Investors love to see stocks in their portfolios rise, but they should also be careful to avoid traps. Growth stocks tend to have aggressive valuations in normal markets that can create outsized (and often negative) volatility during market corrections. Stocks that are delivering huge returns can see their price head off a cliff when the momentum shifts.
Plenty of companies are growing quickly, but investors should try to focus on stocks for companies with these characteristics:
- They deliver strong growth.
- They outperform the market.
- They are set apart from peers because they have specific qualities.
Let's take a closer look at three growth stocks with these characteristics.
Zendesk (ZEN) offers popular customer service software for businesses of all sizes. The company's suite of products brings automation and organization to customer management and communication functions. That makes it an important tool that reduces administrative burden for smaller businesses and enhances the efficiency of sales teams at enterprise-level organizations.
The past few years have been challenging for many sectors across the economy, but Zendesk keeps growing. The company's sales expanded 25% in 2020, 30% in 2021, and management is forecasting 27% growth for this year. The future looks promising, too. Software-as-a-Service (SaaS) companies often report figures that measure contractually obligated future cash flows from customers that haven't been recognized yet. This gives investors a good idea of where sales can go in the near future, and Zendesk's remaining performance obligations (RPOs) were up more than 35% in its latest quarterly report. It's also free-cash-flow positive, so it's not recklessly burning financial resources to achieve this high growth rate.
Zendesk performed well during the pandemic slowdown, and it remains strong amid current concerns of economic slowdown. It's also supported by the great reputation of its products, which receive high marks from Gartner. The stock's performance has reflected all of these factors. Zendesk shares have outperformed the S&P 500 by more than 10 percentage points this year, while it's a full 20 percentage points above the Nasdaq Composite.
An important part of this story is the involvement of activist investor Jana Partners, which owns about 2% of the company. The activists are pressuring Zendesk's management to consider strategies that include being acquired, which would deliver an immediate return for shareholders. Long-term investors shouldn't base their decisions on that sort of news speculation, but it still creates more avenues to success. The presence of a successful activist can force improvements to efficiency and capital allocation.
Zendesk's relatively strong year-to-date performance and its high forward P/E of 140 could lead to extra volatility over the next few months, especially if the activist investors get frustrated and bail on the company. There's also the matter of stiff competition from Salesforce.com (NYSE: CRM) and other heavy-hitter tech stocks. Still, Zendesk is a standout in today's market, with numerous things working in its favor.
Alteryx (AYX 4.57%) offers a valuable SaaS platform that improves its customers' analytics, data science, and process automation properties. This software reduces the cost and talent burden required to unlock the efficiencies and insights provided by data. This ultimately results in meaningful cost savings and smoother digital transformation, both of which are enormous for enterprises from every sector.
Alteryx reported 33% revenue growth in the first quarter, and the company expects to maintain this rate throughout the year. This was driven by the acquisition of new customers along with 119% net revenue retention, which indicates high customer satisfaction. The Alteryx product suite also gets high marks from market research firms.
The stock is down 7% year to date, but that's better performance than the major benchmark indexes. Its relatively cheap valuation could explain some of that. The stock's price-to-sales ratio is down to nearly 6.5; it was around 18 two years ago. Alteryx shares took a beating as growth stocks fell out of favor, even though sales growth has accelerated over the past two years. That's created much more long-term potential for returns.
Like every unprofitable growth business, Alteryx stock comes with some risk and a high potential for volatility. If it keeps beating Wall Street expectations to maintain its position in a high-growth industry, then there's an enormous opportunity at this valuation.
3. Canadian Natural Resources
Volatile growth stocks aren't necessarily great investments for everyone, especially with ongoing rate hikes and the looming threat of economic slowdown. For more risk-averse investors, there are also opportunities in the energy sector right now. The whole sector has been lifted by higher oil prices, some of which are being driven by geopolitical issues related to Russia. Buyers are somewhat late to the party, but stocks such as Canadian Natural Resources (CNQ 1.63%) still have a lot to offer.
Canadian Natural generates a relatively large proportion of its revenue from the sales of natural gas liquids and natural gas, which is a good way to hedge against potential substitution away from crude oil. The company's sales and net earnings rose around 20% in the first quarter, mostly due to higher energy prices. Even if it just maintains the current performance in coming quarters, its year-over-year sales growth will be enormous over the rest of the year.
Canadian Natural produced around $1.5 billion in free cash flow during the first quarter, prompting the company to increase its quarterly dividend to $0.75 per share. It was $0.43 one year ago. That's a 5.1% forward yield, which is excellent in the current market. Future cash flows obviously depend on energy prices, but the payout ratio was only around 25% last quarter. That leaves a large buffer if oil prices drop a bit, and we could even see higher dividends later this year if oil prices are stable.