It’s easy to find growth stocks in today’s stock market. What’s much harder is identifying cheap growth stocks at a time when equities are trading at historically high valuations.
After spending over 25 years picking stocks on Wall Street, Thomas Lott says that cheap growth stocks are generally the best names to buy. He calls these types of stocks “value compounders.” More specifically, Lott, who reports that his picks have returned an annual average of just under 25%, looks to buy the stocks of companies that:
“1) generate high returns on equity, 2) trade at cheap valuations on a free cash flow basis, 3) grow earnings on a per share basis faster than the market, and 4) tend to beat earnings expectations.”
Given Lott’s excellent track record, his approach of finding cheap growth stocks is worth emulating.
My own list of three top cheap growth stocks consists of:
The latter name is one of Lott’s picks as well.
Cheap Growth Stocks: Mastercard (MA)
Mainly, I believe due to increased worries about tough competition, the electronic payment space’s stocks have tumbled over the last several months. For example, after peaking just short of $400 at the end of July, MA stock has sunk nearly 20%.
But there’s enough room to have many winners in the gigantic payments market, which PayPal (NASDAQ:PYPL) CEO Dan Schulman recently estimated to be worth about $100 trillion. Moreover, spurred by the e-commerce boom and the continued transition out of cash and checks, the market should keep growing rapidly. And with its very powerful brand and array of popular credit cards, MasterCard is well-positioned to be a winner in the category.
There have recently been worries about the impact of the new buy now, pay later (BNPL) companies on Affirm (NASDAQ:AFRM). But as I stated in my recent column on Affirm, I believe that “it should be very easy for any sizeable fintech or credit card company to launch the service.” And, indeed, it turns out that Mastercard has already done so.
Mastercard’s trailing return on equity is a huge 127%, versus the S&P 500’s long-term level of 14%, while its free cash flow yield is 2.4%. The trailing free cash flow yield for the S&P as of August was 1.9%.
In 2022, analysts on average expect the company’s earnings per share (EPS) to climb 27%. During the current quarter, the index’s EPS is anticipated to increase 21.7%.
This retail and cloud behemoth really needs no introduction. And over the long-term, this juggernaut should continue to get big boosts from the continued, growing popularity of both e-commerce and the cloud.
What’s more, as I’ve stated in previous columns, I expect the company’s new CEO, Andy Jassy, to be very successful, given the great job he did as the head of Amazon Web Services (AWS), the company’s cloud unit. During his tenure, AWS became the world’s leading cloud company.
Additionally, I believe that Jassy is likely to be “hungrier” in pursuing new initiatives than his predecessor, Jeff Bezos was, over the last five years or so. That’s because by 2016, Bezos had already “made it” from a financial and reputational perspective, while Jassy just started this year as Amazon’s CEO.
Amazon’s trailing return on equity is 25.8%, and its free cash flow yield (based on operating free cash flow) is 3%. The conglomerate’s EPS is expected to surge 26% next year. Although its third-quarter EPS came in slightly below analysts’ average estimate, it did however, beat the mean outlooks by large amounts in the three quarters before that.
Cheap Growth Stocks: Quanta Services (PWR)
Quanta Services is a Houston-based infrastructure company that largely services electric generation. The company’s Electric Power Infrastructure unit develops various electric facilities. Quanta’s sales rose slightly over 10% year over year in Q3, while its EPS climbed around 7% YOY.
Still, the company is very well-positioned to benefit meaningfully from the electrification of transportation and the increased use of renewable energy. Both of those developments are likely to require upgrades of many power plants and electrical equipment around the world.
Also likely to boost PWR stock are the infrastructure law and the Democrats’ spending bill. The former piece of legislation appropriates a great deal of money for electrical equipment upgrades, including EV chargers.
Lott endorsed PWR stock, indicating that its valuation is attractive and that it’s poised to do very well over the longer term.
On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Larry Ramer has conducted research and written articles on U.S. stocks for 14 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.