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
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 P/Es, 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 P/E
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
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
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
A Detailed Look at the Top 10 Growth List by the
|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.
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. (
): Beta .32 Below-Market
AutoZone 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 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
The consensus of 22 analysts reporting to Standard & Poor's
Capital IQ, expect AutoZone to grow earnings at 14.8% per annum
over the next five years.
Catamaran Corp (
): Beta .54 Below-Market
Remarkably, even though Catamaran Corp has produced a powerful
record of earnings growth averaging over 40% per annum, the
company's beta is only .54. Catamaran Corp did experience a drop
in earnings during the great recession; however, the company did
remain highly profitable. Furthermore, post recession earnings
growth has been nothing short of spectacular as it accelerated to
over 60% per annum growth since fiscal 2009. Nevertheless, the
company's current P/E ratio at 42.3 is in alignment with their
historical earnings growth.
Since going public at the end of June 2006, Catamaran
shareholders have enjoyed an annualized rate of return of 52.2%,
which correlates to the company's earnings growth rate enhanced
by modest undervaluation existing when the company first went
The consensus of 22 analysts reporting to Standard & Poor's
Capital IQ forecast Catamaran to grow earnings at 25% per annum
over the next five years. Consequently, even though the company
is reasonably priced based on its historical earnings growth, it
would appear to be moderately overvalued based on expected future
growth. However, due to the power of compounding, the 25% per
annum future growth rate would still offer prospective investors
a strong annualized rate of return.
On the other hand, over the shorter run, there is the risk of a
temporary price drop. Even if that were to occur, if you apply a
growth rate multiple of 25 to the consensus $1.86 for fiscal 2013
earnings per share, you would get a fair value of $46.50. This is
only moderately below the company's current quotation. My point
being that fair valuation can be more generously thought of when
dealing with very fast-growing companies.
Cognizant Tech (
): Beta 1.12 Moderately Above-Market Neutral
Cognizant Technology Solutions has one of the most consistent
long-term records of earnings growth of any company you would
ever find. Moreover, the company has no debt and appears to be
significantly undervalued based on its long-term historical
record of earnings growth.
Thanks to operating earnings growth exceeding 38% per annum,
long-term shareholders in Cognizant have been rewarded with an
annualized rate of return of 31.5%. It's important to recognize
that this long-term rate of return has little or nothing to do
with either the return of the stock market during this time, nor
the economic growth of the United States and/or the rest of the
world. Perhaps this is a clue as to why
and others encourage us to ignore political and economic
Since the F.A.S.T. Graphs? research tool is a dynamic tool, I
thought it would be revealing to look at Cognizant since calendar
year 2008 (the great recession). Earnings growth, although still
significantly above-average, has slowed to just over 22% per
annum. This explains why the company appears so undervalued when
looked at on the earnings and price correlated graph going back
to 1999. Based on more recent history, Cognizant still appears to
be undervalued, but nowhere near as much as it does on the
To further illustrate, and perhaps more greatly appreciate the
power of earnings growth, shareholder returns since the beginning
of calendar year 2008 for Cognizant have still been superior to
the overall market.
The consensus of 13 analysts reporting to Standard & Poor's
Capital IQ forecast Cognizant to grow earnings at 18% per annum.
Although I consider this forecast to be conservative, it
nevertheless justifies today's current valuation.
Express Scripts Holding Co. (
): Beta 1.05 Market Neutral
Express Scripts Holding Co., among other things, is a pharmacy
benefit management company, with a long record of above-average
earnings growth exceeding 30% per annum. The drop in earnings for
fiscal 2012 is attributed to a one-time $0.67 nonrecurring
charge. Excluding the one-time charge, operating earnings growth
would have been approximately 12%. Also, operating cash flow was
very strong in fiscal 2012.
Express Scripts Holdings Co represents another example of a
company with powerful growth that produced returns for
shareholders that far exceeded either economic growth and/or the
returns on the average stock as represented by the S&P 500.
In other words, the level of the stock market has had little to
nothing to do with investing in Express Scripts Holding Company.
The consensus of 23 analysts reporting to Standard & Poor's
Capital IQ forecast Express Scripts' five-year earnings growth
rate at 15% per annum. However, based on their historical record
and the powerful demographics underpinning their core businesses,
I believe these estimates could prove to be very conservative.
