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.
Old Dominion Freight Line (NASDAQ:ODFL)
When you think of cheap fast-growing stocks, you think of trucking, right? I'm right there with you -- trucking wouldn't normally be near the top of my list, but Old Dominion Freight Line, a logistics company in the less-than-truckload, or LTL, category, has all the tools necessary to deliver for growth investors despite some near-term challenges.
The biggest issues for Old Dominion Freight revolve around either a potential weakening in U.S. economic growth, or continued weakness in fuel prices. I know that may sound a bit strange since transportation companies usually love to see fuel costs moving lower; however, trucking companies like Old Dominion Freight have a high-margin tool at their disposal known as fuel surcharges that they pass along to customers to account for fluctuating diesel costs. With diesel costs down, fuel surcharges have either gone away or been greatly reduced. The effect has been negative across the sector.
But have no fear, because pricing power is still here. Old Dominion Freight announced in November that it was increasing its general rates by 4.9%, which pretty much helps it counteract the weakness it's been seeing from the loss of the fuel surcharge. Considering that demand doesn't appear to be an issue, the rate increase should work out nicely for Old Dominion Freight.
The LTL-company is also investing heavily in boosting its capacity, which would imply a strong long-term outlook. During the third quarter, CEO David Congdon affirmed that Old Dominion Freight is on pace for $451 million in capital expenditures in fiscal 2015, with $278 million being spent on tractors and trailers and another $34 million primarily on technology. Old Dominion can likely keep up its breakneck expansion because of its minuscule debt-to-equity ratio of 11%. Funding its purchases with its operating cash flow is the key that makes this trucking company tick.
Expecting to grow its full-year EPS from $3.10 in 2014 to perhaps more than $4 by 2016, this is a growth stock worth watching.
Sun Life Financial (NYSE:SLF)
Just to mess with your perception of a cheap growth stock even more, we'll next turn our attention to the insurance sector with Canadian-based Sun Life Financial. Sun Life handles a number of aspects of insurance, such as life and term-life, as well as asset management.
"Why did Sun Life Financial's share price drop 13% in 2015?" you wonder? A lot of the drop had to do with foreign currency repatriation which weighed on its top- and bottom-line, as well as persistently low lending rates which have hurt its potential to boost investment income. The good news is that it's easy to look past currency fluctuations that are beyond the control of Sun Life, because once you do you'll discover a very healthy company.
The reason insurers tend to perform so well over the long run is that they maintain strong pricing power on their products. It's inevitable that insurers will face periods where a larger number of claims weigh on their bottom-line. However, catastrophes provide the perfect impetus for insurers to request higher rates. Conversely, even in periods of low claim payouts, insurers still have justification to raise rates on the basis that catastrophes are inevitable. With the exception of poor money management skills or a truly mammoth disaster that results in a lot of claims, it's pretty hard to mess up what's often a money-making formula in the insurance industry.
Also working in favor of Sun Life is the Federal Reserve's decision to begin raising interest rates. The average consumer isn't thrilled with the prospect of paying more on variable rate credit cards or for a mortgage, but it's great news for insurers that invest premium payments received into safe, often short-term investments. These investments may not yield a lot now, but they're typically interest-based. Each quarter point increase from the Fed could ultimately have a sizable impact on Sun Life's future profits.
After reporting just shy of $3 in full-year EPS in 2014, Wall Street's consensus is calling for $3.86 by 2017. With a PEG ratio hovering around one, this financial growth stock is worth your consideration.
Taylor Morrison Home (NYSE:TMHC)
Lastly, just to round out this string of surprising growth companies, we'll take a brief look at why homebuilder Taylor Morrison Home could deserve a spot in your portfolio.
Like most homebuilders, the big concern at the moment is "what's next?" Interest rates moved up in December for the first time in almost a decade, and a rising rate cycle will mean consumers have to pay a higher lending rate for a mortgage. The thesis is that this could decelerate growth in the housing industry and eventually hurt the valuations of these companies.
But Taylor Morrison has a trick up its sleeve: it focuses on more affluent homebuyers. Whether they're first-time buyers or experienced buyers looking for luxury customization, Taylor Morrison primarily deals in markets where the standard of living is high, or the demand for luxury homes appear to be strong, such as in Southern California and Texas. This is important, because affluent homebuyers tend to be less inclined to change their spending habits because of a few economic hiccups. It won't shield Taylor Morrison completely if a recession hits, but the assumption would be that its top- and bottom-line would be affected to a far lesser degree than those of homebuilders that target more cost-conscious consumers.
In the company's most recent quarterly report we learned that the average price of homes closed was $458,000, and net sales orders increased 18% from the prior-year period to 1,635 homes. In total, Taylor Morrison ended the quarter with a pretty healthy backlog of 3,560 units. So long as interest rates are stepped up at a reasonably slow pace, as the Fed has suggested, there's no reason to believe we'll see a dramatic slowdown in home sales. In my opinion, if Taylor Morrison can keep its growth trajectory intact, it could turn the $2.7 billion in full-year 2014 revenue into potentially $5 billion in full-year sales before the end of the decade.
This may be just a homebuilder, but it's a surprisingly cheap growth stock that's worth your attention.
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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