This is part two of a series on investing for growth, part one can be found here.
One of my primary objectives for preparing this series is to dispel some of the common myths that many investors hold regarding investing for growth. For example, many believe that growth stocks are, by definition, riskier than dividend paying stocks. Although there is some truth to this, I believe this concept is overblown.
One commonly measured metric for measuring risk is beta. At its core, beta is a measure of volatility which is also referred to as systematic risk. More simply stated, it is a measurement designed to reflect whether or not a given stock is more volatile than the general market. A baseline beta of one reflects the market. Therefore, a stock with a beta less than one indicates that it is less volatile than the market, and a stock with a beta greater than one would indicate that it is more volatile than the market.
More volatility is assumed to be synonymous with more risk, and many investors are led to believe that growth stocks have higher betas than dividend paying stocks. In truth, there are many growth stocks that have betas lower than the general market, and conversely, some that have betas higher than the general market. I will list the betas of each of the 10 examples that I will be presenting in this article next to their title. The results may surprise many readers.
There is another myth, or at least a great over-generalization, that dividend paying stocks outperform non-dividend paying stocks. Once again, the true answer is that it really depends on the individual stocks. Some non-dividend companies (stocks) are really terrible businesses, which is why they don’t pay dividends in the first place.
On the other hand, there are many true growth stocks that don’t pay a dividend but are excellent businesses, and therefore, excellent investments as well. I will be reviewing 10 excellent true growth non-dividend paying stocks in this article. To put it bluntly, a true growth stock will generally create a significantly higher total return than most dividend paying stocks, even if dividends are reinvested. Of course, the true growth stock has to be purchased at a reasonable valuation for this to happen. However, it is quite common that true growth stocks will be priced far above their earnings justified valuations by the market. Therefore, investors need to be careful to avoid the hype and focus on true value instead.
This leads me to a few words about another myth relating to growth stocks. Many investors believe that high-growth stocks simultaneously carry high PEs, and again, higher risk. This particular myth does have some truth based on the fact that companies that are growing at rates that are much faster than the market, are logically worth more than the average company due to the power of compounding. This is why I believe that the PE equal to the growth rate formula for valuing growth stocks (companies with above 15% earnings growth) is an appropriate gauge for fair value.
Consequently, a P/E ratio that is equal to the company’s earnings growth rate would indicate fair value, even though it may be higher than the market multiple. This higher valuation is due to the fact that companies that are growing earnings at rates that are multiples of the rates that the general market is growing at will generate significantly more future earnings than the average company, again, thanks to the power of compounding. Therefore, in the long run, wise investors who are investing in these high-growth stocks are often buying future earnings much cheaper than the future earnings of average companies with lower entry-level PEs.
This article will review 10 established above-average growing businesses that I believe are also fairly valued today, or very close to becoming fairly valued, if there were any correction in the market at all. None of these stocks pay dividends, however, they all have achieved significantly above-average historical growth, and most importantly, they are all expected to produce significantly above-average future growth, at least over the next five years. Consequently, investors interested in earning above-average long-term returns might want to dig deeper into these selections.
10 Fairly Valued High-Growth Stocks
In order to make my top 10 list of high-growth stocks, each candidate had to meet several logical criteria. First and foremost, I searched for companies with historical earnings growth rates that were exceeding 15% to 20% per annum. In addition to the velocity of the company’s earnings growth, I also looked for a high degree of consistency, and the ability to continue growing regardless of the economic environment, including during recessions. I was willing to accept some minor weakness during recessionary times, but not complete earnings collapses.
The following portfolio review lists my top 10 fairly valued growth stocks listed in alphabetical order. Although each of these selections appears to be an attractive long-term investment capable of generating above-average returns, a few of these examples are fully valued to moderately overvalued currently. On the other hand, based on the possibility that current estimates may also be conservative, I included them in my top 10 list. In other words, I would either be looking for a minor pullback or for their high earnings growth to exceed current estimates, and therefore, justify current valuation. More simply stated, I think these are all candidates worth looking further into.
A Detailed Look At The Top 10 Growth List By The Numbers
As usual I will rely on F.A.S.T. Graphs™, the fundamentals analyzer software tool, to provide “essential fundamentals at a glance” on each of my top 10 selections. Please keep in mind that each of these selections are offered as candidates for a more comprehensive research and due diligence process. However, I will provide brief commentary on each, based solely on what their respective F.A.S.T. Graph™ reveals. Also, as I previously stated, I have presented the beta on each selection along with their introduction (all beta figures taken from Google Finance).
AutoZone, Inc. (NYSE:AZO): Beta .32 Below-Market
AutoZone, Inc. (NYSE:AZO) has produced a very consistent record of earnings growth averaging over 21% per annum. Nevertheless, it is also a fact revealed by the earnings and price correlated graph below, that the market has historically valued this company at a discount to its earnings growth. The reader should also note that the company carries a lot of debt, but does generate substantial cash flows to mitigate this risk.
Even though AutoZone, Inc. (NYSE:AZO) has been historically priced at a discount to its earnings growth rate, its total annualized rate of return of 19.4% per annum closely correlates to its earnings growth. Consequently, this business, with its powerful record of consistent growth, has substantially outperformed the S&P 500.
The consensus of 22 analysts reporting to Standard & Poor’s Capital IQ, expect AutoZone to grow earnings