However, if they were proven to be true, then this company would
be moderately overvalued today. On the other hand, thanks to the
power of compounding long-term potential returns could still be
substantial. Once again, it may prove beneficial to be somewhat
liberal with valuation on a company with significantly
above-average prospects for growth.
Fossil Inc. (
): Beta 1.81 High
Fossil Inc. has generated a very strong long-term record of
earnings growth averaging 18.9% per annum. However, due to the
nature of their business, an occasional cyclicality with their
earnings does manifest. On the other hand, there are some very
interesting lessons in valuation that I believe this company's
price history reflects. You can see a strong negative reaction
during the great recession which caused the price to drop
significantly below its earnings justified valuation (the orange
line). However, we also see how it quickly recovered.
But perhaps the most interesting aspects of their price history
are the large spikes of overvaluation that occurred in 2011 and
2012. In both cases, price quickly reverted back to earnings
justified levels, providing clear evidence of market inefficiency
on both occasions.
However, in spite of some pretty scary bouts of price volatility,
long-term shareholders in Fossil Inc. were rewarded in almost
perfect correlation with the company's long-term record of
earnings growth. Another piece of evidence that earnings
determine market price in the long run.
The consensus estimates of 14 analysts reporting to Standard
& Poor's Capital IQ expect more of the same for Fossil Inc.
with a five-year estimated earnings growth rate estimated at
17.5% per annum. This number is consistent with the company's
historical results, and justifies today's current valuation, if
proven to be true.
Hibbett Sports Inc. (
): Beta 1.06 Market Neutral
Hibbett Sports Inc. represents a quintessential example of a
long-term earnings and price relationship. Monthly closing stock
prices (the black line on the graph), have clearly tracked the
company's earnings growth over time. During the few cases where
the price disconnected either above or below the earnings
justified valuation (the orange line), it quickly moves back into
Once again, we see that operating earnings growth and shareholder
returns are highly correlated. But as we've also seen with our
other examples, there is very little correlation between Hibbett
Sports Inc. shareholder returns relative to the overall market
returns, as represented by the S&P 500, over the same
The consensus of 13 analysts reporting to Standard & Poor's
Capital IQ forecast Hibbett Sports to grow at 16% per annum.
Consequently, the stock appears to be moderately overpriced on
that basis. However, due to the high rate of expected growth,
Hibbett Sports would still be a good investment at these levels.
On the other hand, it might be prudent to wait for a better entry
Laboratory CP of America (
): Beta .62 Low
Laboratory Corp of America is currently trading at a below-market
P/E ratio, yet it possesses above-market historical earnings
growth averaging over 19% per annum. However, if I were to
present a six-year graph as I did with CTSH above, LH would
appear fairly valued.
In spite of Laboratory Corp's current low valuation, long-term
shareholders were richly rewarded with a total annual return of
25.9% versus 3.1% for the S&P 500. Once again, we see the
power of above-average earnings growth generating significantly
Laborabory Corp of America is the only example in this group with
forecast earnigns growth below 15% per annum (AZO is forecast at
14.8% rounded to 15%). However, I do believe that these estimates
could be consertative.
LKQ Corp (
): Beta .86 Neutral to Low
LKQ Corp represents a quiessental example of what I look for in a
growth stock. Notice how earnings continued to advance prior to,
during and after the great recession. Also, notice how over the
long-term stock price has tracked the company's long-term
As a result of LKQ Corp's consistent and strong record of
earnings growth, long-term shareholders were rewarded orders of
magnitude better than shareholders in a passive index fund would
have been. This is a classic example of how a powerful,
fast-growing, non-dividend paying stock will greatly outperform
even the best dividend growth stock and the general market at
The consensus of 12 analysts reporting to Standard & Poor's
Capital IQ forecast LKQ to grow earnings at 20% per annum over
the next five years. Consequently, the shares appear moderately
overvalued based on current forecasts. However, considering their
impeccable long-term record, the consensus forecast may prove
Middleby Corp (
): Beta 1.64 High
Middleby Corp has produced a solid record of historical earnings
growth averaging over 31% per annum since 1999. Although the
company did have a modest hiccup during the great recession,
earnings recovery since has been back on its normal track.
