In one sense, this is a market for growth stocks. For much of the last few years, growth has led the way. As I’ve written many times before, investors forced to choose between growth and valuation have been rewarded for focusing almost solely on the former. “Too expensive” has not been a good reason to sell.
But in another sense, growth stocks look awfully risky at the moment — even acknowledging that recent history. Many small-cap growth names in hot sectors like electric vehicles and cryptocurrency have doubled or better in less than three months. Tesla (NASDAQ:TSLA) was worth $35 billion less than two years ago, and now is the sixth-most valuable company in the world. Software names continue to move higher, with price-to-revenue multiples above 15x hardly meriting much notice anymore.
For investors of the GARP (growth at a reasonable price) persuasion, this is a difficult market. The problem isn’t the “growth” part, but the reasonable price qualifier. Cheap stocks in this market are often cheap for a reason, whether due to competitive factors — think IBM (NYSE:IBM) and Intel (NASDAQ:INTC) in tech — or industry conditions (as with many old-line consumer names).
In terms of finding the sweet spot for GARP investing, this is not an easy market. But there are opportunities out there: companies with reasonable valuations that still have solid, if not necessarily spectacular, growth prospects. Here are eight of those names:
- Microsoft (NASDAQ:MSFT)
- Check Point Software (NASDAQ:CHKP)
- Alibaba (NYSE:BABA)
- Fiserv (NASDAQ:FISV)
- Ericsson (NASDAQ:ERIC)
- RH (NYSE:RH)
- Microchip Technology (NASDAQ:MCHP)
- Facebook (NASDAQ:FB)
Growth Stocks for GARP Investors: Microsoft (MSFT)
This week is a big one for mega-cap stocks that have stalled out. A number of those companies are reporting earnings, including Microsoft.
Since early September, this is a market that has been mostly led by small-caps. After an impressive rally of its own, MSFT stock has since stalled out.
But after that sideways trading, the stock looks awfully attractive. This remains unquestionably one of the world’s best companies. It has helped lead the shift to the cloud and is likely to benefit from the acceleration of that shift in the post-novel-coronavirus-pandemic environment.
To be sure, MSFT stock still isn’t cheap by historical standards, at about 30x forward earnings. If the market does turn south, MSFT will follow, as seen in March 2020 and before that in December 2018.
Still, there’s more than enough here to like. And in a zero-interest rate environment, 30x earnings for a company still posting double-digit growth looks like an attractive combination. Whether or not earnings prove to be a catalyst, it’s likely the stock will break out of this range to the upside at some point.
Check Point Software (CHKP)
From a high-level perspective, CHKP stock looks absurdly, ridiculously cheap. Adjusted earnings per share grew 11% year-over-year in the first three quarters of 2020. Cybersecurity seems like it should be a strong market as millions of employees worldwide work from home. In fact, the ETFMG Prime Cyber Security ETF (NYSEARCA:HACK) has gained 39% over the past year.
Yet CHKP is lagging. The stock has a below-market forward multiple of just 18.4x. It has rallied barely 10% over the past twelve months. Neither the performance of the stock nor its valuation seem appropriate given the growth potential of the sector and the growth Check Point is already driving.
There are some risks, however. Competition is one, with cloud-native rivals like CrowdStrike (NASDAQ:CRWD) presenting a real threat. The response to the pandemic is likely pulling forward revenue, creating a tailwind to 2020 results, but leading to potential pressure this year and next.
Still, CHKP is a leader in a growing industry that trades for less than 20x 2021 earnings. That’s a profile that’s hard to find in this market. And it’s a profile that seems easily attractive enough to take on those risks.
In one of the crazier developments of a crazy market, BABA stock has rallied in the past few sessions because its co-founder made a public appearance. Jack Ma had been out of the public eye for several months, sparking speculation that he had been detained by the Chinese central government.
With the initial public offering of Alibaba affiliate Ant Financial already suspended, investors are worried that regulatory pressure is going to put a significant crimp in Alibaba’s growth.
Those worries certainly have some validity. And investing in Chinese stocks remains a higher-risk endeavor. That said, BABA stock looks ridiculously cheap. What is likely the fastest-growing large-cap company in the world trades for 21x next year’s earnings.
Meanwhile, we’ve been here before. Skeptics (and admittedly I personally have been one on occasion) have questioned the company’s accounting, pointed to its opaque corporate structure or predicted a long-awaited “hard landing” in China. Over time, Alibaba’s growth has managed to eventually offset the concerns and lead BABA stock higher.
At this point in the news cycle, it’s easy to fall back into the same trap, but over the mid to long term, it still seems likely that history repeats.
Fiserv was “fintech” before fintech was cool. The has long company provided back-end services across wide swaths of the financial services industry. The 2019 acquisition of First Data only expanded its reach.
