While 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 look 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 of around one or less could signal a cheap stock.
Here are three companies that fit that bill.
We'll start our quest for cheap growth stocks by taking a closer look at Broadcom Limited (NASDAQ:AVGO), a semiconductor company that was created when the former Avago Technologies merged with Broadcom Corporation.
The two big obstacles for Broadcom are the global economy and its balance sheet. Chip plays tend to be cyclical and reliant on the global economy to push higher, thus they tend to trade at what look like cheap earnings multiples. Additionally, following multiple acquisitions by Avago, the combined entity is lugging around almost $3.9 billion in long-term debt, or more than $1.7 billion in net debt. Despite Broadcom's robust cash flow of $2.3 billion in 2015, a skittish market may want to see this company pay down its debts post-merger.
However, Avago's purchases and merger with Broadcom also created a company that could be a technological monster. Combining Avago with Broadcom allows the company to achieve up to $750 million in cost synergies within the next 18 months, and it should help improve production efficiency, margins, and perhaps even pricing power, as it'll have a larger presence in wireless and wireline solutions.
Avago's announcement that it was purchasing LSI Logic in late 2013 for $6.6 billion, and Emulex in February 2015 for $606 million, pushed the company into networking and storage chips, as well as other networking solutions. In other words, Avago has taken its chip foundry and expanded it to include enterprise storage and adjacent wireline and wireless markets beyond just smartphones. This diversity could give it a leg up on foundries that focus almost exclusively on wireless markets.
Presumably, if you expect enterprise data storage and consumer smartphone prevalence to grow (both seem very likely), then Broadcom is a name you'll likely want to have on your radar. Valued at 12 times forward earnings and sporting a PEG ratio of 0.8, this cheap growth monster could head even higher.
Next up, we'll swing over to the consumer goods sector and examine why recreational-vehicle (RV) and manufactured-homes parts supplier Drew Industries (NYSE:LCII) might be a name growth investors should consider going forward.
The vast majority of Drew Industries' sales come from its RV businesses, which supply things like vinyl windows, stabilizing equipment, and vertical lift beds for various types of motorhomes, trailers, and campers. One reason the company has been able to grow so well organically has been its mixture of innovation and a recovering economy. Trailers and motorhomes aren't cheap, therefore as long as lending rates remain low, the upgrade cycle for RVs can be expected, in my opinion, to stay robust.
Innovation has been brought to the forefront through Drew Industries' many acquisitions. Over just the past 13 months, Drew has added four acquisitions to its mix of subsidiaries in an effort to diversify its product portfolio, generate new channels of revenue, and boost innovation. The company's fourth-quarter report alludes to its push into marine furniture, school bus windows, and other adjacent industries as new channels of revenue-generating opportunity for the company. These acquisitions added roughly $113 million in net sales in 2015.
And Drew Industries really proves its M&A savvy with its bottom-line results. Operating margins rose to 7.1% in Q4 2015, up 110 basis points year over year, thanks in part to lower commodity prices (steel and aluminum spot prices have dropped), synergies realized from acquisitions, and the launch of new products.
As long as lending rates remain historically low, this RV parts giant with a forward P/E of 15 and a PEG ratio just a hair above 1.1 could be worth your attention.
Finally, the healthcare sector could offer a bounty of cheap growth stocks. Since we can only pick one this week, I'd suggest taking a closer look at AmSurg (NASDAQ:AMSG), a provider of ambulatory surgical services and outsourced physician services such as anesthesiology, radiology, and emergency medicine.
Like most healthcare service providers, the company's biggest concern is what will happen to government-sponsored programs like Medicare and Medicaid over time. The government has made it clear that it would prefer to reduce corporate reliance on these programs, which could impact care providers like AmSurg.
However, the long-tail growth opportunity for AmSurg appears clear as day. For instance, despite spending concerns arising from Obamacare's implementation, lower uninsured rates are sparking higher medical use rates for consumers. This, in turn, is boosting demand and pricing power for AmSurg's outsourced services and ambulatory surgical services. In fiscal 2015, same-center revenue growth jumped 6% in ambulatory and just shy of 10% in physician services.
Another theme of today's growth stocks is acquisitions. AmSurg purchased Sheridan Healthcare in the summer of 2014, and it's been acquisitions ever since. The company completed a grand total of 16 transactions in 2015, and shareholders bore witness to a full-year sales increase of 58% to $2.57 billion and an adjusted net earnings spike of 68% to $191.3 million.
As life expectancies grow and medical care becomes more accessible, AmSurg is likely to see its business expand further. Currently trading at 14 times forward earnings estimates and a PEG ratio below 0.9, AmSurg could be just what the doctor ordered.
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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