With the stock market in nearly nonstop rally mode over the past five years, investors haven't needed to look far to uncover an abundance of growth stocks. But not all growth stocks are created equal. While some could still deliver extraordinary gains, others appear considerably overvalued and might instead burden investors with hefty losses.
What exactly is a growth stock? Though it's arbitrary, I'll define a growth stock as any company forecast to grow profits by 10% or more annually over the next five years. To decide what's "cheap," I'll use 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 cheap stock.
Here are three companies that fit the bill.
1. Ford (NYSE:F)
If you were to base your opinion on America's No. 2 automaker, Ford, on its February sales report and the fact that it lowered its profit expectations in 2014 by $1 billion to $2 billion, you'd probably drive away pretty disappointed.
According to Ford's February sales report, released two weeks ago, Ford's unit sales fell 1.7% as sales of the Edge, Taurus, Focus, and Fiesta, which had recently carried Ford, all fell by double-digit percentages. This might be viewed as a sign of weakness, but it's actually fantastic news for Ford, as its higher margin vehicles are picking up the slack, possibly due to the drop in fuel prices.
Based on the report, F-150 sales (the F-Series pickup has been the best-selling vehicle in the U.S. for more than three decades) rose by 7% and are being fueled by its recent remodel, which includes an all-new aluminum body designed to lighten the vehicle by 700 pounds, which can, of course, be compensated for by other add-ons, such as a beefed-up tow package. Ford notes its new F-150 is moving off dealer lots four times faster than the comparable truck from its competitors.
Beyond just the F-150, Ford has a lot of other factors working in its favor. Ford has been growing at a lightning quick pace in China thanks to its pledge to introduce 15 new vehicles between 2013 and 2015. At the pace the company is on now, it could claim 10% market share in China by the end of the decade.
Also, Ford has done a good job of focusing on the consumer. Its EcoBoost offerings have increased fuel-efficiency without sacrificing power, while new gadgets in the cabin of the vehicle have boosted driver convenience and added to the luxury factor, even in its smaller car lineup. By focusing on fuel-efficiency and technology Ford has made it readily apparent that it's trying to wrangle in millennials for the long haul.
Finally, Ford has a storied history in American culture. It can transcend generations from grandfathers to grandchildren, and is thus likely to keep its cultural feel for some time to come.
Clocking in with a forward P/E of less than nine, a minuscule PEG ratio of 0.6, and a dividend yield near 4%, this is a cheap growth stock for investors of all risk levels to consider.
2. SJW Corp (NYSE:SJW)
Second up this week is water utility and wastewater operator SJW.
You might consider water utilities to be the unsung heroes of the utility business, as investors tend to focus on electric utilities. SJW is certainly a company that tends to "flow" under the radar of most investors because of its size (it's a small-cap stock) and its relatively small customer based of around 230,000. But, as the saying goes, "good things do come in small packages."
One reason SJW could make for an intriguing investment is that it supplies a basic-need good. If you own a home you need water. From our showers and washing machines to the water we drink, water is a vital component of our existence. Because water is a basic-need good, water utilities are typically able to command strong pricing power for their product. Understandably, most water markets are regulated which can cap water utilities' profit potential, but on the flipside a regulated business also makes for predictable cash flow, which Wall Street loves.
SJW's two primary methods of growth are rate increases on existing customers and prudent acquisitions. In fiscal 2014, for instance, SJW managed to generate $20.2 million from new rate increases and slashed $3.2 million off of its administrative expenses. While operating in California does offer its own unique challenges -- a multi-year drought has consumers using less water, resulting in higher expenses and lower-than-expected revenue -- weather patterns tend to normalize over time, meaning SJW has a good chance of rebounding and living up to the 14% per annum EPS growth that Wall Street is projecting over the next five years.
Boasting a dividend yield of 2.4% and a PEG ratio that's just below one, I'd suggest risk-averse investors looking for cheap growth stocks spend some time investigating SJW.
3. Logitech (NASDAQ:LOGI)
We'll end the week by peeking our nose into the technology sector and uncovering a hidden growth company in Logitech.
Logitech is an interesting business as it's in the midst of a long-term transition from static hardware and software products such as keyboards, computer mice, PC speakers and other wearables toward next-generation growth categories. These entail products such as mobile speakers, tablet accessories, and PC gaming bundles.
If you examine Logitech's most recent quarterly report you'll note that growth wasn't off-the-charts exciting, and this has been a theme with Logitech in recent quarters. As competition among static devices gets more heated and prices become more challenged, sales of Logitech's non-growth segment stagnate. At the moment, sales of keyboards, desktop devices, pointing devices, and so on, account for the majority of Logitech's sales -- and they tend to grow by just 1%-2% per year.
Where Logitech becomes intriguing for growth investors is the company's fast-moving growth segment, which could become its largest revenue contributor closer to the end of the decade, coupled with its recent dividend announcement and cost-cutting efforts.
In its latest quarter, PC gaming product sales rose by 21% to $70.2 million, while mobile speakers sales skyrocketed by 82%. Overall, its growth segment delivered a 16% revenue increase through the first three quarters of fiscal 2015, and it was the primary reason Logitech boosted its forecast for the remainder of the year. As I noted above, the company's non-GAAP operating expenses also fell from $464.5 million to $444.6 million through the first nine months of its fiscal year compared to last year, implying that management is doing an admirable job of controlling its costs.
As icing on the cake, Logitech announced just last week that it planned to return $500 million to shareholders over a three-year period, including $250 million devoted to dividends and another $250 million for share buybacks, which only further enhance EPS growth.
With a growing dividend and a PEG ratio below one, Logitech could be an under-the-radar growth play in the technology sector.
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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