When is a growth stock no longer a growth stock? Some would say the official transition occurs when a maturing business starts distributing profits in the form of a dividend while others look at the pace of growth.
One thing we can all agree on is that most companies in a high-growth phase usually don't have any earnings to report. And when they do, they should probably trade at above-average multiples.
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Over the past three years, Alphabet (GOOG -2.71%) (GOOGL -2.56%) and Lovesac (LOVE -2.67%) reported earnings that have more than doubled. Despite clearly being in a high-growth phase, the stocks are trading at less than 20 times trailing earnings. That's a lower multiple than the average stock in the S&P 500 index.
Both of these businesses have what it takes to continue their outstanding growth rates in the years to come. Here's why buying their underappreciated stocks now could do wonders for your portfolio down the road.
Alphabet
The parent company of the Google search engine and the YouTube streaming platform is heavily dependent on advertising revenue. Snap's abrupt reduction of forward-looking guidance recently caused the market to hammer all digital advertising stocks, Alphabet included.
Advertising budgets are shrinking after a very big year in 2021, but this stock has been driven down too far. Now you can buy Alphabet shares for just 19.2 times trailing earnings, which is a ridiculously low price for a business that has grown earnings by 125% since the beginning of 2020. Even if growth slows by half, patient investors will come out way ahead over the long run.
Snap is highly dependent on the advertising dollars its social media app generates, so declining ad sales should make its investors nervous. Alphabet, on the other hand, is a diverse collection of businesses that push one another forward. The company's first moneymaker, Google Search, is still the largest contributor, and it sends heaps of searchers to YouTube videos that fit their queries. Alphabet bought YouTube in 2006 for just $1.65 billion. During the first three months of 2022, YouTube ad revenue rose 14% year over year to an annualized $27 billion.
Google Search and YouTube require huge amounts of capital to build and maintain the internet infrastructure they run on. As the best businesses often do, Google turned this challenge into another major growth engine, Google Cloud. In the first quarter, cloud services revenue bounded 44% year over year to an annualized $23.2 billion.
Alphabet's "other bets" segment turns cautious value investors away, but it probably shouldn't. This reservoir of potentially lucrative business ventures produced a $1.16 billion loss in the first quarter. This would cripple most companies, but Alphabet can easily absorb losses from potentially lucrative endeavors such as autonomous vehicle technology and on-demand drone deliveries. First-quarter income from operations soared 22% year over year to $20.1 billion. With its diverse operation to offset the incoming effects of shrinking ad budgets, investors can look forward to strong but steady growth for many years to come.
Lovesac
Of all the industries you associate with innovative disruption, furniture probably isn't at the top of your list. After all, expensive handcrafted pieces that carry wide profit margins aren't scalable, while nearly everything else is commoditized.
Lovesac still makes the fancy beanbag chairs it's named after, but these days most of its profits come from its modular sectional sofas, or Sactionals. Those profits are rising at a breakneck pace, too. Net income during the year ended Jan. 30, 2022, more than tripled to reach $45.9 million.
At recent prices, you can buy this high-speed growth stock for just 11.8 times trailing earnings. Even if its growth rate gets cut in half by uncontrollable macroeconomic factors, sales of its pricey sofas could still rise fast enough to deliver a 10-fold gain to patient investors.
Economic downturns always come wrapped up in unique packages. but there is one constant feature investors can count on. People who can afford a $5,000 sofa need to make far fewer adjustments to their spending habits than everyone else.
The road ahead of the global economy is uncertain, but we can count on Lovesac's growing fan base to continue coming back for more. Its modular sofas, with washable and replaceable upholstery, are intended to grow right along with a family's needs. At these prices, an investment in this stock could grow large enough to help you meet all your needs, too.
