Investing in popular growth companies is always tricky
business, but lately, it's been downright heartbreaking. Green
Mountain Coffee Roasters (
), which tripled its share price in the first part of 2011, lost
most of those gains in the months since. Netflix (
) went from $225 a share to about $63 in the past year, and once
brag-worthy MAKO Surgical (
) fell from $39 to $17 in a matter of weeks. Oh sure, Whole Foods
) continued to march upward, but a couple of investments in those
doomed social media IPOs like Facebook (
) or Groupon (
) could make one quickly forget about that nice story.
Same goes for a recent investment in First Solar (
), Juniper Networks (
) or Fossil (
). They too, grew great returns before falling hard.
For investors who want in on the growth game but prefer less
melodrama in their portfolios, YCharts suggests creating another
genre: sane growth. In our estimation, a sane growth portfolio
would be packed with companies that manage decent sales gains but
maintain a few safety valves typically missing in popular growth
stocks: like reasonable share price valuations and earnings
commensurate with revenues. In fact, right now looks like an
especially good time to invest in sanity over popularity.
Picking a winner among popular growth stocks is particularly
difficult now. Joblessness and underwater mortgages in the U.S.;
an economic slowdown in China; and a currency crisis in Europe -
all those issues make sustaining high growth a tall order for any
company. It also makes accurately valuing high growth companies
quite iffy, as anyone involved in those overpriced social media
IPOs can attest. But none of these difficulties has made growth
stocks much cheaper. Overall, share valuations remain relatively
S&P 500 PE10
Now, as always, companies experiencing high revenue growth
trade at far higher valuations than the rest of the market. Those
losers above fell for a wide variety of reasons, but they all had
one thing in common before their crises: high share valuations.
The social media IPOs of recent years managed price to sales
ratios at times well into double digits. Others were trading
between 3 and 20 times sales before their big falls. By contrast,
) price to sales ratio has never, ever, been above about 6.5.
GMCR Price / Sales Ratio
Valuations like that, particularly when paired with high
price-earnings valuations, predict what one would happily call
insane growth. The price is justified and investors get quite
rich if revenue and earnings actually grow as fast as expected.
), for example, trades for an incredible 15 times sales. Today's
share price will look like a bargain if the company really
increases sales more than that amount because the share price
should run up too. If there's any sign that the company can't
achieve that goal - perhaps a missed earnings report - punishment
will be brutal. Disappointing expectations of insane growth
almost always results in big share price drops.
Companies practicing sane growth, on the other hand, usually
get a little more leeway for errors. That's because their growth
is backed by rising earnings, cash and solid fundamentals.
Demanding these backstops actually hurts growth rates - you can
ramp up sales a lot faster if you don't insist on making profits
on them - and that tends to keep their share price valuations
reasonable. But you might be surprised at how many companies
manage double-digit revenue growth with sanity.
With the mission of reducing risk, YCharts looked around for
growing companies with sane data. We set the
YCharts Stock Screener
to find companies that reported sales growth of at least 10% over
the past 12 months and at least that rate of retained earnings
growth. We insisted on an historic price to sales ratio of less
than 1.5. To weed out companies with weak balance sheets, we
looked only at companies that received at 7 or higher from
YCharts Pro for fundamentals. As an added safety, we considered
only companies with market caps of at least $2.5 billion.
Of course, no screen can take the risk out of investing. But
it can decrease the chances that an investment will turn into a
Green Mountain disaster without warning. Here and in following
articles is a sample of what we found:
Redbox operator Coinstar should be out of business by now,
since DVDs were supposed to have gone the way of 8-track tapes
long ago. Instead, the company holds a monopoly-level market
share in a business that remains stronger than anyone
Redbox machines dole out DVD and video game rentals for coins
in thousands of stores ranging from gas stations to pharmacies.
Business has been good as video stores died and budget conscious
consumers ditched their monthly Netflix DVD subscriptions in
favor of $1.20 a day Redbox rentals. Coinstar has bought up
competitors in the kiosk business. Coinstar's revenues grew some
34% in the past 12 months, and its profits have soared.
Shareholders have had a grand ride too, as the share price has
more than doubled in five years. In the first six months of 2012
alone, the price was up more than 50%, as seen in this
The inevitable death of the DVD keeps valuations on Coinstar
shares much lower than they would normally be on a company with
such fast growth. With a market cap of about $2.1 billion,
Coinstar's price to sales ratio hovers around one, and its
is about 10 after a recent decline in the stock.
CSTR Price / Sales Ratio
Investors are betting that the company will invest in some
other low-cost kiosk technology when the DVD run is done.
Coinstar already operates some 20,000 coin-counting kiosks that
take money for turning coins into bills. It signed an agreement
with Starbucks (
) in June to build thousands of coffee dispensing kiosks.
Six more articles on growth stocks will be published in coming
Companies covered in this series: Coinstar (
), VF Corp. (
), Davita (
), United Natural Foods (
), Dollar General (
), Airgas (
), and Oil States International (
Dee Gill is an editor for the
YCharts Pro Investor Service
which includes professional