Investing in growth stocks requires a long-term outlook. Growth stocks tend to trade based on future expectations, and a failure to live up to those expectations in the short run can hammer growth stocks like nothing else.
For growth investors with a long time horizon, three of our Motley Fool contributors think Facebook (META 0.95%), Cisco Systems (CSCO 0.49%), and Insulet (PODD 3.02%) are solid growth stocks worth owning. Here's why.
Social media hits a speed bump
Nicholas Rossolillo (Facebook): If ever there was a stock requiring investors to have a short memory, it would be Facebook. 2018 has simply been a dreadful year for the king of social media. It all started with the Cambridge Analytica debacle in the spring, but investors shrugged those headlines off after a better-than-expected first quarter 2018. The inevitable day of reckoning finally came during the second-quarter report, though.
Revenue was higher on a still-growing global user base and higher advertising spending, but the growth rates for both have been decelerating. However, the real area of concern came from an expected higher rate of spending as Facebook invests in new privacy updates and promotion of new social experiences. Over the next couple of years, those expenses should eat into profit margin. The outlook put investors in a gloomy mood and sent the stock tumbling, erasing all 2018 gains and setting a record for the largest one-day valuation drop for a U.S.-listed company.
The stock has done little to recover since, but there is a silver lining. Facebook is still expanding as its average revenue per user continues to rise, and the company is still early in the game in exploiting the fast-growing online advertising industry. Facebook is also the owner of other emerging social tools, including WhatsApp and Instagram. Its media empire generates a gross profit margin of 83% and an operating profit margin of 44%.
Thus, even though spending will rise, Facebook can afford it. While taking care of sensitive user information is long overdue, much of that spending could eventually result in even more growth as the company finds new areas to invest in. As for the existing business, it's still acquiring more users every quarter (at an 11% year-over-year rate at last report), making near-term uncertainty a great buying opportunity for investors able to cut through the noise.
Growth at a reasonable price
Tim Green (Cisco Systems): Networking hardware market leader Cisco has only recently returned to robust revenue growth, so whether it's considered a true growth stock is up for debate. But I think the stock provides a nice combination of value, growth potential, and dividends that can make nearly any investor happy.
Cisco reported 6% year-over-year revenue growth in its fiscal fourth quarter, and it expects revenue growth between 5% and 7% in the first quarter of fiscal 2019. The success of its subscription-based Catalyst 9000 switching platform, as well as double-digit growth from the security and applications businesses, helped push revenue higher. Adjusted earnings grew at an even faster 15% pace in the fourth quarter.
Cisco's results depend on the health of the global economy. Its customers are large companies and government agencies that can delay orders if the economic outlook becomes unclear. Cisco's growth will be inconsistent for that reason, but some key competitive advantages should keep Cisco growing in the long run.
Cisco's growth potential comes at a reasonable price. The stock trades for less than 16 times the average analyst estimate for fiscal 2019 earnings, and its balance sheet still features more cash than debt, even after aggressive share buybacks this year. Cisco isn't nearly as cheap as it was a few years ago, but it's still not a bad deal, especially compared with its high-flying tech peers.
Cisco's dividend is another selling point. The stock currently yields about 2.8%, far above the yield of the S&P 500. The payout ratio is below 50% based on that fiscal 2019 estimate, so continued dividend growth is a good bet.
Cisco may not look like a typical growth stock, but it's worth considering regardless of what school of investing you subscribe to.
Pumping up profit
Todd Campbell (Insulet): Automated systems that better control blood glucose levels are the next big thing in diabetes treatment, and although Insulet is behind Medtronic (MDT -1.27%) and Tandem Diabetes (TNDM 3.03%) in the race to develop such a system, it could launch its Horizon solution as soon as 2020.
Using an insulin pump and a continuous blood glucose monitor, automated systems measure and deliver insulin based on real-time and predicted blood sugar levels. These solutions can help prevent dangerous blood sugar highs and lows that can accelerate diabetes progression while also improving quality of life by reducing the need for finger sticks.
Medtronic launched the first of these systems last year, and Tandem Diabetes system won approval of its system in June. These systems are revolutionary, but I expect patients who are adequately controlled by existing options will wait for the most patient-friendly solution to become available, and arguably, that will be Insulet's system. Why? Because Insulet's highly popular Omnipod pump is affixed directly on a patient's skin, so it doesn't rely on inconvenient tubing to deliver insulin. This tubeless advantage has already made Omnipod a top seller, and despite the availability of Medtronic and Tandem Diabetes' closed-loop systems, Insulet's still guiding for revenue of at least $547 million this year, up 18% from 2017.
Importantly, rising revenue and a decision to bring international distribution in-house has Insulet on track to report its first full-year operating profit. Gross margin increased 7.1% to 66% in the second quarter, and for the full year, management expects to report an operating margin in the low single digits.
Competition from existing automated insulin systems could crimp growth until Insulet launches its own solution, but I think any slowdown will be temporary. If I'm right, then an expected 48% increase in the number of people with diabetes through 2045 should provide plenty of opportunity for market-beating long-term returns.