Long-term shareholders in Middleby Corp were rewarded with an
annualized rate of return that highly correlated to the company's
long-term record of earnings growth. Once again we see an example
of a fast-growing business rewarding shareholders far in excess
of economic growth or stock market averages.
The consensus of 7 analysts reporting to Standard & Poor's
Capital IQ forecast Middleby to grow earnings in excess of 19%
over the next five years. Consequently, Middleby shares appear
within the fair value corridor defined by the five orange lines
on the graph.
) Beta 1.28 Moderately High
The long-term earrings and price correlated graph on Priceline
provides an interesting insight into the dangers of investing too
early in a hyped IPO. As you should see from the monthly closing
stock price line (the black line on the graph) Priceline's price
spiked initially after their IPO release before collapsing over
the next year and a half back to its earnings justified level.
This further validates my belief in waiting nine months to a year
or more before investing in a hot IPO no matter how much I
believe in the company's long-term future.
Here is a classic example of how overpaying for even the best of
companies can destroy potential returns. Even though Priceline
grew earnings in excess of 63% per annum, the massive
overvaluation during the initial IPO reduced returns to mere
This next graph reviews Priceline after its initial overvalaution
moved into better alignment with the company's operating
potential. The operating earnings growth rate on this company
remained the same as we saw with the 15-year graph; however, as
we will soon see, the effect of better valuation on long-term
returns is extrodinary.
By simply waiting for Priceline shares to move into better
alignment with the company's earnings potential, long-term
shareholder returns went from average to extraordinary. However,
it should also be interesting to note that Priceline did not
generate any real earnings until 2002. Consequently, even in
calendar years 2001 and 2002, Priceline was actually overvalued,
however, due to the incredible power of compounding, long-term
shareholders would have achieved an annualized return of 44.8%
The consensus of 28 analysts reporting to Standard & Poor's
Capital IQ forecast Priceline to grow earnings at 20% per annum
over the next five years. Consequently, Priceline appears
reasonably valued at today's levels.
Summary and Conclusions
When reviewing very fast-growing companies, the rules of fair
valuation still apply. However, due to the power of compounding,
very fast-growing businesses will generate significantly higher
levels of future earnings than slower-growth businesses. As a
consequence, investors can actually pay slightly more than
earnings justify for a very fast-growing company and still
generate an attractive long-term rate of return. The reason this
is important, is because it is difficult to find very
fast-growing companies that can be bought at the strictest
definitions of fair value.
It should also be pointed out that as companies get bigger; their
earnings growth rates are likely to slow down a bit. Therefore,
the reader should have noticed that most forecasts for this group
of stocks were lower than the company's historical achievements.
Future purchases should be based with a greater emphasis placed
on the future than on the past. However, I believe a lot of
credit should be given to a company with a long history of
above-average earnings growth. Therefore, I believe there is room
for high-quality fast-growing companies to be included in
portfolios designed to fund retirement during the accumulation
Nevertheless, there are limits to how much overvaluation a
prudent prospective investor should be willing to take. Of the 10
sample companies reviewed in this article, three or four of them
could be, under the strictest definitions of fair value,
considered moderately overvalued. However, none of the samples in
this article are what I would consider dangerously overvalued.
However, this does present a dilemma of sorts. Do you take the
risk of waiting for a better valuation to manifest, only to be
left out of the upside? Or do you go ahead and purchase them now,
with a commitment to buy more if the price does happen to fall
I believe these are questions that only each individual investor
can answer for themselves. On the other hand, I believe that very
fast growth is a rare and precious attribute, and therefore,
worthy of some moderate overvaluation. But again, there are
limits. In the next and final part three of this series on growth
stocks, I will present examples where I believe dangerous
overvaluation is manifest. In honor of my Mother, after all, last
Sunday was Mother's Day, I always try to honor her rule of not
saying anything if I can't say something nice. However, since I
am so adamantly averse to overvaluation, I feel it is my
responsibility to provide insight into its dangers to my readers.
Disclosure: Long CTSH, ESRX and LKQ at the time of writing.
The opinions in this document are for informational and
educational purposes only and should not be construed as a
recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies
discussed may not continue and the companies may not achieve the
earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a
person act upon the information contained within. We do not
recommend that anyone act upon any investment information without
first consulting an investment advisor as to the suitability of
such investments for his specific situation.
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