With the stock market in nearly-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 could signal a potentially cheap stock.
Here are three companies that fit the bill.
1. Harley-Davidson (NYSE:HOG)
Motorcycle giant and true symbol of Americana Harley-Davidson may not be the world's premier bike manufacturer, but it's put the depths of the Great Recession in the rearview mirror and is now splitting lanes, and analyst estimates, like the old days.
In Harley-Davidson's recently reported fourth-quarter results, the company announced a 2.8% increase in global retail sales, which was led by a 9.2% increase in international units sold, and a modest 2.9% increase in adjusted EPS. If there was one downer, it was that U.S. unit sales fell by 1.6% in Q4 from the prior year. But, looking toward 2015, Harley-Davidson is forecasting a 4%-6% increase in global motorcycle shipments to 282,000-287,000 from 2014 levels.
Why is Harley-Davidson finding its groove again? I suspect it has to do with the company proactively making its business model more flexible. This isn't to say the company wants to alienate its core customers, but it needs to address the real idea that a newer generation of buyers with different interests could soon emerge, and that various price points and engine sizes need to be offered in ex-U.S. markets.
For example, Harley-Davidson introduced the world to LiveWire last year, its first electric motorcycle prototype. The company plans to tour the U.S. and Canada with the bike in order to determine if there'd be an audience to build it for. By a similar token, Harley-Davidson also announced the move to open a factory in India to have more direct access to a rapidly growing middle and upper class in India, China, and other emerging markets in Asia. This strategy should allow Harley-Davidson to expand its top line without cheapening or softening its image.
In total, Harley Davidson is valued at 12 times Wall Street's projected 2017 EPS of $5.37 and is sporting a PEG ratio of under 1.2. Tack on a recently increased dividend, which places the company's yield at nearly 2%, and you have a cheap growth stock for all generations of investors to consider.
2. Textron (NYSE:TXT)
Typically, the aviation and defense industry aren't where I personally look for high growth since these companies can sometimes be at the mery of government spending. But, I suspect an exception can be made for Textron, a manufacturer of business jets and single-jet Cessnas, military helicopters and protection systems, and an array of auto parts.
Looking at Textron's latest quarterly results would be a possible reason to call my bullish reasoning misguided. For instance, even though Textron delivered Q4 revenue that rose 16.8% to $4.1 billion over the prior-year quarter, and EPS growth jumped 26.7% to $0.76, Textron's 2015 full-year guidance of $2.30-$2.50 missed the mark. Wall Street had been predicting that EPS would be more on the order of $2.55.
Yet, I suspect this is Textron's management merely being cautious with investors in lieu of its restructuring of Bell, its military products and helicopter division. With a lot of one-time expenses now out of the way, it's more likely that Bell will show profitability improvements and yield much easier to understand sales and profits. Additionally, it doesn't hurt that President Obama's initial budget proposal aligns with the Republican-led Congress's wishes with regard to increasing the military budget.
Another key point here is that lending rates continue to persist near record lows. Low interest rates are critical for Textron to thrive, as they make purchasing a business jet or single-engine Cessna reasonable without paying for the product in full. As long as lending rates remain near record lows, I'd suggest its aviation operations will remain strong.
Looking ahead, Textron is trading at less than 15 times Wall Street's projected 2016 EPS of $3 on the dot, and it's sporting a PEG ratio that's slightly over one. While its annual dividend yield of 0.2% is tiny, its avenues for growth make up for what it lacks in shareholder incentives.
3. Ethan Allen Interiors (NYSE:ETH)
Lastly, I'd remind investors that home is not only where the heart is; it's where big money can occasionally be made!
Ethan Allen is a large outlet for home furnishing and interior designs. It's reliant on a healthy U.S. economy and low lending rates to push its business higher. The good news is both of these things are cooperating. In the fourth quarter, U.S. GDP advanced 2.6%, and as I mentioned above, U.S. lending rates are still near record lows. This provides a nice impetus for home prices to head higher, and for homeowners to redesign or add value to their new or existing homes.
Ethan Allen did take a bit of a hit recently upon announcing its latest quarterly results, where both a 2.1% increase in sales to $197.1 million, and its adjusted EPS of $0.37 missed the mark. However, higher expenses tied to freshening up its stores' interiors, launching a new and updated website, introducing new product offerings, and investing in new technology both on the manufacturing and logistics side of the business, hampered results.
What Wall Street doesn't understand is that these costs are unlikely to last beyond 12-18 months, and they're critical to maintaining Ethan Allen's long-term growth strategy. In fact, according to Wall Street, Ethan Allen should see its EPS grow from a reported $1.45 in 2014 to $2.47 by 2018, placing the company at a mere 11 times forward estimates with double-digit EPS growth expectations beyond 2015. Finally, investors will also receive a 1.7% dividend yield just for sticking around and being patient while Ethan Allen invests in its future. This is a cheap growth stock that could also become a major boon to income investors over time.
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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