Weeding Out True Growth Stocks

 | Sep 19, 2012 | 4:30 PM EDT
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One of my favorite Value Line screens to run is a growth stock search. I advanced the theory several years ago that a true growth stock was one where not only were sales and earnings growing at a rapid clip but the reinvested profits were causing book value to grow at the high rate. The absolute book value does not matter in this screen -- just the growth rate. Management that is unsuccessful at allocating capital and reinvesting profits successfully will see growth slow and eventually disappear. Those who reinvest successfully in new products and even acquisitions can continue to grow for many years. This theory has held up well over the years; the screen has uncovered some of the biggest growth stocks off the past decade.

I am often asked why a value guy would look for growth stocks. Simply being aware of strong growth companies provides valuable information about market and social trends. Plus, I am aware that not everyone invests like I do, and providing information on great growth stocks may be of service and interest to other investors and traders. In addition, these are the type of stocks I want to buy in the type of full-fledged market meltdown that we saw in 2002 and 2008. Sometimes these great growth companies will sell like bargain issues and I want to be aware of the stocks that fit this definition.

Originally, we tested for growth over the past decade to produce the list. I found that a lot of busted growth stocks would make the list just as they began to decline. Indeed, if you run that screen today, stocks such as Apollo (APOL) are on the list because of their very high growth rates five years ago. To filter the list, we added shorter-term growth criteria as well. Doing this trims the list of true growth stocks considerably. Only 11 stocks made the final cut.

The list contains some of the names you expect, with long-time growth winners Apple (AAPL) and eBay (EBAY) making the grade. As always, it is the stocks that are not exactly household names that capture my attention. One such stock is Carbo Ceramics (CRR), which makes the resin coated ceramic and sand proppants that are used in hydraulic fracking of gas and oil wells. The company also offers fracking related consulting, engineering and simulation services and software to the oil and gas industry. The company is facing stiff pricing competition from Chinese proppant manufacturers but was still able to report 19% top line growth in the last quarter. Over the past decade book value, earnings and sales have all grown by more than 15% annually. The company also raised the dividend payout by 13%.

In spite of the very high growth rates and the enormous potential growth of the fracking market, the stock is not egregiously expensive. Carbo shares trade at about 11x earnings and a small premium to my intrinsic value estimate. Growth investors might want to consider this issue for long-term portfolios. I, of course, will wait for the stock to trade at a large discount to my valuation estimates.

Another great growth stock that is not widely discussed is Middleby (MIDD). The shares are currently trading near all-time highs but it does not generate the excitement, as the company makes cooking and warming equipment for commercial kitchens. However, through organic growth and intelligent acquisitions the company has done an incredible job of growing the top and bottom line. Book value growth has been accelerating over the past five years as management acquired several key technologies that allow restaurants to improve profitability. The stock is too expensive for me, as it is trading at 19x earnings but growth oriented investors will probably want to look at this company.

Looking at the list of true growth stocks can provide some clue at what is going on in the economy and the market. Growth stock investors might consider purchasing the shares that make up the list as they historically have performed well. Occasionally the market will give me a chance to buy these stocks at safe and cheap prices, so I always want to be aware of which companies are true growth stocks with extraordinary potential.

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