Five Solid Growth Stocks Priced Right
04/20/2010 9:09 am EST
As the global recovery gains steam, don't expect to find as many bargains. But you can still pick up reasonably priced stocks of some well-positioned companies.
Three cheers: Growth is back.
Of course, what investors want to know is where economic growth is likely to produce the biggest increases in earnings. And perhaps even more important: Where growth, actual or just hoped for, hasn't already been priced into share prices.
Not surprisingly, I think, growth has been priced into the share prices of the world's fastest-growing economies. Everyone has wanted a piece of the growth story in China or Brazil or India. Growth there isn't cheap anymore.
Growth is much more reasonably priced for stocks of companies based in the United States, Europe, Canada, and Japan. But growth has been much slower in those economies—when there's been any growth at all—and the growth stories in those economies come with huge uncertainties for the second half of 2010 and 2011.
So what's an investor to do?
I think it's important to pay attention to the macroeconomic trends. For example, I don't think investors should ever ignore the possibility that a country's central bank will raise interest rates by 2.5 percentage points, as economists are projecting for Brazil before the end of this year. And I certainly wouldn't ignore forecasts that put economic growth in the euro zone economy at well below 2% in 2010.
It's difficult, although not impossible, to make money when the economic winds are blowing that strongly against you.
Right now, I'd recommend identifying the fastest-growing sectors in the global economy and hitching your portfolio to one of those stories. That will let you search across borders to find the cheapest way to buy into a sector's growth, as well as give you a chance to avoid some of the worst potential macroeconomic dangers.
In this post, I'm going to suggest three global sectors—well, more accurately, one sector, one industry, and one niche—where growth seems especially juicy right now and where you can still find growth that is at least reasonably priced. And I'm going to suggest five stocks that I think are especially attractive right now for their growth prospects. On Tuesday, I'm going to add one of them to my Jubak's Picks portfolio.
Different Shades of Growth
First, here's the macro background: Pretty much everything except the European Union is showing solid growth for 2010.
That isn't to say that all growth rates are the same. China grew 11.9% in the first quarter; US growth is projected at somewhere around 3%.
That's also not to say that every economy is at the same stage of the growth cycle. Growth in developing economies such as Brazil and China is so established and so fast that governments and central banks are set to pull away the punch bowl by withdrawing economic stimuli and raising interest rates. In the United States, growth is still putting down roots, so government officials and central bank leaders are only talking about reducing debt and raising interest rates sometime in the future.
We also don't know how fast individual economies will grow in the second half of 2010. Higher prices for commodities such as oil and iron ore could slow growth across the global economy. Higher interest rates in developing economies would be the equivalent of stepping not-so-gently on the brakes. Problems in the various national real estate sectors (ranging from housing prices that are too low in the US to prices that are too high in China) and on bank balance sheets could still throw enough sand in the gears to slow recovery, if not to stop it entirely.
But all in all, investors in 2009 and 2010 have felt much more certain about growth in developing economies such as China than they have about growth in a developed economy such as the United States. And you can see that in the current prices of Chinese and US growth stocks.|pagebreak|
So for example, the American depositary receipt of China Life Insurance (NYSE: LFC), the largest life insurance company in China, now trades on the New York Stock Exchange at a price-to-earnings ratio of 29 times earnings per share for the past 12 months. That wouldn't be so pricey except that there seems to be a good chance—at least according to some Wall Street analysts' projections—that earnings will actually dip in 2010. The ADR's forward P/E ratio (that's the ratio based on projected earnings for the year ahead) is 31. That's expensive for a stock that's not growing at all.
Other standard valuation measures also put this ADR in the expensive category. It trades at 5.3 times sales, for example, and at 4.5 times book value. (More about how to evaluate these numbers in a moment.)
And there is an additional risk that isn't captured by these valuation measures. The company's net income has been extremely volatile in recent years. For example, it climbed 95% in 2007 as the stock market rallied and China's Life's portfolio went along for the ride. Net income fell by 45% in 2008 as stock prices tumbled. China Life was one of the biggest investors in the $1.1 billion initial public offering of Sinopharm and the $700 million IPO of construction materials producer BBMG. That has increased the company's leverage to stock prices again just as the government is making noises about the need to prevent asset bubbles.
Now compare growth and valuations at Intel (Nasdaq: INTC), based in the US: Intel has traded at a P/E multiple of about 20.4 for the past four quarters. Wall Street is projecting earnings growth for Intel of 69% in 2010. That sends the forward P/E ratio to a low 12.9.
Those other valuation measures? The price-to-sales ratio for Intel is 3.8 (compared with 5.3 at China Life) and the price-to-book ratio is 3.0 (compared with 4.5 for China Life). Those ratios certainly don't make Intel a value stock. (A value investor would be looking for price-to-sales nearer to 1.0 and price-to-book below 1.0.)
But these measures are reasonable compared with Intel's own ten-year history and compared with the current market average. Intel's average price-to-sales ratio has been 3.4 over the last five years, and the average price-to-book ratio for Standard & Poor's 500 Index stocks is currently 3.7.
It's not that there's no danger in owning Intel. Growth stocks can always disappoint. It's just that the danger of a disappointment is greatest when a growth stock is most expensive. Given Intel's current valuation and the earnings momentum in the first quarter financial report that the company released April 13, I'd say the shares won't reach a serious danger zone until 2011. Wall Street analysts are projecting earnings growth of just 8% for 2011. I think they're likely to turn out to be wrong. But the danger is still there.
