When the stock market was in nearly nonstop rally mode for most of the past six years, investors didn't need to look far to uncover an abundance of growth stocks. But not all growth stocks are created equal: While some appear poised to deliver extraordinary gains going forward, the recent market turbulence has crushed some that were overvalued, burdening investors with hefty losses.
What exactly is a growth stock? I'll define a growth stock as any company forecast to grow profits by 10% or more annually during the next five years -- although that's an arbitrary number. 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.
To kick off this week, we'll begin by taking a deeper dive into Interface (TILE -0.26%), a global designer and seller of modular carpet around the world. Why has Interface hit a rough patch?
Primarily, there's been disappointment with the company's recent growth prospects. After handily surpassing Wall Street's EPS projections in three prior quarters, Interface only met expectations in the third quarter, which was reported back in October. As noted in its Q3 press release, Interface's sales grew by a meager 1%, to $254.7 million. With exceptional growth prospects being the selling point of Interface, Wall Street and investors took this as their cue to run for the exit.
However, digging a bit deeper, we'd see that Interface's results weren't nearly as bad as the reaction in the company's share price would suggest. In local currency (basically, excluding currency vacillations for which Interface has no control), Interface saw revenue climb by just shy of 10%.
The company delivered currency-neutral growth of 7% in the Americas, nearly 5% in Asia, and almost 20% in Europe. Furthermore, even including the negative effect currency had on the company's margins, operating margin still expanded by 450 basis points, to 12.3%.
Interface's success should also get a lift in the corporate realm. Businesses truly appreciate the ease of installation with modular carpet, and currently low lending rates -- and an expectation that these rates will remain low relative to the long-term average -- provide an inexpensive way for businesses to expand, and furnish new offices.
Interface is currently valued at just 13 times forward earnings, a PEG ratio that's well below one, and it's widening operating margin gives the company an opportunity to lower its debt, as cash flow improves. This is a cheap growth stock that could be worth your consideration.
Sometimes, the greatest finds are gems you've never heard of before. Kimball International (KBAL 0.08%), a manufacturer of office and hospitality furniture that's sold under the National, Kimball Office, and Kimball Hospitality brands, could be just the cheap growth stock you're looking for.
In Kimball's second-quarter results, which were reported earlier this month, the company announced its highest second-quarter earnings in 15 years, and it subsequently boosted its full-year guidance. Net sales in Q2 rose by 8%, administrative expenses dropped 5%, and adjusted operating income exploded higher by 145%!
CEO Bob Schneider attributed much of the success to the company's employees, as well as new office-furniture innovations, which pushed sales in the segment higher by a healthy 13%. Additionally, Schneider notes that hospitality sales would have seen a 27% increase if not for a large special order in Q2 2015 that's being recognized over multiple quarters.
Kimball's success is tied to many of the same catalysts discussed above with Interface. The company is benefiting from businesses having relatively easy access to cheap capital, which is allowing them to take on debt and expand. This expansion means new equipment, just as it means new carpet for Interface. As long as the U.S. economy continues to grow, and lending rates remain low, this isn't a pattern that I anticipate will change much.
Kimball's hospitality segment also benefits from Americans having more income at their disposal. Hotels have witnessed a successful rebound from their Great Recession lows, and many are looking to grow their capacity. This bodes well for Kimball.
Although it can be lumped in with a wide swath of cyclical companies that are dependent on economic growth to drive sales and profits higher, Kimball's 2% dividend yield, nearly $26 million in net cash, and sizable Q2 profit could make this an attractive add for growth investors looking for hidden value.
Finally, we'll shift our attention to the healthcare sector where health-benefits provider Centene (CNC 2.35%) is serving up some incredible growth prospects.
For many health insurers, the Affordable Care Act, which is better known as Obamacare, was expected to be a huge moneymaker. The prospect of millions of people needing to buy health insurance had these benefit providers drooling. However, reality has been far different from insurer expectations.
The ability of consumers to easily switch health plans from one year to the next has hurt member retention, and the removal of an insurers' ability to deny coverage for pre-existing conditions has led to higher medical care use rates (and thus, higher expenses). The nation's largest insurer, UnitedHealth Group, and Humana, are both losing money on Obamacare's individual marketplace exchanges, and they've both threatened to leave Obamacare's individual market entirely by 2017.
Then we have Centene, a company that focuses primarily on government-sponsored patients, and has done so for more than 30 years. Centene's focus on appealing to Medicaid enrollees has paid off in a big way considering that 31 states have taken federal funding, and expanded their Medicaid programs.
In the company's recently reported fourth quarter, it announced that total membership for the year grew by 26%, or more than 1 million, to 5.1 million. Broken down further, nearly three-quarters of its membership growth came in the form of new Medicaid customers. Even though private payers offer juicier margins than Medicaid patients, Medicaid customers generate guaranteed payments because they're backed by funding from the government.
The result? Centene's health benefits ratio -- a measure of margin for insurers -- fell 40 basis points, to 88.9%, in 2015. A lower number is more favorable as it means Centene is more profitable. Year-over-year adjusted profits also grew nearly 10%.
With Wall Street predicting that full-year EPS could hit $5.49 by 2018, this burgeoning health insurer is one cheap growth stock worth monitoring closely.