Don't Overpay For Growth

5/26/2014


Mixed March-quarter results stoked fears that corporate profits have stalled. We are to here to say that most companies are growing — and it's probably enough to keep the market moving higher.

The median company in the S&P 1500 Index delivered a 5.3% year-to-year increase in per-share earnings in its most recent quarter, with sales up 5.1%. The median represents the middle figure, with an equal number of companies above and below it. Overall, 61% of companies posted higher per-share earnings and 70% grew sales.

To be sure, growth has slowed. Since 1994, S&P 1500 stocks have reported median quarterly profit growth of 9.1% and sales growth of 6.1%. Moreover, there are fewer truly strong profit growers. Among S&P 1500 stocks, 44% are expected to deliver double-digit growth in per-share earnings this year, down from 46% last year and 59% three years ago. 

Relative to historical norms, stocks of both fast and slow growers are expensive. The table below divides the S&P 1500 Index into five equal-sized groups, based on earnings and sales growth in the most recent quarter.

STOCKS ARE EXPENSIVE CONSIDERING GROWTH

Stocks of all stripes look expensive, particularly considering recent growth rates. The table divides the S&P 1500 Index into five equal-sized groups based on year-to-year median earnings and sales growth for the most recent quarter. In the top section, the median (middle) stock posted a 5.3% increase in per-share profits, below the norm of 9.1% since 1994. Yet that group has a median trailing P/E of 20.1 — a 19% premium to the norm of 16.9.

The story is similar for sales. In the bottom section, the median S&P 1500 stock posted a revenue increase of 5.1% in the most recent quarter, versus the norm of 6.1%. Those stocks trade at a median P/E of 20.6, above the norm of 17.5.

--- S&P 1500 Stocks Divided Into Quintiles (5 Equal-Sized Groups) ---
Worst
4
Middle
2
Best
EPS change last quarter (%)
(33.9)
(7.1)
5.3
16.8
41.2
Norm since 1994 (%)
(36.5)
(5.5)
9.1
21.5
44.7
P/E ratio
19.0
18.0
20.1
21.3
21.8
Norm since 1994
17.4
16.3
16.9
18.6
19.3
Premium (%)
9.0
10.3
19.2
14.4
12.8
Sales change last quarter (%)
(8.4)
0.0
5.1
10.9
22.3
Norm since 1994 (%)
(15.0)
(1.1)
6.1
13.5
28.9
P/E ratio
19.0
18.9
20.6
22.2
22.3
Norm since 1994
17.1
17.1
17.5
18.6
19.4
Premium (%)
11.2
10.3
17.2
19.1
15.2

As shown, the one-fifth of stocks with the best profit growth posted a median increase of 41.2%, below the norm of 44.7% since 1994. Yet the stocks trade at a median P/E of 21.8 — a 13% premium to the top group's historical norm of 19.3. The fastest-growing stocks grew sales 22.3%, versus the norm of 28.9%. Those stocks have a median P/E of 22.3, above the norm of 19.4.

Fortunately, investors can counter sluggish growth trends with stock selection. Quadrix helps us uncover stocks with superior growth rates and reasonable valuations. The 40 stocks on our buy lists posted 19% median per-share-profit growth last year, compared to 9% for S&P 1500 stocks. Buy list stocks are expected to report 13% growth in per-share profits in their current fiscal year, versus 9% for the broad index. Yet our stocks trade at a median P/E below 17 based on expected current-year profits, versus 18 for S&P 1500 stocks. Below we profile three standout growers.

Profit estimates for Alaska Air Group ($96; ALK) for 2014 and 2015 have moved sharply higher in recent months, reflecting solid growth in air traffic, expanded capacity, and favorable pricing. For 2014, the consensus calls for per-share earnings of $7.10, up from $6.52 three months ago and implying 32% growth. For 2015, the consensus is $7.88 per share, up 11%. The stock's Quadrix Earnings Estimates score is an impressive 91, ranking it in the top 10% of U.S.-traded stocks and above the industry average of 69.

A $650 million share-repurchase program, which represents roughly 10% of the company's market capitalization, should bolster per-share earnings. Up 62% over the past year and trading at 16 times trailing earnings, the stock is not a bargain versus its history. But shares seem capable of climbing 15% to 20% in the year ahead, fueled partly by solid cash flow and expanding profit margins. Alaska Air is a Focus List Buy.


