Don't Give Up On Growth
Have you ever played king of the hill?
Kids can play that game in different settings, and using a variety of rules. But one aspect never varies — the king stays at the top until someone else forces him out. If the opponents are fairly equally matched, the king rarely rules for long.
While it's too early to be sure, value may have grabbed the top spot, leaving growth stocks nursing their wounds at the bottom of the hill. Growth has lagged the market so far this year. We looked at growth from three angles:
1) The S&P 1500 Growth Index, a subset of the broader S&P 1500 Index of large, midsize, and small stocks. To measure growth, S&P considers three-year growth of sales and earnings, as well as 12-month price change.
2) Our Quadrix Quality score, which takes into account long-term growth metrics, as well as profitability ratios such as return on equity.
3) Quadrix Momentum, which gauges growth for periods of one year or shorter, as well as some profit-estimate trends.
Growth stocks, as measured by all three indicators, have underperformed the average stock this year. The S&P 1500 Growth Index underperformed the value index by nearly three percentage points.
One reason for growth's recent underperformance could be skepticism about the sustainability of earnings momentum. Growth expectations for the broad market have steadily slowed over the last few years. The S&P 500 Index's profits declined in each of the last four quarters, and the consensus projects a slight decline in index profits in the current quarter.
However, analysts project a rebound to 8% profit growth in the fourth quarter and 14% profit growth in 2017, targets that seem overly optimistic. According to consensus estimates for long-term profit growth, 50% of the index's stocks should deliver double-digit profit growth over the next five years. Over the last five years, only 36% managed double-digit growth.
With that in mind, we've identified some industries with solid growth credentials. To see what kind of growth other industries deliver, visit www.DowTheory.com/Go/IndGrowth. In the table below, we present individual stocks that offer genuine growth — at a good price. Four of those stocks are reviewed in the following paragraphs:
Technology distributor CDW ($44; CDW) has posted an impressive growth record, with 10 consecutive quarters of at least 6% sales growth and at least 10% growth in per-share profits. Analysts expect that growth to continue, projecting sales gains of 9% this year and 6% next year, with earnings up 13% this year and 10% next year.
While CDW expects total U.S. technology spending to grow less than 3% this year as corporate executives take a cautious approach to upgrades, the company believes it can top the industry growth rate by at least two or three percentage points. CDW trades at 13 times expected year-ahead earnings, 6% above the average for distributors, a premium justified by the company's consistent growth. CDW's trailing P/E of 14 is 29% below its own three-year average. CDW is a Focus List Buy and a Long-Term Buy.
EQT Midstream Partners ($76; EQM) is the only energy stock we currently recommend. The average S&P 1500 energy stock earns a Quadrix Overall score of just 25, by far the lowest of any sector. Analysts expect the S&P 500 energy sector's profits to fall 66% in the third quarter, the lack of operating momentum stemming in large part from low energy prices. Against that backdrop, EQT Midstream's solid growth stands out.
The operator of pipelines and storage tanks grew sales 19% over the last year and 44% annualized over the last three, with profits up 18% and 29% in the same periods. EQT Midstream, a master limited partnership (MLP), is making headway on pipeline and storage projects even as some rivals stall. Its Ohio Valley Connector should come online in the fourth quarter of this year, while the Range Header system should finish phase I development this year and phase II by mid-2017. Earnings estimates are on the rise but still seem too low, with the consensus projecting profit growth of 4% in the second half of this year and just 3% next year. EQT Midstream, yielding 4.1%, is a Buy and a Long-Term Buy.
Lam Research ($92; LRCX) has been one of our best-performing stocks, returning 11% over the last three months, 17% year-to-date, and 26% over the last 12 months. Despite those impressive gains, the shares remain attractively valued, earning a Quadrix Value score of 78, tops among S&P 1500 semiconductor-equipment stocks. Lam trades at 14 times trailing earnings, 32% below the industry average. Lam also sports discounts based on price/sales, price/operating cash flow, and price/free cash flow.
Don't assume we started this review with Lam's valuation simply to compensate for a lack of growth. Sales rose 12% and per-share profits 31% over the last year, with three-year annualized growth of 18% and 66%, respectively.
While the proposed merger with KLA-Tencor ($69; KLAC) will not close by the previous Oct. 20 deadline, don't worry. We found Lam worth buying long before the merger announcement. Lam Research is a Focus List Buy and a Long-Term Buy.
Over the last year, Owens Corning ($51; OC) grew per-share profits 52% and operating cash flow 55%. On an annualized basis, profits increased 38% and operating cash flow 40% over the last three years. While sales growth hasn't been strong, profit margins have risen steadily in recent quarters. The company generated operating profit margins of 18.5% in the 12 months ended June, up from 14.6% in the same period a year ago and 12.4% three years ago. The maker of building materials also looks attractive based on other growth metrics, earning Quadrix scores of 89 for Momentum and 91 for Quality.