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 equal. 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.
No. 1: General Motors (NYSE:GM)
I'm not going to lie: it's been a rough year for General Motors. I've personally lost count of how many automotive recalls Detroit automakers have racked up this year, but based on a filing with the Securities and Exchange Commission in October we know that through the first nine months of 2014 General Motors had announced defective part recalls on roughly 34 million cars, and it's cost the company $2.7 billion.
More than the cost of the repairs, the big concern that investors and CEO Mary Barra have to worry about is whether peers are taking domestic market share amid a sea of negative publicity. It's possible this could be happening to a small degree already, with U.S. market share falling to 17.7% through the end of November from 17.9% same time last year.
However, there are plenty of reasons to believe GM is going to get through this series of events stronger than ever.
For starters, let's not forget that General Motors is a Warren Buffett stock. Buffett has a tendency to buy into companies when he sees an opportunity to be greedy when others are fearful. Clearly investors are worried about the ultimate scope of the auto recalls and the costs associated with these repairs, but in the grand scheme of things this should all be in the rearview mirror within a few more quarters.
Buffett also likes to buy companies with sound business models regardless of how competent their management teams are. Personally, I think Barra's mea culpa has been sincere, and her efforts to deliver on exciting new vehicles is hitting home with consumers. The redesign of the Chevy Silverado and GMC Sierra resulted in a 24.5% and 57% increase in year-over-year sales last month. For the year, Silverado sales are up nearly 8% to 471,918 units year-to-date, while Sierra sales are up 13.1% to 188,397. Pick-ups are the cornerstone of profitability for GM, and it's clear these designs are being well-received.
Finally, GM has a lot of history behind it. It's a company whose products have the potential to transcend generations, from grandparents to grandchildren. That history still means a lot to buyers, and as long as GM can maintain that bond with its loyal consumers it should have no trouble remaining healthy and profitable.
With a projected EPS growth rate of 15% per year between 2013 and 2017, GM is currently valued at a mere six times 2017's profit projections. With a PEG ratio of less than 0.9 I believe investors should seriously take a closer look at GM here.
No. 2: Air Lease (NYSE:AL)
Air Lease is an interesting company in that its business model is to purchase airplanes and lease them to commercial airline companies for multi-year periods. Because planes are so darn expensive and Air Lease has to put so much cash and debt upfront to squeeze out a single-digit return on equity, it's the antithesis of what an investor like Warren Buffett would normally go after.
Skeptics of Air Lease are quick to point at its $6.65 billion in debt, which can act as a concrete block on its back when it comes to making corporate maneuvers. As for me, I think overlooking Air Lease could be a mistake, as it's a great cheap growth stock.
What makes Air Lease so attractive just also happens to be the reason why skeptics dislike the company: the high price of new planes. Commercial airlines would much prefer to have newer planes in their fleet because of the clear advantages in fuel efficiency. Since fuel is the primary expense for airline companies the easiest way to reduce costs is to buy newer planes. But not every commercial airline can afford $200 million-plus for a new plane. Then again, utilizing 25 year-old planes isn't optimal either, since fuel and maintenance costs can be killers.
The solution is leasing. Leasing provides a cheaper alternative for airlines to lower their fuel costs, while Air Lease is able to deliver predictable income by locking in relatively long-term contracts. The result has been annual sales growth of around 20%.
Best of all, in spite of this rapid growth Air Lease is still a cheap growth stock at less than 14 times forward earnings and a PEG ratio of 0.8. Unless new planes dramatically drop in price or lending rates get even closer to zero, there's little reason to suspect that Air Lease's business won't benefit moving forward.
No. 3: Lennar (NYSE:LEN)
Homebuilding certainly isn't the first industry I think of when searching for growth stocks, but when it comes to building homes Lennar is the name to know.
The knock against the homebuilding sector is twofold. The aftermath of the housing bubble has made it difficult in some instances for people with good credit to obtain loans, potentially hindering the new home sale process. Additionally, the end of QE3, the Federal Reserve's economic stimulus, could mark the beginning of rising interest rates next year. If rates rise quickly it could dampen new home sales.
That aside, Lennar has two factors working in its favor.
First, home prices are on the rise. This has to do with homebuilders keeping a tight lid on production in order to keep supply low. As home prices have continued their steady ascent, demand, from first-time homebuyers and investors alike, has picked up in a big way. As long as homebuilders can keep supply from getting out of hand they should prosper.
Secondly, Lennar has pretty impressive margins -- in the third quarter, for example, Lennar stated that its gross margin on home sales rose 30 basis points to 25.2% from the prior-year period. These beefier margins are what could allow Lennar to more than double its EPS between 2013 and 2017.
Based on Wall Street's profit projections, Lennar is currently valued at less than 10 times 2017's profit potential, and considering that Lennar has crushed Wall Street's profit projections in 11 straight quarters, perhaps it's time you took a closer look at this cheap growth stock.
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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