Strong production is helping drive EOG Resources' ($102; EOG) profits higher. With core operations centered on the burgeoning Eagle Ford shale formation in southern Texas, the company targets a 29% increase in oil production in 2014, on top of 40% growth last year and 39% in 2012. The increase stems partly from improved productivity, reflecting higher recovery rates at existing wells. Meanwhile, last year's shift toward self-sourced sand — a key component in the hydraulic-fracturing process — has helped reduce operational costs and boost profit margins.

A Quadrix standout, EOG boasts an Overall score of 97 on scores of 98 for Momentum and 94 for Earnings Estimates. Consensus estimates, revised upward in the past month for both 2014 and 2015, project per-share-earnings growth of 29% to $5.31 this year. Based on potential benefits from new wells and production gains, EOG seems capable of topping the consensus. EOG is a Long-Term Buy.


Union Pacific ($194; UNP) is thriving in a cyclical industry. Despite poor weather that disrupted rail travel across the U.S. and impacted costs, March-quarter per-share profits increased 17%, reflecting higher volumes and pricing gains. The railroad's operating ratio, an efficiency measure defined as operating expense divided by revenue, was 67.1% — two percentage points better than a year earlier and a March-quarter record.

Consensus estimates, revised upward in the last month, project per-share profits will climb 16% to $10.90 in 2014. Revenue should advance 7% to $23.5 billion. For 2015, the profit consensus is $12.38 per share, up 14%. Those estimates could move even higher as analysts incorporate potential volume growth and gains in operating efficiency. The stock earns a 93 Overall score, paced by a 94 in Earnings Estimates. The company plans a 2-for-1 stock split, set for June 6. The railroad company also raised its target for 2014 capital spending by $150 million to $4.1 billion, up 17% from 2013 levels. Union Pacific is a Focus Buy and Long-Term Buy.

 

12 STRONG GROWERS
The stocks listed below are expected to deliver growth in per-share earnings and sales this year that outstrips the median company in the S&P 1500 Index. All 12 earn scores above 80 for Quadrix Quality (mostly driven by long-term growth record) and Overall. Importantly, all 12 are reasonably valued considering their growth potential, offering solid year-ahead upside potential. The stocks below are recommended for immediate purchase.
------- Estimated Current-Year -------
-------- Estimated Next-Year --------
3-Year Ann.
--- Growth ---
-- Quadrix Scores --
Company (Price; Ticker)
EPS
($)
EPS
Growth
(%)
Sales
Growth
(%)
Est. P/E
Ratio
EPS
($)
EPS
Growth
(%)
Sales
Growth
(%)
Est. P/E
Ratio
EPS
(%)
Sales
(%)
Quality
Overall
Alaska Air Group
($96; ALK)
7.10
32
8
13
7.88
11
6
12
15
9
96
99
B/E Aerospace
($95; BEAV)
4.39
24
18
22
5.17
18
11
18
30
21
95
82
Continental Resources
($135; CLR)
6.96
31
33
19
8.32
20
19
16
43
60
99
95
Cognizant Technology
($47; CTSH)
2.47
22
17
19
2.86
16
16
17
20
24
98
93
EOG Resources
($102; EOG)
5.31
29
18
19
5.86
10
8
17
92
34
82
97
Helmerich & Payne
($105; HP)
6.31
12
9
17
7.09
12
10
15
26
22
91
96
Packaging Corp.
($67; PKG)
4.62
41
60
15
5.41
17
6
12
26
15
95
96
Qualcomm ($80; QCOM)
5.14
14
7
16
5.72
11
10
14
25
31
95
83
Schlumberger
($100; SLB)
5.69
20
8
18
6.77
19
10
15
18
18
86
94
Skyworks Solutions
($41; SWKS)
2.81
28
17
14
3.19
13
11
13
21
19
96
96
Union Pacific
($194; UNP)
10.90
16
7
18
12.38
14
6
16
19
9
92
93
United Rentals
($96; URI)
6.40
30
12
15
8.13
27
9
12
146
30
92
97
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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