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.
Citigroup (C 0.05%)
Sure, banking giant Citigroup's growth is heavily skewed toward fiscal 2015 as opposed to 2016 through 2018, but there are enough catalysts here for growth investors to give serious consideration to adding Citigroup to their portfolios.
There are plenty of reasons why Citigroup's stock has struggled since the recession. It's heavily tied to growth in foreign markets, and it's been hammered along with its peers by the Justice Department regarding its mortgage practices during the housing bubble. Instead of putting these fines in the rearview mirror, Citigroup has been dealing with a recession hangover for the better part of six years. Adding icing to the cake, record-low lending rates have stymied its ability to expand its net interest margins.
But times are changing for Citigroup, and growth investors looking for an exceptional deal should take notice. For starters, lending rates have begun rising. The Federal Reserve announced the first interest rate hike in nearly a decade last month, and plans are for an additional four hikes in 2016. Economic conditions will ultimately dictate whether or not the Fed continues to raise rates, but each quarter-point hike could pack quite the punch for Citigroup's top- and bottom-line.
What I view as even more important is that it's put most of its regulatory issues in the rearview mirror. In the third quarter, Citigroup noted that operating expenses sank by 18% to $10.7 billion, and its allowance for loan losses declined by $3.3 billion to $13.6 billion. Lower legal expenses, improved credit quality, and higher lending rates should be an excellent combo that could help drive full-year EPS over $6 by 2018.
Sporting a sub-one P/E and trading well below its tangible book value of $60 as of Q3, this cheap growth stock might be worth a closer look.
SLM Corporation (SLM -0.10%)
For the next cheap growth stock we're going to stay within the financial sector and take a brief look at SLM Corporation, which you probably know best as Sallie Mae.
Sallie Mae is a specialized bank that originates student loans, profiting from the interest on those loans. As my Foolish colleague Jay Jenkins pointed out at the end of December, Sallie Mae was the second worst performing bank stock of 2015, losing well over a third of its value. The reason? Its loan servicing division (which has since been spun off into a public company) has faced regulatory scrutiny over the way it serviced student loans. There's been speculation that Sallie Mae could eventually face repercussions tied to its now spun-off servicing entity.
But just like Citigroup, I suspect Sallie Mae can put these doubts in the rearview mirror and grow nicely over the coming years. To begin with, a study from Pew Research Center from Feb. 2014 demonstrates just how important it is for people to get a post-secondary degree. Pew's research showed that millennials aged 25-32 without high school diplomas earned a median of $28,000 per year, compared to $45,500 for millennials of the same age range with at least a four-year bachelor's degree (or higher). The data doesn't lie: college is pretty much a prerequisite for success and socioeconomic advancement these days, and that bodes well for Sallie Mae.
Secondly, Sallie Mae is set to benefit from the ongoing increase in interest rates. The higher rates go, the more Sallie Mae can reasonably charge for its student loans. Initially the effect isn't expected to be substantive, but over two or more years we could begin to see notable net interest margin expansion.
Finally, looking past the speculation of fearful investors, we can see that Sallie Mae's underlying business has been fairly strong. Third quarter loan originations jumped 6%, net interest income rose 22%, and the average number of private education loans outstanding rose to nearly $10 billion. Sallie Mae has done a good job of adding high-quality loans to its portfolio, and its reasonably low delinquency rate of 1.9% is testament to that fact.
With more than $1.15 in EPS expected in fiscal 2018, investors would be wise to give this stealth growth stock a closer look.
Air Methods (AIRM)
Finally, we'll saunter over to the services sector and examine why specialized air transportation company Air Methods could be worth a spot in growth investors' portfolios.
Air Methods' business is predominantly based on medical transportation, but it does also have a tourism franchise and medical modular installation segment that contributed to nearly 15% of total revenue in the third quarter. The two primary reasons you may have witnessed Air Methods struggle recently are poor weather, which affects its services for obvious reasons, and uncertainties tied to the Affordable Care Act, which you likely know best as Obamacare. The more uninsured people that Air Methods transports, the higher the potential for uncompensated care.
The good news for investors is that Obamacare could actually be a long-term growth catalyst for Air Methods, assuming the health law survives beyond Barack Obama's presidency. Obamacare's individual mandate requires that consumer purchase health insurance or face penalties. This, along with the expansion of Medicaid in 30 states (and Washington, D.C.), and the offering of subsidies up to 400% of the federal poverty level, have brought the uninsured rate in the U.S. to its lowest levels on record according to the Centers for Disease Control and Prevention. What this means is a higher probability that its medical transports are insured, and a lower likelihood of written-off services.
Also working in Air Methods' favor is that it operates in a pretty niche space. It's not as if there are dozens of medical transport companies fighting for patients. Operating in this unique space gives Air Methods quite a bit of pricing power that it can use to outpace inflation and cover its maintenance costs.
Lastly, Air Methods is also benefiting from reduced fuel costs, at least for the time being. With oil forecasts not indicating a quick rebound, it looks as if Air Methods' fuel expenses could remain depressed for some time to come.
Expected to grow its full-year EPS from a reported $2.46 in 2014 to $3.53 by 2017, this company very well could propel its way into growth-seekers' portfolios.