Value investors are primarily concerned with company fundamentals and balance sheet strength, and look for companies that trade for significantly less than their intrinsic worth. Growth investors, on the other hand, focus primarily on expansion potential. That is, they aim to identify companies that will grow substantially faster than others. The theory is growth in earnings or revenues will directly translate into an increase in the stock price.
Typically, a growth investor looks for investments in young companies or rapidly expanding industries, especially those related to new technology.
When growth companies flourish, they can yield astronomical returns. But before any investor adopts a growth investing strategy, they should realize it can come with substantial risks and is not for everyone. Every year, we assemble a portfolio of what we consider 25 of the best aggressive growth stocks. Three of these stocks are discussed here to help guide investors’ decision-making processes. They were selected by employing a growth at reasonable price (GARP) strategy. That is, in selecting them, we were principally concerned with the growth prospects of the companies and wanted to see positive earnings numbers for the past few years, coupled with positive earnings projections for upcoming years. But unlike growth investing “purists,” we were resistant to invest in any of these companies for growth at any price and were generally more conservative in making our projections.
Methodology
Growth investors are concerned primarily about expansion, but there is no bulletproof formula for estimating this potential. Every growth stock we follow and discuss here required individual interpretation and judgment. We applied certain screens and guidelines as a framework for our analysis and tailored the screens to each company’s particular industry and situation. Furthermore, we considered all companies in relation to their past performance and their industry's performance.
When selecting stocks for growth, we looked for companies that have:
Strong historical earnings growth.
Strong forward earnings growth.
Costs under control.
Moderate to high returns on invested capital.
PEG ratios that were generally below 1.
Were liquid and had manageable levels of long-term debt.
Were reasonably priced.
For 2016, we followed this process and built a portfolio consisting of 25 top American and Canadian companies. The portfolio generated a 37.1% gain (excluding the impact of dividends) and beat all indexes by a wide margin, including the Dow Jones Industrial Average, the S&P 500 and the Nasdaq. Our top three performing positions included Insight Enterprises Inc.Ă‚ (NSIT, Financial), NetEase Inc. (NTES, Financial) and Discover Financial Services (DFS, Financial). Our three worst-performing positions included McKesson Corp. (MCK, Financial), Open Text Corp. (OTEX, Financial) and Autoliv Inc. (ALV, Financial).
Of course, we do not claim that by following this process every position in the portfolio will be a winner each year. In 2016, of the 25 companies that made up the portfolio, 96% of them appreciated in value.
Three aggressive growth picks
Apple Inc. (AAPL, Financial) is one of the world’s leading designers and manufacturers of mobile communication and media devices, personal computers and portable digital music players and sells a variety of related software, services, accessories, networking solutions and third-party digital content and applications. As most people know, it is the company behind the famous iPhone, iPad, Mac, iPod and Apple TV products.
The figure below highlights the company's historical growth profile. While there has been some pullback over the last 12 months, Apple has proven to be a phenomenal growth stock, compouding revenues at over 30%, operating income at over 40% and free cash flows at over 42% per year over the last 30 years.
At today’s levels, Apple’s stock trades at just 14.5 times trailing 12-month EPS of $8.29 and only 13.5 times expected future EPS of $9, both of which are reasonably priced compared to a five-year average price-earnings (P/E) multiple of 13.8 times and the S&P 500's average multiple of 19.
With the multiples above, a PEG ratio of 0.8, consensus EPS estimates of $9 for 2017, $10.15 for 2018 and $11.09 for 2019, we believe Apple’s stock could consistently command a fair multiple of 13.6 times per-share earnings. This seems well aligned with the company's long-term historical valuation multiples and places its shares upward of $153.
In addition, the company pays a quarterly dividend of $2.18 per share annually, which gives its stock a 1.8% yield. Investors should also note it has raised its annual dividend payment for five consecutive years, and is only expected to continue to grow.
Adobe Inc. (ADBE, Financial) is one of the largest software companies in the world, generating more than $5.8 billion in 2016. Adobe’s cloud and digital marketing services allow customers to create interactive digital content and deploy it across all forms of media devices. Adobe’s software is some of the most well regarded in the industry. It is an innovation leader and has a strong competitive advantage in digital media and marketing, positioning the company for continued growth well into the future.
The figure below shows Adobe’s historical growth profile, which is very impressive. Trailing 12 months growth is phenomenal, but unrepresentative of our future projections. As can be seen, the company has grown revenues by about 8.5% per year over the last 10 years and 5.6% per year over the last five years. Further, free cash flow growth, while exceptional last year, has more realistically averaged about 7% per year.
At today’s levels, Adobe stock trades at 52 times trailing 12-month EPS of $2.32 and only 22 times expected future EPS of $5.34, both of which are reasonably priced compared to a five-year average P/E multiple of 76 times.
With the multiples above, consensus EPS estimates of $3.73 for 2017, $4.86 for 2018 and $5.34 for 2019, we believe the stock could consistently command a fair multiple of 25 times per-share earnings. This seems reasonable for a growth stock with a diminishing long-term growth trajectory and places its shares upward of $142.
Check Point Software Technologies Ltd. (CHKP, Financial) is a leading developer and marketer of information technology security products and services. It offers its customers a portfolio of network security, endpoint, data and management solutions to protect consumers from hackers, spyware and identity theft. The company's products are sold, integrated and serviced by a network of partners. It sells through a network of channel partners, including distributors, resellers, value-added resellers, system integrators and managed services providers. Its customers include businesses and organizations of all sizes, including all Fortune 100 companies.
Check Point's growth profile is presented below. Once again, we are looking at another strong grower. It has generated revenue growth of 14.1% per year over the last 10 years, diminishing to 11.5% per year over the last five years. EPS growth has been nearly identical, with free cash flows growing by 14.2% per year and 8.2% per year over the same period respectively.
At today’s levels, the stock trades at 24.1 times trailing 12-month EPS of $4.20 and only 16.5 times expected future EPS of $6.12, both of which are acceptable compared to a five-year average P/E multiple of 20.1 times.
With the multiples above, consensus EPS estimates of $5.15 for 2017, $5.67 for 2018 and $6.12 for 2019, we believe Check Point’s stock could consistently command a fair multiple of 20 times per-share earnings. This places its shares upward of $122.
Conclusions
Which of these stocks should be on your 2017 buy list?
Apple, Adobe and Check Point Software Technologies are three of the biggest, best and strongest growth companies in their respective industries, and all have promosing futures with the potential to keep growing. All investors with a growth focus should take a close look at these companies and consider buying their shares either at today’s prices or following a market dip.
Disclosure: We currently hold no positions in AAPL, ADBE or CHKP.
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