What are we looking for?
In the late stage of the business cycle, such as many argue we are in now, it is important for growth investors to improve their downside protection without sacrificing potential upside returns. Today we look for growth stocks supported by favourable fundamentals that should allow them to capture further gains in a rising market.
We screened Inovestor’s U.S. universe of stocks by focusing on the following criteria:
- Market capitalization greater than US$10-billion;
- 12-month change in the economic value-added (EVA) metric greater than 10 per cent – a positive figure shows us that the company’s profits are increasing at a faster and greater pace than the costs of capital. The EVA is the economic profit generated by the company and is calculated as the net operating profit after tax (NOPAT) minus capital expenses;
- One-year return of at least 10 per cent;
- Average annual earnings-per-share (EPS) growth over five years of at least 15 per cent;
- Annual sales change one year ago or two years ago of at least 10 per cent;
- Current economic performance index (EPI) greater than one. This is the ratio of return on capital to cost of capital, representing the wealth-creating ability of the company. A ratio above one is key for sustainable investment opportunities;
- Free-cash-flow-to-capital ratio. This ratio gives us an idea of how efficiently the company converts its invested capital to free cash flow, which is the amount left after all capital expenditures have been accounted for. It is an important measure because it gives us the company’s financial capacity to pay dividends, reduce debt and pursue growth opportunities. We are looking for a positive ratio.
- Future-growth-value-to-market-value ratio (FGV/MV). This ratio represents the proportion of the market value of the company that is made up of future growth expectations rather than the actual profit generated. The higher the percentage, the higher the baked-in premium for expected growth and the higher the risk.
Please note that most ratios are reported as of last fiscal quarter except market capitalization, one-year return and price, which are reported as of recent close date. FGV/MV is reported on a trailing 12-month basis.
More about Inovestor
Inovestor for Advisors is a fundamental analysis research platform specializing in the economic value-added (EVA) method. It helps advisers save time in identifying good investment opportunities and communicate them easily to their clients through client-friendly reports. In addition, Inovestor allows investors to generate lists of the best companies, to track their portfolio’s performance and obtain in-depth analysis on more than 13,000 companies.
What we found
All the growth companies on our list are trading at a premium (as shown by the FGV/MV multiple). The company with the lowest premium, at 42.8 per cent, is Starbucks Corp. Starbucks, like many of the companies on our list, has seen annual sales growth over the past two years, from 4.9 per cent in 2017 to 11.2 per cent last year. Meanwhile, with a FCF-to-capital ratio of 34.1 per cent (one of the highest on the list), it is well positioned for sustainable future growth.
Ubiquiti Networks Inc., a manufacturer of wireless data communication products, had an extraordinary one-year return of 132.4 per cent. This rally gained added traction recently, owing to favourable second-quarter results in February, which surpassed expectations. Given those returns, it is highly probable that Ubiquiti has already experienced most of the possible gains for 2019. Nonetheless, the 12-month change in EVA of 151.6 per cent and its high EPI ratio, at 3.6, reflect the growing profits and the added value the stock is creating for shareholders.
Investors are advised to do further research before investing in any of the companies listed in the table below.
Noor Hussain is an analyst and account executive for Inovestor Inc.