Finding secular growth stories – those stocks representing above-average revenue and profit growth and with high probabilities of continuing market-beating growth in the future – is the holy grail of equity markets. Companies capable of sustaining strong growth paths without the help of falling interest rates or strong global economic growth are particularly attractive in the current period of market volatility.
Thankfully, the research team at Morgan Stanley recently released its 25 top picks of secular growth stocks for the next two years.
The research team defines secular growth companies as those it believes “can deliver strong growth, driven by forces such as sustainable competitive advantages, product cycles, market share gains, or pricing power.”
The methodology for uncovering the best opportunities started by identifying companies that have generated positive revenue growth for each of the past 12 quarters. Within that group, the analysts screened for stocks where average annual earnings growth for the 2017 to 2020 period is forecast above 15 per cent and revenues were predicted to improve by at least 10 per cent a year. (The report made allowances for cases where analysts had particularly high conviction on a stock, which I think explains why four of the 25 stocks fall below the 10-per-cent threshold for revenue growth.)
The resulting list is shown in the accompanying table. It includes some of the usual suspects such as technology giants Amazon.com Inc., Alphabet Inc., Salesforce.com Inc., and credit card companies Mastercard Inc. and Visa Inc. Surprises include cosmetics retailer Ulta Beauty Inc., instructional software provider Pluralsight Inc. and animal health product manufacturer Zoetis Inc.
Three companies caught my attention as potential sources for further research – Illumina Inc., Intuitive Surgical Inc., and Palo Alto Networks Inc. Each company appears fairly valued at first glance in light of expected growth rates and situated in industries – health care and network security – with clear tailwinds.
Morgan Stanley describes Illumina as “the dominant provider of technology to sequence DNA” and is set to benefit from increases in corporate and government investment in DNA analysis. Consumer interest in DNA testing continues to climb with a 300-per-cent increase in DNA-related orders for Illumina over the past two years.
Intuitive Surgical builds robots that perform surgery. The analysts say the company “has gained significant adoption within urology and gynecology and is still in the relatively early stages of penetration internationally and within broader procedures."
Palo Alto Networks develops software to protect information networks from hacking. The volume of high profile network security issues in recent years, combined with the growth of “big data” operations that collect and analyze huge amounts of information, implies that demand for Palo Alto software will continue for the foreseeable future.
Morgan Stanley provides a plausible growth story for each of the 25 stocks in the table, but that does not mean these investments are without risk.
In many cases, a company’s growth has already been recognized by the market and the stocks are trading at extreme valuation levels. Atlassian Corp. and Biomarin Pharmaceuticals Inc., for instance, are both trading close to 90 times 2019 earnings estimates. The analysts could be correct in predicting continued profit growth, but there is no guarantee that valuation levels will stay the same. A fall in price-to-earnings ratios to more reasonable levels would come at the expense of the stock price even if growth estimates proved accurate.
Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.