So if we don't go looking for growth in what have been the world's fastest-growing economies in the past year or so, where do we look for growth?|pagebreak|
The Inside Scoop on Intel
I think Intel's first quarter earnings are a useful guide. The numbers were great: The company beat Wall Street projections by five cents a share and raised its outlook for the rest of 2010 on a forecast that its gross margin would climb to 62% to 64%. (The company earlier had projected a range of 58% to 64%.)
But for the clues we need, you'll have to look beyond the "what" of the numbers to the "why."
In Intel's case, we see a classic example of what happens to a company's revenue and profit when customers who have been out of the market—in this case, because of fear and smaller budgets as a result of the global economic slowdown—return to resume their normal rate of buying, and then some.
First, Intel is the beneficiary of a return to normal buying by PC customers. Corporate customers had been out of the market ostensibly since January 2007 as a result of disappointment with Microsoft's (Nasdaq: MSFT) Windows Vista operating system. An estimated 80% of corporate customers running Microsoft operating systems simply never upgraded to Vista, and they slowed their purchases of hardware as well. The Great Recession simply put the cherry on top of the collapse in PC growth.
But the end of the recession and the introduction of Microsoft's Windows 7 have resulted in a return to growth. PC sales climbed 5% in 2009 and soared 27% in the first quarter of 2010 from the first quarter of 2009, according to market researcher Gartner.
That would be enough to produce good growth for Intel. But Intel isn't seeing just good growth. It's seeing great growth, and that's a result of what happened in the server segment during the Great Recession. (A standard definition of a server is a computer, more powerful than a PC, which provides services across a network to a number of individual users.) With the economic recovery, companies discovered that growth in Internet traffic required them to buy new servers—and that the increased energy efficiency of new server products and their reduced heat production made replacing old servers an economic no-brainer. A new server, thanks to those improvements, would turn an investment profit in two years or less.
So suddenly Intel—and other chipmakers and server manufacturers—saw an explosion in server demand not just from catch-up orders, but also from a massive wave of replacement buying created by product improvements. Because server chips carry a higher margin than PC chips, Intel saw its profit margin explode along with sales. (For more on the server market, see this April 19 post.)
That's the growth model I'm looking for right now: A solid growth base produced by catch-up buying from customers who put off purchases during the Great Recession. And add in a rocket booster from product improvements that are spurring replacement sales or that have significantly expanded the market.
Getting the Growing
Where to start? Intel would be a good buy. Except that I already own it in Jubak's Picks. Purchased on January 15, the stock was up 16% as of April 15. I recently raised my target price to $30.40 a share, so it's not too late for you to buy the stock.
But you can find an additional way to grab a piece of this growth story if you head upstream to Intel's suppliers. ASML (Nasdaq: ASML) is the world's largest maker of lithography equipment, the machines that etch more and more circuits onto tinier and tinier chips. The company returned to profitability in the third quarter of 2009, and on April 14, reported first quarter earnings of 25 cents a share. What gave the company's report an Intel-like flavor was a projection that said the company was on track to beat its annual sales record, set in 2007.
And fortunately, ASML is a Dutch company. (It trades in the United States as an ADR.) That means it hasn't run away from us like it might have if it were a Chinese or Brazilian or South Korean company. The stock trades at just 15.8 times projected 2010 earnings per share. Analysts are expecting earnings to grow this year to $2.21 per share from a loss of 50 cents a share in 2009. For 2011, earnings growth is now projected to slow to 17.2%. I think that Wall Street estimate is low, but even so, investors are paying a multiple of 15.8 for 17.2% growth in 2011.
By the way, the stock actually sold off modestly in the days after its earnings report. I'm adding this one to Jubak's Picks today, and I'll also have a more detailed post about this buy.
Where else can you find this kind of Intel-like growth? How about among truck manufacturers?
Sales of Class 8 trucks—big rigs—fell well below the long-term replacement rate during the Great Recession. The result is that the age of the US fleet is now at a two-decade high. That's a classic replacement-drives-demand story. Orders have started to turn up, so the industry looks like it's seen bottom.
But there's an equivalent to the Intel server story in trucks, too. While customers were sitting on the sidelines, truck makers and their suppliers, especially among the engine makers, were turning out new products that use less fuel and produce lower emissions. That's not a minor point when the Environmental Protection Agency (EPA) is putting in tighter emissions standards. My favorites in this industry are truck maker Paccar (Nasdaq: PCAR), engine maker Cummins (NYSE: CMI), and emissions filtration company Donaldson (NYSE: DCI). I'll be adding one of these to Jubak's Picks later this week.
My last suggestion for where to look for growth is actually more a niche than an industry. Stanley Works acquired Black & Decker in March to form Stanley Black & Decker (NYSE: SWK). The merger gives the combined company a huge share of the market for construction and do-it-yourself tools just as the construction sector is starting to crawl off the bottom. (Industrial tools make up the second biggest business unit at the combined company. That's not a bad business to be in when manufacturing is in turnaround.)
Standard & Poor's projects that Stanley Black & Decker's organic sales growth (that's sales growth that isn't a result of the acquisition) will climb 5% in 2010 and 16% in 2011. The company is scheduled to report earnings April 27. I'll take another look at the company after that report.
At the time of publication, Jim Jubak owned shares of the following company mentioned in this column: Microsoft.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.