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.
Akamai Technologies (NASDAQ:AKAM)
We'll begin the week by taking a closer look at content delivery networking giant Akamai.
At first, you may be wondering why Akamai's stock price is down in the dumps. Part of this drop can be blamed on the overall market's weak start to 2016, but we can also point to recent weakness in its third-quarter report. Akamai's Q3 showed a 3% decline in adjusted operating margins on a year-over-year basis, while adjusted income fell less than 1% to $157 million from the prior-year quarter. For a company with 11% top-line sales growth, more was clearly expected. Akamai also warned that weakness from a handful of key media customers could weigh on its fourth-quarter results, which are due out in February.
That's the bad news. Now here's the good news: Akamai is one of the premier cloud security companies you can invest in. Not only does Akamai look to optimize the content delivery process, but it's working diligently to protect its clients from Internet vulnerabilities, primarily as they relate to the cloud. By all accounts, we're still very early in the game when it comes to the development of the cloud for most enterprises, affording Akamai a huge growth opportunity. As we saw in Q3, Akamai now has a cloud security revenue run rate north of $250 million per year, and cloud security solutions as a whole grew 44% on a constant currency basis.
Secondly, Akamai has incredible scale. According to Business Insider in 2014, the company was operating more than 150,000 servers worldwide to speed up content delivery, and it served about 30% of all Internet traffic at the time. A separate reading from Datanyze shows Akamai holding more than 16% of all CDN traffic, although Datanyze's data is limited by the number of websites containing a code that it can read and analyze. In short, Akamai's size and scale give it pricing power that it can use to translate into steady growth.
Akamai still appears cheap despite its PEG ratio of around 1.4, especially when accounting for EPS growth from an estimated $2.43 for full-year 2015 to $3.77 by fiscal 2018. Consider this a cheap growth stock worth monitoring closely.
Next up, I believe growth seekers could find plenty to like in the health insurance industry with Anthem, the operator of Blue Cross Blue Shield in 14 states and the nation's second-largest health-benefits providers.
Lately, Anthem's biggest issue has simply been that it hasn't taken a breather in more than three years. Beginning in 2012, prior to the implementation of the Affordable Care Act, better known as Obamacare, and continuing through 2015, Anthem's stock more than tripled. The close to 20% sell-off we've witnessed since the end of June 2015 appears to be nothing more than some expected short-term profit-taking.
Two aspects in particular make Anthem such an intriguing growth story. First, we have Obamacare and the individual mandate, which requires everyone to purchase health insurance or pay a penalty come tax time. The individual mandate may not be working perfectly, but it's certainly coerced some previously uninsured consumers to enroll for health insurance.
Along those same lines, Obamacare also allowed the use of federal funds to expand Medicaid in all 50 states (should those states choose to do so). In total, 31 states, including Washington, D.C., chose to expand their Medicaid programs. This is important because Anthem purchased Amerigroup, a company that focused on government-sponsored patients, in 2012, putting it in the perfect spot to benefit from Medicaid's Obamacare bump.
The other key point is that catalysts exist beyond Obamacare. Anthem's purchase of CIGNA (NYSE:CI) for roughly $48 billion is expected to bolster both company's commercial portfolios, helping it address a steadily growing employer-sponsored market that's looking to keep costs down. Further, the merger should help Anthem and CIGNA cut costs of their own by eliminating overlapping jobs. This merger should close in the second-half of this year. With a strong presence in commercial plans, there's not much to worry about, even if Obamacare doesn't prove to be the answer.
Looking down the road, Anthem's projected $10.14 in EPS for 2015 may turn into almost $14 in EPS by 2018. Add in a reasonably low PEG ratio of 1.2 and a dividend yield of 1.8%, and I believe you have the recipe for a cheap growth stock with upside.
Lastly, I believe growth seekers looking for a good value may want to set their sights on small-cap Chemtura in the chemicals space.
Chemtura's third-quarter earnings report wasn't pretty, and it's a big reason why shares lost about a quarter of their value since the beginning of November. Chemtura's Q3 report demonstrated weakness in both of its core business: industrial performance products (IPP), which is predominantly petroleum-additive products, and industrial engineered products (IEP), which includes bromine-based products. Product demand was notably lower for both segments, and net sales for the quarter fell 22% year-over-year to $434 million on an adjusted basis.
Yet there are reasons to be excited. To begin with, the 22% tumble in sales on a year-over-year basis isn't as bad as it appears. Chemtura's IPP segment has been hit by foreign currency translation tied to a stronger dollar, ultimately hurting revenue. More importantly, Chemtura has been transforming its business by divesting non-core assets. Chemtura AgroSolutions was sold for $1 billion in 2014, and in 2013 it parted ways with its antioxidant and UV stabilizer business, as well as its consumer products business. The divestment of AgroSolutions weighed on Chemtura in 2015, with the AgroSolutions business accounting for $1.8 billion in sales in 2014. In other words, if we make the comparison more apples-to-apples, Chemtura's top-line would look a whole lot better.
On the flipside, Chemtura is also experiencing benefits from markedly lower petroleum prices. Even though lower prices means it has reduced its own product pricing, lower petroleum costs are pushing its input costs way down. Combine this with restructuring costs it announced in late 2014, and you can see why profits actually rose by a double-digit percentage in Q3 2015. The company is also observing strength in bromine pricing, which could translate into better IEP margins.
Looking ahead, Chemtura's full-year EPS is forecast to grow from $1.44 in 2015 to $2.72 by 2018. This places the company's PEG ratio well below one, and implies that it could be undervalued.
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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