number of rounds played has declined over time. Yet the contraction in the industry leaves Callaway Golf standing taller. In its recent earnings report, the golf equipment maker said sales of new products helped push revenue 13% higher to $309 million, although profits were lower as a result of adding an apparel joint venture in Japan that carries lower margins and higher operating costs.
Even so, Callaway Golf is off to a strong start this year, and the market reflected that by sending its stock some 6% higher. Yet with shares trading at just six times earnings and a tiny fraction of its earnings growth estimates, this golf star is one investors could ride to future gains.