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 in the technology sector and in an overseas market for a change this week by taking a brief look at why China's online social platform YY (NASDAQ:YY) could hit the spot for growth investors.
The one drawback for YY (and practically all China-based stocks, as we've witnessed for more than a half-decade) is there's a lack of business transparency that can sometimes be a detriment to shareholders. Mid-cap and large-cap stocks tend to run into transparency issues less often, which works in YY's (and shareholders') favor, but differing corporate regulations in China are something investors should keep in the back of their minds.
However, based on what we do know about YY, there's a lot to like. Perhaps the most attractive aspect of YY is that it's basically modeling itself as the Facebook (NASDAQ:FB) of China. It's targeting Chinese consumers, both on PCs and mobile, but make no mistake about it -- it's seeing far greater growth in its mobile ventures. While all aspects of its growth strategy are clicking, it particularly highlighted online music and entertainment as its quickest-growing segments, with mobile average revenue per user in these segments increasing by 139% year-over-year. In fact, mobile revenue as a whole grew 452% year-over-year (no, that's not a typo), and now accounts for 45% of total revenue for the company. Sound reminiscent of a certain U.S.-based social media giant you might know?
Investors may also like the lack of competition. Facebook is banned in China, which is allowing YY to swoop in and gobble up a large number of Chinese consumers looking for video-based personal interactions, gaming, dating, music, and other forms of entertainment. At last check, 30% more users were paying customers (3.2 million) as of Dec. 31, 2015 compared to last year.
Lastly, YY can rely on China's superior GDP growth and still expanding market economy. Even with its worst GDP growth in the past 25 years in 2015, the Chinese economy is still growing at better than 6% annually. This should give YY all the more reason to reinvest in infrastructure and innovation.
A PEG of 0.8 and a forward P/E under 14 could mean YY is ripe for the picking.
Sometimes the best values and growth can be found in niche industry players, which is why our second cheap growth stock this week, Gentherm (NASDAQ:THRM), hails from the auto parts industry.
Gentherm primarily develops thermal management technologies for the automotive industry. That heated seat in your car, or your heated steering wheel, very well could have been developed by Gentherm. The company also integrates its individualized thermal comfort systems into furniture and mattresses.
What makes Gentherm so intriguing are two particular factors.
First, it maintains more than half of all comfort control system market share for heated seats in autos. The company's fourth-quarter press release attributed its recent growth to the Ford Mustang offering a climate control seat (CCS) for the first time ever. All told, Gentherm's CCS segment generated $400 million in revenue in fiscal 2015, up 9% from the previous year, with the company noting particular strength in the luxury vehicle market. Having a niche product with dominant market share affords Gentherm strong pricing power.
The other point here is that global auto sales are expected to increase over the long run. Automakers have only touched the tip of the iceberg in parts of Asia and Africa, affording plenty of expansionary opportunities. Among the ways automakers are luring in new customers are through interior luxuries, including heated seats. Based on the long-term trajectory of the auto sector (and Gentherm's CCS domianance), the company should be a beneficiary.
Currently sporting a double-digit percentage long-term growth rate and a PEG ratio of well below one, Gentherm could be just the stock to heat up growth investors' portfolios.
United Community Banks
Finally, growth investors looking for a cheap stock that they can bank on for future returns may want to consider turning to the regional banking sector. Specifically, I'd point to United Community Banks (NASDAQ:UCBI), a retail and commercial bank that services North and South Carolina, Tennessee, and Georgia.
As with most banks, United Community Banks' biggest obstacle is overcoming a low net interest margin, which is being perpetuated by the Federal Reserve's multi-year stance of keeping its federal funds target near record lows. While a nuisance for United Community Banks, the company has other solutions up its sleeve.
For starters, the company is focusing on only its highest-margin assets. This would essentially boil down to various fee-based services, which pack the most punch. We witnessed its commitment to this strategy via its disposition of $190 million worth of healthcare loans to Hancock Bank, a subsidiary of Hancock Holding, in October. Healthcare loans typically bear lower yields, and since disposing of these assets we've seen a modest uptick in net interest margin for United Community Banks.
There's also a strong push to grow inorganically, too. United Community Bank scooped up Palmetto Bancshares, the holding company for Palmetto Bank, for about $240 million last year. The deal improved the combined company's presence in South Carolina and brought in the neighborhood of $1.2 billion in total assets to United Community Banks' balance sheet.
United Community Bank also acquired First National Bank in January 2015 in order to expand its influence in Tennessee and add more than $350 million in assets to its balance sheet. Yet in spite of these acquisitions, we're seeing UCB's nonperforming assets remain at historically low levels, implying that its loan portfolio's credit quality is still very high.
A PEG ratio of 0.6 and a forward P/E of just 12 could very well make this burgeoning regional bank one growth investors will want to closely monitor.
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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