With the stock market in nearly nonstop rally mode over the past six years, investors haven't needed to look far to uncover an abundance of growth stocks. But not all growth stocks are created equal: while some could still deliver extraordinary gains, others appear considerably overvalued and might instead burden investors with hefty losses.
What exactly is a growth stock? Though it's arbitrary, I'll define a growth stock as any company forecast to grow profits by 10% or more annually over the next five years. To decide what's "cheap," I'll use the PEG ratio, which compares a company's price-to-earnings ratio to its future growth rate. Any figure around or below one could signal a cheap stock.
Here are three companies that fit the bill.
Brinker International (NYSE:EAT)
First up we have Brinker International, the company in charge of the Chili's Grill & Bar and Maggiano's Little Italy brands. On the surface this doesn't look like a traditional growth stock, and its comparable-store sales of late haven't suggested it's a rapidly growing company. In the company's recent first quarter, Brinker reported that comparable-store sales at Chili's and Maggiano's fell 1.6% and 1.7%, respectively. But dig below the surface and you'll find a lot of exciting sales growth and value-building initiatives.
For starters, Brinker acquired 103 restaurants from a franchisee during the quarter, helping push sales higher by nearly 8% for the company. Beyond this acquisition, Brinker's pricing power remains strong thanks to the solid footing of the U.S. economy. Prices were up 1.7% at company-owned Chili's restaurants and 3% at company-owned Maggiano's restaurants. If Brinker can maintain strong pricing power, its margins should be less prone to wild fluctuations from changes in traffic and product mix from quarter to quarter.
Brinker's tabletop tablet experiment at Chili's could also be a convenience and profit driver. Brinker has outfitted all company-owned Chili's with a grand total of 45,000 tablets that allow guests to place drink orders, order dessert, browse the menu, pay quickly, and play interactive games for a fee. The interactive games should be great for attracting families with kids who might normally stay home, while the emphasis on the convenience of placing drink and dessert orders highlights two bread and butter margin products for Chili's.
Let's also not forget that Brinker has also been actively repurchasing its shares. Buying back stock reduces the number of outstanding shares and can favorably impact EPS. With a PEG ratio around one and EPS growth hovering around 10% in the coming years, Brinker could be worth a nibble for growth-seeking investors.
Toll Brothers (NYSE:TOL)
Next up we have another company you might not expect to find in a list of cheap growth stocks -- but you'll see below that luxury homebuilder Toll Brothers fits the mold.
Like practically all homebuilders, Toll went through a long rough patch following the recession. Tightened lending standards for jumbo loans and depressed home prices gave little incentive for prospective homebuyers to make a purchase. But times have changed in a big way for Toll. Home prices are on the rise again, and the latest Fannie Mae Mortgage Lender Sentiment Survey showed that mortgage lending standards have eased, making it easier to obtain a loan. This all points to growth in the housing sector.
Specific to Toll is its focus on the luxury housing market and the more affluent customer. Upper-income customers aren't necessarily less likely to take out a mortgage, per se, but they are far less likely to be affected by minor-to-moderate swings in the U.S. economy. This gives Toll an advantage over a number of its peers that tend to target lower price point buyers. The average price of homes delivered in its recently reported fourth quarter was $790,000, up $43,000 from Q4 2014, and net signed contracts in Q4 rose by 29% in terms of dollars and 12% in terms of total units.
Looking ahead, Toll is forecast to grow its revenue from $4.2 billion to $5.7 billion between 2015 and 2017, while its EPS should expand from a reported $1.97 in 2015 to $3 by 2017. All told, Toll's sub-one PEG ratio and niche standing among homebuilders make it an intriguing growth play.
Skyworks Solutions (NASDAQ: SWKS)
Lastly, we'll turn our attention to the tech sector and take a brief look at why radio frequency (RF) chipmaker Skyworks Solutions is a growth stock you should be closely monitoring.
To start with, we can get the 800-pound gorilla out of the way: Skyworks is a huge RF chip supplier for Apple, arguably the kingpin of mobile devices in the United States. Even though Android is the dominant operating system worldwide, there's just no way to describe consumers' love for Apple, its operating system, and its products other than "cult-like." With Apple expected to sell 200 million-plus smartphones per year for the foreseeable future, this looks to be a major boon for Skyworks.
But Skyworks has had success beyond just Apple. Skyworks' SkyOne Ultra front-end module is powering the Samsung Galaxy S6, arguably the greatest iPhone competitor, and the company's One Mini 2G/3G/4G front-end modules have been popular choices for mobile devices in emerging market countries where the infrastructure isn't there to support widespread LTE capacity.
Beyond just finding its products in devices not named Apple, Skyworks also has a long-tail growth opportunity in wearables and other wireless devices in the home. The Internet of things is set to change how we live and how some of our appliances communicate with us and each other, and it's possible that Skyworks' technology will be at the forefront of this shift.
A sub-one PEG ratio and more than $7 expected in EPS by 2017 makes Skyworks a cheap growth stock you'll want to be following.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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