When the 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 their shareholders with hefty losses.
What exactly is a growth stock? I'll define it as any company forecast to grow profits by an average of 10% or more annually during the next five years -- although that's an arbitrary number. To gauge what's "cheap," I'll use the PEG ratio, which compares a company's price-to-earnings ratio to its forecast future growth rate. A PEG around or below 1 could signal a cheap stock.
Here are three companies that fit that bill.
If you're on the lookout for cheap growth stocks, you might be amazed to discover that some still exist within the oil and gas industry. Specifically, I'd point you toward refining and midstream company HollyFrontier (NYSE:HFC).
The biggest concern for the oil and gas sector is the better than two-thirds haircut crude prices have been dealt with over the past year and a half, and the nearly 75% dip in natural gas prices since the beginning of 2014. If energy commodities continue to drag near their lows, the vast majority of the industry could suffer.
That's where HollyFrontier comes in. It operates in two factors that each have an opportunity to contribute to profits in a notable way. First, HollyFrontier's refineries are benefiting from the rapid drop in crude prices vis-à-vis the crack spread. The crack spread is merely the difference between the futures prices for refined petroleum products such as gasoline, diesel fuel, and jet fuel, and the price refiners have to pay for crude oil -- their profit margin. When crude prices fall quickly, it tends to have an expansionary effect on crack spreads. Although this would suggest that crack spreads will fall in 2016 as the market normalizes to sub-$40 West Texas Intermediate, HollyFrontier's refineries should remain healthfully profitable, and in high demand.
The other factor is its subsidiary Holly Energy Partners (NYSE:HEP), which operates pipeline, storage, and terminals in the Central, South-Central, and Southwestern United States. Acquisitions and its favorable geographic location are certainly helping Holly Energy Partners, but the real source of promise here are its long-term contracts. Because midstream operators like Holly Energy Partners tend to lock in contracts for long periods of time, they largely avoid wholesale cost exposure and quarter-to-quarter demand fluctuations. There also tend to be price hikes built in to ensure growth for the business.
Sporting a minuscule PEG ratio of 0.5, and a delectable 3.6% dividend yield, growth investors hunting for cheap stocks should really consider giving HollyFrontier a closer look.
Next, we'll move over to the technology sector and briefly examine a cheap small-cap growth stock that you may very well have heard of before: Web.com Group (NASDAQ:WEB).
As the name probably gives away, Web.com Group owns the Web.com portal, which focuses on small- and medium-sized businesses, providing solutions that range from domain and hosting to search engine optimization. While you might be of the opinion that domain companies are "so late '90s," Web.com still has solid growth potential for a variety of reasons.
First, look at its core clients: small businesses. Small businesses often need that nudge of assistance to remain competitive, and Web.com's services aren't going to bankrupt their budget. The company can provide advertising assistance, pay-per-click management, Facebook services, and a host of other solutions. Taking the small-business approach has its risks, considering the high failure rate of smaller companies, but Web.com appears to be benefiting on sheer volume alone, ending the fourth quarter with 3,353,000 net subscribers.
The company is also doing what it can to improve its balance sheet and reward shareholders. Web.com Group repurchased $50.6 million worth of its common stock in 2015, which can help boost EPS and make its stock appear more attractive to investors, and it reduced its debt by $95.3 million. All the while, cash from operations grew $35 million year-over-year to $152.7 million.
With a number of levers it can pull to ignite growth, (acquisitions, cost-cutting, and increased advertising), Web.com Group's forward P/E of 6 makes it appear mighty attractive.
G-III Apparel Group
Finally, we'll wrap up in the retail sector by taking a look at G-III Apparel Group (NASDAQ:GIII), which was pummeled following the release of its third-quarter results.
In early December, G-III Apparel announced Q3 sales growth of 12%, and adjusted net income expansion of 20%. However, those gains were all for naught after the company updated its full-year guidance to reflect warmer-than-expected weather adversely affecting outerwear sales. The company's new guidance was for a full-year EPS range of $2.67 to $2.82, down from the prior forecast of $2.78 to $2.88 in EPS. Long story short, investors weren't thrilled.
But I'd suggest this was an overreaction, and that G-III Apparel's future looks bright.
Two things have really worked in G-III's favor, and I suspect they'll continue to do so. First, it has product diversity: Among the core brands it emphasizes are Andrew Marc and Marc New York, but it also has licenses for more than dozen major fashion brands, such as Calvin Klein, Kenneth Cole, Tommy Hilfiger, and Levi's, to name a few. Adding to that diversity, the company doesn't just sell outerwear. It offers an array of handbags, footwear, accessories, sportswear, and dress clothes. In other words, Mother Nature can do what it wants, because G-III has brand-name, diverse products that should remain in demand year-round.
The other factor here is G-III Apparel's affinity to grow by acquisition, as well as make deals. Earlier this year, G-III announced an expanded deal with PVH (NYSE:PVH), the company behind the Tommy Hilfiger brand, that Women's Wear Daily believes could turn into a $1 billion opportunity for the company. G-III will be responsible for designing, producing and distributing Tommy Hilfiger's women's wear, which comes on top of other licensing agreements G-III holds for PVH's men's outerwear, women's outerwear, and luggage. Long-term licensing agreements like this help provide steady cash flow for G-III, but also show other retailers that G-III Apparel Group can handle the design and production of any product line.
G-III Apparel's expected to nearly double its full-year EPS between 2015 and 2019, and as such, should be on the radar of growth-seeking investors.
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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