With the stock market in nonstop rally mode over the past five years, an investor doesn't need to look far to uncover an abundance of growth stocks. But 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 arbitrary, I'll define a growth stock as any company forecasted to grow profits by 10% per year or more over the next five years. To decide what's "cheap," I'll be using the PEG ratio, which compares a company's price-to-earnings ratio to its future growth rate. Any figure around or below one signals a cheap stock.
Here are three companies that fit the bill.
1. Freeport-McMoRan (FCX -0.16%)
What's an easy way to send a multi-billion dollar company screaming to a fresh 52-week low? Have it two most important commodities -- copper and oil -- touch five-plus year lows within the same month.
Freeport-McMoRan's push back into oil and natural gas resources seemed like a smart move in 2013 when prices were high and stable. Furthermore, it looked as if the move would give Freeport-McMoRan a diversified stream of income that could help counter weak copper prices. Unfortunately for shareholders and Freeport-McMoRan both, commodities dove at the same time, leaving Freeport exposed to pricing pressure and leading some on Wall Street to question whether the company can deal with its more than $19 billion in net debt.
The good news here is I believe Freeport-McMoRan is still in good shape and that the dip in both commodities will be generally short-lived. In China, for example, the government is preparing to launch $1.1 trillion worth of infrastructure projects designed to spur growth in an economy that's expected to grow GDP by roughly 7%, well below its three-decade average of 10%. Copper is a key component to most building projects, so this stimulus package, coupled with Freeport-McMoRan's advantageous copper mining location in Indonesia, make it a clear beneficiary to any Chinese stimulus package.
Also, I don't think we can overlook the possibility for a quick rebound in oil. I believe it's a simple case of supply and demand. As oil prices have fallen the demand for gasoline should rise with prices hitting levels not seen in nearly six years. As demand increases the oversupply will quickly dwindle and prices will stabilize, if not move higher. I also don't anticipate OPEC will purposefully keep prices down for any extended period of time as it also hurts their own profitability even if they're able to gain global market share from U.S. shale producers.
In short, Freeport-McMoRan is expected to see its EPS more than double from an estimated $2.11 in fiscal 2014 to a projected $4.63 in 2017. This means the company is valued at a shade over 4 times its estimated 2017 profitability which is about as cheap of a growth stock as you'll find in the commodity sector right now.
2. Silicon Motion Technology (SIMO 2.44%)
Technology stocks may have galloped higher since the recession, but that doesn't mean there aren't plenty of cheap growth stocks still at your disposal.
One that comes to mind is Silicon Motion Technology, a fabless semiconductor company that develops mobile storage solutions such as microcontrollers used in solid state storage devices and mobile communications solutions like LTE transceivers. Put plainly, these devices are critical to the operation of smartphones and tablets. According to a report from GSMA Intelligence the number of smartphone connections between today and the year 2020 are expected to triple from roughly two billion to six billion. This means the importance of mobile market component suppliers is only going to increase.
Silicon Motion also has the luxury of having one of the most successful smartphone developers (Samsung) in its corner. Dating back to design wins in 2011 Silicon Motion has been supplying a number of Samsung smartphones with its LTE transceiver ever since, leading to sustained growth as Samsung has pushed its products into rapidly growing emerging and developing markets.
In Silicon Motion's latest quarter the company reported year-over-year revenue growth of 52% to a record $86.6 million. Furthermore, its operating margin expanded a whopping 380 basis points to 27.3% from the sequential second quarter as the shipment of new products from Samsung to the Korean market helped boost its profitability.
According to Wall Street's estimates Silicon Motion's EPS should nearly double from the $1.06 it reported in 2013 to the $2.04 currently expected in 2015. This works out to a forward P/E of just 12 with an expected revenue growth rate in 2015 of 23%. It's a cheap growth stock worth a closer look for slightly more risk-oriented investors.
3. Alaska Air Group (ALK 2.40%)
Lastly, I'd opine that sometimes you have to look up to find the cheap growth stocks, as is the case with Alaska Air Group.
Despite being very near a 52-week high, I suspect Alaska Air still has a lot to offer investors. According to The Wall Street Journal's airline scorecard, Scott McCartney dubbed Alaska and Virgin America as this year's best airlines. McCartney hit on a key point when discussing why Alaska is one of the top two airlines because it has placed an increasing focus on customer satisfaction. This is evident in the company's 20-minute baggage guarantee which ensures that your bag is at the carousel no more than 20-minutes after your flight's arrival or you get a $25 discount code for a future flight. This extra pressure ensures that Alaska's operations remain efficient and it serves as a reminder to the consumer that their bags and their time are important priorities to Alaska.
Alaska has also succeeded by hitting routes that major airlines have traditionally avoided. By taking to routes that are outside of many of the major's main hubs it's done a good job of avoiding a lot of head-to-head pricing competition.
Let's not also forget that Alaska is going to benefit from the recent swoon in fuel prices. Because jet fuel is now the largest expense for airlines the dramatic drop in oil prices should translate into an almost immediate benefit for the airline sector.
Based on Wall Street's estimates Alaska Air's full-year EPS should more than double from a reported $2.70 in 2013 to an expected $7.45 in 2017. If Alaska can hit this mark it'd mean the company is valued at roughly eight times 2017's EPS forecast. Assuming oil remains under $100 per barrel and Alaska keeps hitting its stride with consumers this could still be a very attractive growth stock.