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.
We'll begin our quest for cheap growth stocks this week by taking a trip across the Pacific Ocean to China, where you'll find perhaps the largest search engine on the planet, Baidu (BIDU -1.46%).
The concern of late for Baidu has been the slower growth of China's economy. In 2015, China's GDP, while still growing at nearly 7% on a year-over-year basis, increased by its slowest pace in 25 years. That slowdown is worrisome for investors considering Baidu's push into commerce-based businesses, as well as its reliance on advertising, which is typically a cyclical industry.
Yet, if you look at Baidu's results year in and year out, there's little cause for concern.
As noted above, Baidu's push into online-to-offline (O2O) commerce is giving it new pathways to generate revenue beyond just traditional advertising. Although O2O commerce is a big upfront expense, and it's weighed down Baidu's high-flying growth a bit, it's a long-term play that should meld its rapidly growing mobile base with a burgeoning middle-class in China that's eager to spend. Baidu's O2O ecosystem should allow search and services to meet up under one umbrella without the consumer having to head to a third-party app or site, which can reduce consumer loyalty. Along those lines, gross merchandise revenue basically quintupled in Q4 2015 compared to the prior-year period, while Baidu Wallet accounts rose by a brisk 189% year-over-year.
Investors can also take comfort in the fact that Baidu's search dominance in China is unmatched. Baidu controlled 79.8% of all search in China according to China Internet Watch as of Q2 2015, which is well ahead of Google China and Sogou, which controlled 10.9% and 6.4% shares, respectively. Having such a commanding lead in market share in search means it's the preferred choice for advertisers. This places Baidu in a pretty advantageous position when it comes to pricing.
Baidu's forward P/E of 20 might not seem "cheap" by traditional means, but its estimated five-year growth rate of nearly 30% pushes this tech giant's PEG ratio to just 0.7. It could be time to consider digging deeper into Baidu if you're looking to spice up your portfolio's growth prospects.
Next up, we'll switch gears to the healthcare sector and take a look at small-cap home health services provider Almost Family (AFAM).
There's no hiding the fact that the past six months have been rough on Almost Family shareholders, with the stock experiencing a near-30% decline. Almost Family's visiting nurse services are often tied to patients with Medicare coverage, meaning the company is intricately tied to the growth, or contraction, of the government-sponsored program. It's no secret that with the U.S. national debt rising, the federal government would like to pare back Medicare reimbursements over the long-term. This uncertainty clearly has some investors on Wall Street concerned.
But there's a bright side to this cheap growth story too.
To begin with, Almost Family has the numbers firmly on its side. Even if Medicare spending remains relatively stagnant in the coming decades, Almost Family's customer base should continue to grow as baby boomers retire and an aging population lives longer. Almost Family can win by sheer numbers alone, and that's something investors should keep in mind.
Additionally, Almost Family is expanding its reach and diversifying its services through an aggressive campaign of acquisitions. In 2015, Almost Family acquired six businesses for a grand total of nearly $150 million, with its primary focus being on its Healthcare Innovations segment. Almost Family's recent purchase of Long-Term Solutions, or LTS, for $37 million adds a provider of long-term care assessment and care coordination to its portfolio of services. A separate venture with NavHealth last year seeks to develop technology-based tools and analytics to improve patient experiences and lower care costs. These acquisitions and partnerships, while small, could pack some serious punch once Almost Family has had time to integrate them into its portfolio of services.
Sporting a reasonably low PEG ratio of just 1.2, and demonstrating its ability to grow organically and by acquisition, Almost Family could be just what the doctor ordered (if you happen to be deficient of cheap growth stocks in your portfolio).
We'll end the week by highlighting a company that would, in theory, walk 500 miles for your portfolio, and then walk 500 more: Caleres (CAL -4.59%). And yes, I did just sneak a really bad Proclaimers pun in there.
Caleres, which was known as the Brown Shoe Company prior to May 2015, is a footwear retailer and wholesaler that you've probably come across at a mall or while shopping online. It operates through Famous Footwear, but also sells its products online through Famous.com, Naturalizer.com, and Dr.SchollsShoes.com, just to name a few sites. In recent months its stock has pulled back modestly, primarily on concerns of a slowdown in the U.S. economy. We know retailers tend to be cyclical, so when U.S. GDP growth slows, consumer spending isn't often far behind.
In spite of these near-term worries, the future appears bright for Caleres.
Working in its favor is the fact that consumers' appetite for brand-name products has been nearly insatiable. What Caleres offers is the ability to buy brand-name products at an often discounted price, which is something most cost-conscious consumers can get behind. In Q3 2015, Caleres wound up delivering same-store sales growth at Famous Footwear of 4.4% in spite of a challenging retail environment.
Caleres is also doing its best to boost its margins. This means maintaining tight control of its inventory on hand such that steep promotions don't weigh on margins, as well as promoting its e-commerce sites, which combine convenience with a low-cost shopping experience. In Q3, inventory at Famous Footwear was down 5.6% despite same-store sales being up, presumably meaning margins are on track to improve (although no immediate impact was witnessed on margins in Q3).
With a PEG ratio hovering around one and a forward P/E of 13, Caleres could be a cheap growth stock that winds up walking all over its competition.