What are we looking for?
Growth stocks outperformed value by a huge margin over the past 10 years. And while higher valuations are often seen as problematic for growth companies, let’s put that into perspective. Today, we look for U.S. and Canadian large caps with a growth-at-a-reasonable-price (GARP) tilt.
The screen
We screened U.S. and Canadian companies focusing on the following criteria:
- Market capitalization higher than $25-billion;
- Economic performance index (EPI) higher than 2.5 – this is the ratio of return on capital to cost of capital. We look for businesses with a sizable risk-adjusted return on capital;
- StockPointer (SP) Performance Score of more than 75. The score, which can range between zero and 100, mainly considers risk-adjusted return on capital and free cash flow per share;
- PEG ratio below three – this is our GARP factor, which considers valuation and growth. It uses the price-to-earnings ratio divided by the five-year earnings growth mean (while mean is similar to average, this method puts more weight on extreme values);
- 12-month sales growth higher than 4 per cent – we are looking for a company showing sales momentum in the past year;
- 24-month growth in net operating profit (NOP) of more than 10 per cent. We want a company showing strong improvement of its operations in the past two-year period;
- Most recent return on capital lower than 50 per cent – we exclude companies with an unsustainable ROC (a really high ROC is often temporary, owing to a short-term boost from unusual items);
For informational purposes, we have also included recent price-to-earnings ratio, five-year earnings growth mean, dividend yield, one-year price return and recent stock price. Please note that some ratios may be as of end of previous quarter.
More about Inovestor
Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock picking by using model portfolios and easily communicate investment decisions with clients through client-friendly reports.
What we found
The top three on our list using this approach, ranked by SP Performance Score, are Home Depot Inc., Intuit Inc. and Clorox Co.
Home improvement retailer Home Depot is an excellent example of how long-term growth can generate massive returns for investors. It has the highest return on capital and performance score of our list. The PEG ratio is in the middle of the pack and this company is also of premium quality based on its long-term historical growth. This more than justifies the higher PEG ratio than some others on our list.
Software developer Intuit has a P/E of 45.5, but the valuation is one of the cheapest if we consider the PEG ratio. This case illustrates that a P/E ratio can mean nothing if it is not compared with historical growth statistics. Intuit premium valuation is supported by its superior SP Performance Score, its 12-month sales growth and its 24-month NOP growth.
Clorox, a maker of disinfectant products and other household items that have been in high demand during the pandemic, has had a massive tailwind in the past three quarters. (Its fiscal first-quarter earnings, reported Monday, topped Wall Street’s forecasts, with sales up 27.2 per cent compared with the year-ago period.) In the short term, we can expect health measures to contribute to sales even if a vaccine makes it to the market. Its high EPI can be attributed to its strong retail brands and market dominance. More than 80 per cent of the company’s sales are generated from brands that hold the No. 1 or No. 2 market share positions in their respective categories. While the return on capital is lower than other candidates, that is a small price to pay for its incredible stability.
Investors are advised to do further research before investing in any of the companies shown here.
For more details about these growth stocks, please subscribe the Inovestor for Advisors platform for free here.
Christian Godin is a portfolio manager at Inovestor Asset Management.
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