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 1 or less could signal a cheap stock.
Here are three companies that fit that bill.
Orange
The first cheap growth stocks that I'd strongly suggest investors dig into is French-based telecom giant Orange (ORAN 0.47%).
In the earlier part of the decade, Orange struggled mightily with the introduction of lower-priced wireless competitors in its key market of France. Coupling this new competition with a general economic malaise in Europe brought about by multiple debt crises created a perfect storm that sacked Orange's growth prospects. However, following years of cost-cutting and internal investments, Orange looks as if it could be ready to fly once more.
Image source: Flickr user Marjan Lazarevski.
One of the more exciting growth opportunities for Orange is in France where it's made big investments over the last half-decade on boosting data speeds and capacity. Instead of getting involved in a price war with its low-priced French competitors, Orange stuck to its guns of focusing on higher-priced data plans with the assumption that consumers would pay more for a wireless plan with higher speeds and better coverage. This assumption appears to be paying off for Orange, which recently reiterated that 2016 EBITDA would surpass what it reported in 2015.
Orange also has an intriguing opportunity to expand beyond its primary market of France. While investors commonly look to other EU countries for opportunity, I believe Orange's long-tail growth opportunity is in Africa, a market that's largely untapped in terms of wireless and broadband service and infrastructure, is far more attractive. In January, Orange acquired Liberia's leading mobile provider, Cellcom Telecommunications, and it also gobbled up Bharti Airtel's subsidiaries in Burkina Faso and Sierra Leone. In total, Orange has broadened its presence in Africa to 20 countries, and it anticipates the region will become a bigger contributor to its top- and bottom-line in the coming years.
Growth and value investors should also appreciate Orange's healthy shareholder return policy. The telecom giants' current yield of 4% is almost double that of the S&P 500.
With a PEG of less than 0.5 and a long-tail growth opportunity in Africa, Orange is a cheap growth stock worthy of serious consideration.
Steelcase
The next company I'd encourage growth investors to check out is Steelcase (SCS +0.00%), a global developer and manufacturer of office furniture and architectural solutions.
The biggest issue for Steelcase of late has been a slowdown in orders from its Europe, Middle East, and Africa (EMEA) operations. After reporting robust double-digit percentage organic growth in fiscal 2015, organic growth in EMEA slowed to just 1% on a year-over-year basis. Furthermore, EMEA resulted in a wider year-over-year operating loss of $43.9 million in fiscal 2016 compared to an adjusted operating loss in the region of $32.2 million in the prior year. But slowdown aside, Steelcase could be just what cheap-growth investors ordered.
Image source: Steelcase.
Perhaps the biggest factor working in Steelcase's favor is the perpetuation of low lending rates in developed countries around the world. Although growth rates in the U.S. and other leading economic powers have been lower than Steelcase would like to see, the low-yield environment created by respective central banks is making access to capital cheap (and often easy) for American and European businesses. This means business expansion will probably continue in the U.S., favoring Steelcase for many years to come.
Also working in Steelcase's favor is the integration of technology that goes into its office furniture designs. Steelcase isn't trying to compete against your average office-furniture manufacturers. Instead, it's operating in the niche space that looks to emphasize the growing use of technology in the workspace, and in understanding that workspaces need to be mobile and functional. Doing so has helped it move beyond the traditional confines of "the office" and into school classrooms and healthcare facilities around the country. In fiscal 2017, Steelcase anticipates launching more than 20 new products that are focused on its strongest areas of growth.
Sporting a very generous 3.3% dividend yield a PEG of 0.7, Steelcase could be a stock for growth investors to cozy up to.
CalAtlantic Group
Lastly, cheap growth stock investors would probably be wise to give homebuilder CalAtlantic Group (CAA +0.00%) a closer look.
CalAtlantic Group is the company formed from the merger between Standard Pacific and Ryland Group that was completed at the beginning of October 2015. Like most homebuilders, CalAtlantic's share price has suffered over the past year because investors anticipate an eventual increase in the Federal Reserve's fed funds target rate – and since lending rates can strongly influence homebuyers, investors have simply assumed that the best is already in the rearview mirror for homebuilders. However, it's my opinion that CalAtlantic could be an exception.
Image source: CalAtlantic Group.
The merger between Standard Pacific and Ryland Group solved a lot of problems for both companies, creating a substantially stronger homebuilder with a more diversified home profile in a number of key U.S. markets. Combining allowed CalAtlantic to trim redundant positions, which it estimated at about 10% of its workforce (approximately 280 jobs). Trimming jobs and eliminating overlapping business operations is expected to save $50 million to $70 million annually, which could work out to roughly $0.50 in added EPS each year.
CalAtlantic Group's customer base is another reason why its valuation could head higher. In CalAtlantic's first-quarter earnings report we learned that average selling prices for homes dropped 10% to $432,000. Even with this drop, it's clear that CalAtlantic serves a middle-class to upper-middle-class consumer; and these individuals tend to be less affected by fluctuations in the U.S. economy. The next time a housing downturn does occur, CalAtlantic will be far better prepared than it was as two separate homebuilders between 2007 and 2009.
Finally, I believe fears of rising lending rates may be overdone. Although rates are eventually going to rise, the Fed has been pretty clear about its intention of targeting low-to-moderate interest rates in the coming years. That bodes well for the mortgage industry and homebuilders in general.
With a microscopic forward P/E of 8 and PEG of just 0.5, CalAtlantic may be an attractive addition to growth investors' portfolios.