Here, too, competition is a worry. The likes of PayPal (NASDAQ:PYPL) and Square (NYSE:SQ) can encroach on Fiserv’s turf, and a host of niche-focused rivals are attacking the market (often with newly raised capital from so-called “SPAC mergers”).
But Fiserv is so entrenched in the industry that it’s going to be difficult to dislodge. Meanwhile, the company is posting solid growth of its own. Adjusted earnings per share have risen 11% so far this year. A massive share repurchase authorization of roughly $7 billion can boost per-share growth on its own.
And Fiserv has an intriguing initiative in Clover, a point-of-sale platform that rivals Square in terms of merchant volume. With FISV stock trading at less than 20x earnings, the bad news looks priced in, but the good news does not.
I’ve been recommending ERIC stock for some time, but in recent months the call hasn’t quite played out. Going back to July, shares have been stuck in a relatively narrow range around the current price near $12.
There’s no reason to give up on the stock just yet, however. Ericsson still seems to be besting Nokia (NYSE:NOK) in 5G (fifth-generation) equipment, while China’s Huawei remains under political pressure. The market should grow for years, given that 5G deployments are only beginning worldwide.
And Ericsson remains cheap, at just over 20x 2020 earnings despite expectations for high-teens growth in 2021. The case hasn’t played out yet, but I still believe it’s likely to at some point.
Investors could reasonably argue that RH doesn’t belong on a list of growth stocks. The home furnishings retailer plays in a historically cyclical industry. Thus, its growth of late has been driven to at least some extent by the booming pre-pandemic economy, and then the desire of consumers to improve the homes in which they have spent prodigious amounts of time since March.
RH has been aggressive with financial engineering as well, using debt to fund share repurchases. Those repurchases not only accelerate EPS growth, but have served to, on occasion, “squeeze” the short interest in RH stock. That short interest has been heavy. Even at a seven-year low, 14% of shares outstanding are sold short at the moment. The figure stayed above 30% for nearly three years between 2016 and 2019.
That said, even considering those factors, RH’s ability to increase profits and profit margins has been spectacular. In fiscal 2013 (ending January 2014), RH generated adjusted earnings per share of $1.71. Adjusted EPS in 2020, according to Wall Street consensus, should clear $17. RH has become an unparalleled luxury brand within home furnishings, and there’s room for expansion in both the United States and, in 2022, the United Kingdom.
Certainly, the macroeconomic and housing cycles need to cooperate. Growth will slow at some point, and likely reverse after that if and when external tailwinds turn into headwinds. But this remains a well-run company that’s carved out a solid niche at the high end of the home furnishings industry. Over the long haul, RH likely still has quite a bit of growth yet, and at 26x forward earnings not all of that growth looks priced in.
Microchip Technology (MCHP)
MCHP stock already has seen a nice rally, gaining over 40% from late October lows. Sector optimism certainly has been a big factor: the Philadelphia Semiconductor Index has risen more than 30% over the same stretch.
But with with MCHP just off all-time highs, there’s a case for more upside ahead. Microchip has excellent market share in microcontrollers and microprocessors. Demand tailwinds like higher chip content in automobiles and the Internet of Things are just getting started.
Meanwhile, valuation is hardly onerous. MCHP trades at just 21x forward earnings. If the chip space truly is no longer the cyclical industry it once was (as seems increasingly likely), that multiple is probably too low, and Microchip stock has plenty of room to keep rallying.
Purely in terms of near-term profile, Facebook stock looks like one of the best in the market — even better than a name like CHKP. Based on Wall Street estimates, FB stock trades at less than 30x this year’s earnings. Yet those estimates suggest 45% year-over-year growth. That puts FB’s so-called PEG (price to earnings to growth) multiple below 1x, which is considered a buying signal for GARP investors.
As always, the case isn’t quite that simple. Facebook’s growth is coming off a 2019 base that was depressed by a $5 billion fine paid to the Federal Trade Commission. The multi-year earnings growth rate isn’t quite as impressive, and Wall Street expects something closer to 12% in 2021 (though the current range of estimates is quite wide).
Still, that broad case gets to the core of the argument for Facebook stock: there’s still a lot of growth left, compared to an attractive valuation. And while investors see a number of risks, it’s not clear all of those concerns actually would be negative.
An antitrust-driven breakup of Facebook might actually be good news for the stock, as it would unlock the standalone value of WhatsApp and Instagram. Regulators have made noise before, and the $5 billion fine is essentially the core penalty the company has faced so far. In the context of a $780 billion market capitalization, that fine is barely worth noticing.
As with Alibaba, the numbers look attractive, while the external risks seem less severe than they might appear at first glance. And as with Alibaba, Facebook stock seems like a potential buy.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.