With the stock market in nonstop rally mode over the past five years, an investor doesn't need to look far to uncover an overabundance of growth stocks. Unfortunately, not all growth stocks are created equally. While some could still lead investors to extraordinary gains, others appear considerably overvalued and could wind up burdening investors with hefty losses.
What exactly is a "growth stock?" Though arbitrary, I'm going to define a "growth stock" as any company forecasted to grow profits by 10% per year or more over the next five years. For the context of "cheap" I'll be using the PEG ratio, which examines the relative cheapness of a company's growth price-to-earnings ratio compared to its future growth rate. Any figure around or below one would constitute a cheap stock.
Here are three companies that fit the bill.
Driving Gilead's top- and bottom-line growth are three drugs: Harvoni, Sovaldi, and Stribild. Make no mistake about it; Gilead has seen growth from other drugs in its product portfolio, but these three Food and Drug Administration-approved products are the cornerstone of Gilead's future.
Sovaldi is the company's breakthrough oral hepatitis C medication that can be administered without the need for interferon to genotype 2 & 3 HCV patients. Since interferon can cause flu-like symptoms during the duration of the treatment course, Sovaldi's approval was a major step forward in improving patient care. Even more so, it was an incredible improvement in patient cure rates (known as sustained virologic response, or SVR). Within a span of just three years most HCV genotype SVRs improved from around 50% to 90% or higher in many instances.
Harvoni is Gilead's latest cocktail drug, comprised of Sovaldi and ledipasvir. It's designed to treat the considerably larger and tough-to-treat genotype 1 HCV patients without the need for interferon or a ribavirin. Compared to the previous standards of care, the simplicity of taking a single pill each day for eight, 12, or 24 weeks is night and day, not to mention some clinical studies hit or approached a 100% cure rate.
Lastly, we have Stribild, Gilead's four-in-one HIV infection drug. With HIV/AIDS still the biggest infectious lethal disease worldwide, Gilead's market potential is arguably still enormous. More importantly, all four compounds are now made in-house, as opposed to the prior-generation therapy Atripla, which was a combination of three therapies from three different companies -- meaning Gilead only netted a third of the revenue. With all sales now headed Gilead's way, it can reap huge rewards.
Gilead's earnings per share are expected to catapult from its reported $2.04 in 2013 to more than $12 per share in 2017, or just 8.5 times 2017's projected profit. With a PEG ratio well below one, I'm compelled to believe Gilead has more upside potential.
Southwest Airlines (NYSE:LUV)
Yes, an airline! Now I kindly ask that you push those eyeballs back in your head and pick your jaw up off the floor.
Sometimes the greatest growth stocks are the best run businesses. I can't say I much care for the airline sector as a whole, since it requires a large investment just to generate a small return. Remember, buying and fueling planes isn't cheap, and all it takes is a really bad storm or an Act of God to completely change the airline industries' landscape.
However, Southwest Airlines has two primary factors working in its favor that should lead to above-average growth over the coming five years.
First, Southwest Airlines is constantly a consumer favorite. It may not rank at the top of every customer satisfaction list, but regardless of the survey source you're likely to find it very close to the top in most satisfaction studies. The reason is that Southwest sticks to a very consumer-oriented business model. It flies to quite a few off-route cities that major airlines have long avoided. In addition, the company's "bags fly free" program allows its passengers to check up to two bags free of charge. Because Southwest doesn't use ticket brokers to sell seats, it doesn't have to pay a commission for sales, affording it the ability to "perk" its passengers with two free checked bags.
The other component to Southwest's success is rapidly falling oil prices. Chances are that oil prices aren't going to stay down for too long, but Southwest has done an exceptional job in the past of hedging against higher fuel costs. In the meantime, Southwest will simply relish lower fuel costs and reap the extra profits.
Having earned $1.12 in EPS in 2013, Southwest's projected 2017 profit could more than triple to $3.52. That works out to a forward P/E in 2017 of just 11.5 and a PEG ratio of just 0.5. As long as Southwest can keep its consumer base happy, its stock could have a chance to fly high as well.
Alliance Resource Partners (NASDAQ:ARLP)
The final cheap growth stock you should consider buying right now is coal producer Alliance Resource Partners. And no, your eyes aren't deceiving you again... I really said "coal!"
Coal prices have been under some pretty intense pressure over the past couple of quarters as a slowdown in demand for thermal and metallurgical coal compounded with an oversupply of product has hurt prices. Amazingly, it's hardly affected Alliance Resources' bottom line, as the company is on pace to produce its 14th consecutive year of record profits!
What sort of sorcery is Alliance Resource Partners employing, you ask? Simple: The company works hard to contract its production many years in advance, taking most of its market price exposure off the table and making its cost structure fairly predictable.
For example, in its third-quarter earnings report Alliance Resources commented that it had 33.5 million tons of coal secured by contract in 2015 and another 26.6 million tons accounted for already in 2016. To add context to these figures, Alliance Resources might produce somewhere in the neighborhood of 40 million tons per year. This means only 16% of its 2015 production and a third of its 2016 production could be exposed to volatile market pricing.
Furthermore, as a master-limited partnership, Alliance Resource Partners avoids high U.S. corporate income tax rates. These lower costs allow the company to keep more of its income and pass it along to shareholders in the form of a rapidly growing dividend. The 2% dividend increase Alliance Resource announced during the third quarter, reaching $0.6375 per share, marked the 26th straight quarter it's raised its payout! That's right, you also get a 5.5% yield if you hang onto Alliance Resource shares!
After bringing in $3.63 in EPS last year, Alliance Resource is forecast to earn $5.03 in 2015 based on Wall Street's estimates. This works out to a forward P/E of just 8.8 and a PEG ratio that's well below one. This is a stock that growth and income investors can both give serious consideration to.