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 begin the week by examining a personal favorite watchlist company of mine in the healthcare sector that I suspect could be ripe for the picking: Medivation (MDVN).
Medivation has garnered a lot of buyout speculation of late, going so far as to hire financial advisors to protect against a potential takeover bid. While a takeover of Medivation would likely not be cheap, and that alone could create value for shareholders, I see reasons why growth investors would prefer to hold this over the long term rather than bet on a buyout.
The real selling point for Medivation is Xtandi, a metastatic castration-resistant prostate cancer drug it developed with partner Astellas Pharma (ALPMY 0.32%). After dazzling Wall Street and the scientific community with what it could do in the post-chemo setting for advanced mCRPC patients, Xtandi's real value might be found in the treatment-naïve setting.
In clinical studies, Xtandi provided a 17-month longer window before chemotherapy needed to be started compared to the placebo. Also, a mere 14% of patients progressed or died during its pre-chemo study compared to 40% of placebo patients. But it's true selling point might be that it can be administered by itself, whereas Zytiga, the current standard of pre-chemo care for advanced mCRPC, needs to be administered with a steroid that isn't always well-tolerated. By itself, Xtandi could see peak annual sales approach $5 billion within a decade, reaping substantive rewards for Medivation and Astellas Pharma.
Medivation also has two more late-stage trials under way -- talazoparib for gBRCA mutated advanced HER2-normal breast cancer, and pidilizumab for relapsed or refractory diffuse large B-cell lymphoma. Should either of these trials succeed, it'd be just gravy on top for shareholders.
Medivation's PEG is currently a reasonable 1.2, and EPS between 2015 and 2019 is expected to triple from a reported $1.01 to an estimated $3.11. This is what cheap growth is supposed to look like!
KKR & Co.
Next, I'd suggest growth investors looking for a cheap deal switch their interest to the financial sector and take a closer look at KKR & Co. (KKR -4.34%), a company that provides investment management services to public, private, and capital markets.
The past year has been pretty rough for KKR, with a volatile market capping gains on its private-equity portfolio and causing it to report a profit of $0.07 per share in Q4 when Wall Street had been looking for a $0.27 per share profit. But, hiccups are to be expected considering that KKR has been transitioning for a year to a more shareholder-friendly and profitable business model.
Under KKR's previously fee-heavy model during buyout deals, it would use various funds to invest in buyouts and take a small management fee as well as a percentage of the funds' investment gains. Under its new business model it's looking to invest substantially more of its own capital in buyout deals. Doing so reduces its management fees and fund investment gains, but it allows the company to gain new sources of revenue, as well as allows investment gains to flow directly to the company's balance sheet. In other words, after some short-term pain, KKR's newer business model should yield substantially stronger profits.
KKR has also done what it can for its investors. Since October, the company has purchased $270 million worth of its own shares (lowering its outstanding shares can boost its EPS and improve the valuation of its stock in the eyes of investors), and it still has up to $230 million remaining on its announced stock buyback. As icing on the cake, it's currently paying out a handsome 4.5% yield, which is double what you'd get investing in the S&P 500.
Sporting a PEG that's well below 1, and expected to deliver well over $2 in EPS beginning in 2017 and beyond, KKR appears to be a cheap growth stock worth serious consideration.
Finally, we'll end the week on a small-cap note by taking a look at how Lionbridge Technologies (NASDAQ: LIOX), a cloud-based provider of translation, marketing, and content management solutions around the globe, could be a cheap growth stock worth your while.
What makes Lionbridge so attractive, aside from its niche translational cloud services, is its business diversity, attention to inorganic growth, and shareholder yield.
First, Lionbridge has worked hard to diversify its business away from traditional technology. It's been focusing on life sciences businesses, law firms, automotive, entertainment, and other industries that would help stretch its influence more broadly, and leave it less reliant on the tech sector. The results? In 2015, the company boosted its non-tech revenue to 47% from 37% in fiscal 2014. This should allow for more balanced long-term growth.
Secondly, Lionbridge has been active on the acquisition front in an effort to boost its product offerings and expand its reach into non-tech sectors. The acquisition of Geotext in November allowed it to become a niche provider of translation services to law firms, and its CLS Communication acquisition, which was completed in January 2015 for $77 million, helped boost its professional content management solutions in the financial sector. Though organic growth is often preferred, few, if any, shareholders are complaining about Lionbridge's smart acquisitions.
Third, Lionbridge has done an admirable job of returning money to shareholder via stock buybacks. The company repurchased 1.4 million shares of common stock in 2015.
All told, we're looking at a sub 0.5 PEG, and a forward P/E of less than 7. I'd certainly say this qualifies Lionbridge as a cheap growth stock.