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. Lear (NYSE:LEA)
Lear may be nearly six years removed from a bankruptcy filing that tainted its image and its history during the height of the Great Recession, but the Lear of 2015 represents nothing of the Lear that we knew back in the late 2000s.
For those unfamiliar with Lear, it's one of the largest manufacturers of automobile seats and onboard electrical systems in the United States. Thus the metrics that predict its success and failure are pretty easy to follow: A growing economy and a healthy car market where low lending rates continue to prevail should signal continuing growth for Lear's sales and profits. A shrinking economy, on the other hand, would be cause for concern. In other words, this is a cyclical stock. The good news is that the U.S. economy grew by a robust 5% pace in the third quarter, signaling that Lear should be doing just fine.
Furthermore, with the exception of midsize and large cars, every other subcategory of vehicle (including all-sized trucks, SUVs, and crossovers) saw year-over-year sales expansion in 2014 relative to 2013. We can see this strength translated into Lear's third-quarter results, which yielded its "best third quarter ever" according to CEO Matt Simoncini. Sales grew 8% to $4.2 billion, while adjusted EPS tore higher by 33% to $1.93 on the heels of a 60 basis points expansion in operating margin.
It also doesn't hurt that Lear has worked diligently for the last half-decade to control its costs, especially in its electrical systems segment, where year-over-year margins have shown improvement for 20 straight quarters.
Between 2013 and 2017 Wall Street expects Lear to double its EPS to nearly $12 per share, placing the company at just eight times forward earnings and a PEG ratio of below one. I can't say I'm thrilled with the sub-1% dividend yield, but this cheap growth stock could more than make up for any dividend shortcomings in the share price appreciation department.
2. H&E Equipment Services (NASDAQ:HEES)
Sticking within the industrial sector, I'll turn your attention next to heavy construction equipment lessor and retailer H&E Equipment Services.
H&E provides heavy-duty machinery such as cranes and industrial lift trucks, and as such is reliant on strong commercial construction growth in order to boost its profitability. Like Lear, H&E is benefiting from robust economic growth in the U.S., as well as the fact that it operates in some of the states hit hardest by the Great Recession. This should, in theory, give H&E an opportunity to continue to capitalize on a rebound in these states.
What I really like about H&E Equipment Services is its wide range of revenue streams. The bulk of its revenue comes from equipment rentals, which makes sense considering that not all construction companies want to spend millions on new heavy-duty equipment. However, H&E caters to buyers as well, selling new equipment, used equipment, parts, and even providing service to existing equipment. In short, it has a way to hit every avenue of the supply chain for commercial construction companies.
Although Wall Street didn't care very much for H&E's third-quarter results, I see little to be concerned about. Total revenue grew 1.7% while gross margin jumped 340 basis points to 33.1% from Q3 2013. Average time utilization also increased by 180 basis points to 74.1%. These metrics demonstrate that more equipment was in use, pricing power for H&E's rental equipment is still advantageous, and its expenses are under control. The fact that H&E's average rental fleet age fell also implies that fewer repairs will be needed on owned equipment.
At a forward P/E of just 11 and sporting a delectable 5% yield, this cheap growth stock is just begging to be added to your watchlist.
3. Green Dot (NYSE:GDOT)
Lastly, I'd suggest that prepaid debit card and cash processing services company Green Dot could be a cheap growth stock you'll want to keep an eye on.
Green Dot might look like an instant winner on paper when you consider that it's operating in the highly lucrative and high growth prepaid debit card business. Unfortunately, Green Dot has been far too reliant on Wal-Mart for a few years. Thus, when Wal-Mart chose to expand its debit-card offerings a few years back, Green Dot got hammered.
The positive news is that Green Dot has done a complete about-face and is once again delivering strong earnings growth, steady sales growth, and healthy gross dollar volume expansion through its prepaid cards. A lot of this has to do with its expansion into new retail environments and select financial centers. Green Dot recently renewed its agreement with the Walgreen Boots Alliance to provide branded and reloadable cards at Walgreen locations for many years to come, while also launching its products in approximately 3,000 ACE Cash Express locations. The more Green Dot can distance itself from relying solely on Wal-Mart, the better.
In Green Dot's latest quarter investors observed a 50% increase in EPS to $0.36, a 210,000 unit bump in the number of cash transfers initiated from Q3 2013, and $162 million rise in gross dollar volume from the year-ago quarter.
Valued at only 11 times forward earnings and sporting a PEG ratio of just 0.7, I'm of the opinion that this is a stock you may want to consider loading up on in your portfolio.
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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