I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus. In this series, we'll take a closer look at many of the market's great growth stocks, to see which of them show real, numerically relevant signs of sustainability.

This time, we're tackling SmartHeat (Nasdaq: HEAT), a manufacturer of plate heat exchangers, pipes, and related equipment for customers in China. The company says it's aiming to create a system that captures and passes along energy efficiently, thereby lowering costs for a nation badly in need of cheap oil.

Sound enticing? It should. In January, Beijing's mayor said that China's capital city faces an "extremely serious" pollution problem, and announced plans to increase public transportation and green energy, Reuters reports. This is why four of the 10 highest-rated solar power stocks in Motley Fool CAPS hail from the Sino superpower: ReneSola (NYSE: SOL), JA Solar (Nasdaq: JASO), Suntech Power (NYSE: STP), and Yingli Green Energy (NYSE: YGE). SmartHeat's in good company, to be sure.

Foolish facts



CAPS stars (out of 5)


Total ratings


Percent bulls


Percent bears


Bullish pitches

56 out of 56

Highest rated peers

Hubbell, SL Industries (NYSE: SLI), BTU International (Nasdaq: BTUI)

Data current as of Aug. 30.

China's glaring need for efficient heat transfer could explain why there isn't a single bearish take on SmartHeat. While too much optimism can lead to an overheated stock price, that doesn't seem to be the case here.

SmartHeat entered the week trading for just 14 times trailing earnings, and 7.1 times its projected 2011 profit. In the long term, analysts see SmartHeat improving per-share earnings by more than 30% annually.

The elements of growth


Last 12 Months



Normalized net income growth




Revenue growth




Gross margin




Receivables growth




Shares outstanding

32.8 mil.

32.8 mil.

24.2 mil.

Source: Capital IQ, a division of Standard & Poor's.

There's good news in this table:

  • As the bold text shows, the gap between revenue growth and net income growth is narrowing. We like seeing this, because it suggests that earnings growth is being driven by demand, rather than share buybacks or some other gimmick.
  • Stable gross margins further suggest that demand isn't being driven by massive price cuts, another good sign.
  • Receivables have grown faster than revenue recently, but not at a worrisome pace. We'd only fret if receivables started to grow twice or three times as fast as sales. At that point, we'd have to wonder whether the company were making deals it couldn't collect on.

Competitor checkup


Normalized Net Income Growth (3 years)

Alfa Laval AB


GEA Group



Not applicable

THT Heat Transfer

Not applicable

Source: Capital IQ, a division of Standard & Poor's. Data current as of Aug. 26.

SmartHeat doesn't have three full years of net income growth records in Capital IQ. Interestingly, neither does THT. Although both companies tripled earnings in 2008, THT's bottom line is up just 30% over the past year, while SmartHeat's earnings improved more than 90% during the same period.

Grade = sustainable
SmartHeat has several attributes we look for at Rule Breakers: high levels of organic growth, stable margins, and evidence of market leadership, to name three. I like the stock as a sound market-beater over the next three years, and I've rated it accordingly in my CAPS portfolio.

Now it's your turn to weigh in. Do you like SmartHeat at these levels? Would you make it one of our 11 O'Clock stocks? Let the debate begin in the comments box below, and when you're done, click here to get today's 11 o'clock portfolio pick.

You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.