Poking Around in Growth Stocks

 | Sep 12, 2011 | 2:04 PM EDT
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It was a busy weekend here at Chez Melvin. Not only was it the first anniversary for me and my wife, but it also saw the start of the NFL season and a full slate of college football, as well as some interesting pennant races heating up. Sunday afternoon the kids were at the house for some football, steaks on the grill and a chance to raid Dad's wine cabinet. As we watched the Ravens pulverize the Steelers, my son was asking questions about the stock market and how to pick stocks. He expressed the idea that he might prefer more exciting stocks than the old asset value situations his father preferred. I suppose it was inevitable that one of my kids would end up as a growth-stock investor as punishments for my past mistakes. I suppose it could be worse, though: He could have turned out to be a Steelers or Red Sox fan.

I spent some time teaching him my definition of a true growth stocks. There can be fad and momentum stocks that temporarily dominate the headlines, but these often fail my definition of a real growth company. I define a real growth stock as one where both revenue and earnings have grown at least 15% annually for the past five years. I would also want to see that book value has grown at least that quickly. This would tell me management is doing a good job of reinvesting profits. It doesn't matter how high or low book value is in this example -- only that it is growing as fast as the sales and earnings.

I sat down this morning and ran a list of stocks that fit the basic criteria, and found 103 names that fall under the definition of Melvinish True Growth Stocks. Of course, being me, I had to add valuation criteria -- so I added a cutoff of a 15 price-to-earnings ratio and shrank the list to 59 names that were growing and selling at reasonable prices.

Oil-service companies were well-represented on the list. In recent weeks, energy-related names have sold off as gears of a slowing global economy have driven oil prices a little lower. But, in the long run, oil and gas demand will continue to increase, and I believe these companies should continue to see strong earnings growth.

Ensco (ESV) easily fits the definition of a true growth stock. For the past five years the company has grown book value and earnings by 20% annually, with earnings having climbed 40% a year, on average. The company completed the acquisition of Pride International earlier this year, and is now the second-largest offshore rig fleet in the world. The acquisition also helped the company gain a stronger presence in markets such as Brazil and West Africa, which complement their Asian, European and Mexican market operations. Other oil-related names on the list -- that I deem attractive for the long term -- include National Oilwell Varco (NOV) and Petrobras (PBR).

One of the really intriguing companies that made the list is Itron (ITRI). The company is the world leader in smart meters for electric, water and gas companies. This is a market that is in the very early stages of what should be a sustained period of solid revenue and profit growth. For the past five years, the company has grown sales by a little over 20% annually while earnings have risen 16%. Management has successfully reinvested cash flow in the company, and book value has also grown by more than 20% a year. Itron has also paid down debt over the past five years, now holding just one-third of the long-term $1.5 billion in debt it reported in 2006.

Otherwise, the company is currently bidding on contracts that cover 40 million smart meter installations, and some of that business should begin to show up in results as soon as early 2012. As measures continue to be taken to reduce emissions and control costs, opportunities in Europe and emerging markets should allow Itron to be a true growth stock for many years into the future.

Even an old, curmudgeonly asset-based investor has to admit that the list of true growth stocks contains some interesting and exciting names. There is little chance I will own them unless they trade below book value -- but, if I were 23 and just starting out in life, I would have to consider many of these true growth stocks as a potential path to building wealth.

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