Growth stocks are known for their market-beating returns, which also explains why such stocks often command a premium in the stock market. For a company to outperform its industry and the market, it should have a sustainable economic moat and operate in a high-potential industry, so it can consistently grow sales and cash flows at a strong clip. That's what truly makes a growth stock.
Fortunately, it's not that tough to find good growth stocks to add to your portfolio. To save you the hard work, we asked three of our Motley Fool contributors to pick a growth stock worth buying right now. Here's why Five Below (NASDAQ:FIVE), A.O. Smith (NYSE:AOS), and Agenus (NASDAQ:AGEN) made the cut.
Don't discount the power of teens and tweens
Rich Duprey (Five Below): Deep discounter Five Below has built a sustainable business around young kids by pricing trend-right goods right within their wallet wheelhouse. Selling everything for $5 or less, the retailer has been able to expand its store base without cannibalizing sales. In fact, they're accelerating.
Revenue rose 24.6% in its third quarter heading into the important Christmas sales season, as both new stores and existing ones posted solid performance. Comparable-store sales jumped 4.8% for the period, and investors are expecting Five Below to exceed Wall Street estimates when it reports holiday period results later this month.
Five Below has been one of the few consistent retail standouts. It has grown earnings at a compound annual rate of 28% for the past five years, and is expected to see them expand 40% this year and 18% next year. In addition, analysts are forecasting it will produce a 27% compound annual growth rate for the next five years.
The stock of this discount retailer to teens and tweens is up 73% over the past 12 months, and it trades at a forward earnings multiple of 37, but this fast grower and rising retail star deserves its premium. And when you compare its P/E ratio against what Wall Street is looking at long term for the company, Five Below seems fairly valued. But if it exceeds expectations as it has been known to do, building on an already solid base, the stock may rise proportionally, suggesting this growth rocket may be one you want to buy now.
Look beyond the short term to find winners
Neha Chamaria (A.O. Smith): Water heater and boiler manufacturer A.O. Smith has proved its mettle as a growth stock over the years, having grown its sales at a compound annual rate of 10% and adjusted EPS at a 25% clip since the beginning of the decade. In 2018, its sales and net earnings hit record highs. In another sign of a true growth stock, A.O. Smith's cash flows have grown steadily and rapidly in recent years.
While a typical growth company doesn't pay dividends, A.O. Smith's prudent capital allocation has meant rich returns for growth and income investors alike. So in just the past five years, A.O. Smith's dividends have grown at a compound rate of 30%. It even recently bagged a spot in the coveted Dividend Aristocrats list, having increased dividends every year for at least 25 years now.
So what's going to make the company click in coming years? Three catalysts, I'd say:
- Huge growth potential in populous and fast-growing nations like China and India, where demand for water heaters and boilers should rise with disposable incomes.
- Opportunities in water treatment.
- Replacement demand.
While the first and last points are self-explanatory, A.O. Smith is focusing more intently on water treatment lately. And rightly so: Its global water treatment sales have risen to nearly $400 million from only around $35 million seven years ago.
Macro factors like a slowdown in China could dent A.O. Smith's prospects, but the company should be able to navigate any storm in the long run. With the stock trading considerably below its five-year average P/E and price-to-cash-flow, now is an opportune time to consider this long-term winner.
A top growth play at a fire-sale price
George Budwell (Agenus): When it comes to top immuno-oncology plays, the small-cap biotech Agenus generally doesn't come to mind. This tiny biotech, after all, has clearly failed to capture Wall Street's imagination based on its current market capitalization of $378 million -- a pittance compared with the commercial potential of its broad checkpoint inhibitor pipeline.
Even though Wall Street may not be paying attention, the pharmaceutical industry has clearly taken notice of Agenus' status as an up-and-coming immuno-oncology company. Over the last three years, the company has signed development deals with pharma heavyweights Incyte, Gilead Sciences, and Merck. These partnering deals have helped Agenus build out a strong footprint in the high-value checkpoint inhibitor space, with its lead CTLA-4 and PD-1 programs both on track for accelerated approvals by 2020.
As an important side note, Incyte and Gilead both agreed to sizable equity investments in Agenus as part of their respective licensing deals. As such, these two top pharma companies could end up in a bidding war for this promising immuno-oncology company. Equity investments, after all, tend to be a prelude to a formal tender offer in the biotech space. The bigger point, though, is that Agenus has been able to attract ownership stakes from two of the best in the game at developing novel drugs. And that fact arguably speaks volumes about the company's prospects.
So why buy this under-the-radar cancer play right now? Eventually the market will wake up to Agenus' tremendous potential as a top growth vehicle, and that day could be near. The company isn't that far away from its first set of regulatory filings in immuno-oncology -- a seminal event that should light a fire under Agenus' share price in the not-so-distant future.