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 it's somewhat arbitrary, I'll define a growth stock as any company forecast to grow profits by 10% per year or more over the next five years. As far as defining "cheap" goes, I'll be using the PEG ratio, which examines the relative value of a company's price-to-earnings ratio compared to its future growth rate. Any figure around or below one indicates that a stock is cheap.
Here are three companies that fit the bill.
1. JetBlue (JBLU 6.02%)
No, your eyes are not deceiving you -- it's an airline stock. I admit I'm not a huge fan of the airline industry for the same reason Warren Buffett has mostly stayed on the industry sidelines: It's a highly capital-intensive, low-margin business. It takes so much capital to turn a small profit that the debt burden can often be scary for long-term investors.
Since 2000, each of the major U.S. carriers have sought bankruptcy protection at least once, although we can blame the tragic events of Sept. 11, 2001 for derailing the industry for a number of years. On top of the terrorist attacks, airlines have dealt with steadily rising jet fuel costs. Jet fuel now comprises the single greatest cost for today's airlines.
Despite this, national airline JetBlue appears to be a cheap growth stock that could fly even higher.
To begin with, oil prices are near five-and-a-half year lows, which will result in lower fuel costs for airlines, at least in the intermediate term. Because fuel is airlines' highest cost, this will have the biggest and quickest impact on their bottom lines.
Secondly, consumers like JetBlue. According to J.D. Power's 2014 North America Airline Satisfaction Study, JetBlue placed first with a score of 789 in the low-cost carrier group, edging out Southwest Airlines and its score of 778. JetBlue offers a number of perks that passengers seem to enjoy, including TV entertainment during flights, the ability to check one bag for free, and built in WiFi on most flights. JetBlue has been the highest-scoring airline in J.D. Power's study for 10 consecutive years.
Lastly, JetBlue should have good control of its expenses for what I'd presume would be another decade. According to AirFleets.net, a website that aggregates aircraft age for the nation's largest airlines, JetBlue's aircraft are only 7.6 years old on average. This means many of JetBlue's planes are more fuel-efficient and also less prone to mechanical problems, which means they spend more time in the air servicing customers.
With a PEG ratio that's well below one and EPS growth that should average 36.8% through 2017, JetBlue is a cheap growth stock that should be flying high on your radar.
2. Whirlpool (WHR 2.83%)
The name "Whirlpool" might denote something that's headed down the drain, but the company is far from it.
As you may recall, Whirlpool struggled for years following the Great Recession, with U.S. home sales way down and Europe struggling to get its regionwide debt crisis under control. The end result was fewer people buying big appliances for their homes.
Fast-forward to today, and we have a far different scenario. The U.S. housing market is in good (if not great) shape, and consumers in the U.S. are being tempted by near-record-low lending rates to make purchases on new appliances, including washers and dryers. In Europe we've seen the housing market stabilize, which has reduced pressure on Whirlpool's overseas results.
Look ahead, and things really get exciting. A mixture of acquisitions -- growth through acquisitions has always been a core component of Whirlpool's strategy -- and rebounding European and U.S. housing markets are expected to drive Whirlpool's EPS significantly higher through 2018. Based on guidance issued by Whirlpool just this past week, the company is forecasting $22-$24 in EPS in 2018, which is double the $10.75-$11.75 in GAAP diluted EPS offered as guidance for 2015. It also places Whirlpool at just eight times its median 2018 EPS forecast.
Whirlpool also wants its investors to know that it's keeping its expenses under control, and it plans to continue to reward those who stick around for the long term. Since early 2011 Whirlpool has increased its dividend payout three times. Instead of $0.43 per quarter, shareholders are now privy to a $0.75 per-quarter payout, which is good for a 1.6% yield.
Whirlpool is a household name, an appliance juggernaut, and an attractively priced growth stock that you should be closely monitoring.
3. Baidu (BIDU 3.92%)
If you want phenomenal growth potential, then look no further than China's dominant search engine, Baidu.
Baidu has been a paragon of consistency in China, pushing its search engine market share in the fast-growing country from 79.7% in the fourth quarter of 2012 to an estimated 82.2% in Q3 2014. In fact Baidu has delivered search engine market share growth in all but one of the past seven quarters. Its dominance leads to superior pricing and negotiating power when it's dealing with advertisers, and it also allows Baidu to benefit directly from China's growth rate, currently north of 7%.
But it's not just PCs where Baidu dominates. According to Barron's, nearly 90% of Baidu's PC faithful have made the transition to mobile, an area expected to see high double-digit growth throughout the coming years.
With Baidu's third-quarter report we can get a feel for just how dominant this search engine is within China. Revenue rose by 52% to $2.2 billion from the year-ago quarter, while net income jumped 27.2% to $631.5 million. Why the weaker income growth if revenue soared? Simple: Baidu is still investing heavily in its future, which includes a keen focus on mobile and the possibility of acquisitions.
With Baidu's revenue expected to nearly triple between 2013 and 2016 and its EPS forecast to nearly double between 2014 and 2016, the company's current P/E of 20, based on 2016's profit projections, appears ridiculously cheap.