One way to find stocks with a better chance to outperform the market is to look for high-growth stocks that, for one reason or another, have fallen out of favor, but have now big upside potential. Those stocks would have to show a very low debt and generate strong free cash flow.
I have searched for very profitable companies with strong growth prospects in the technology sector. I have elaborated a screening method, which shows stock candidates following these lines. Nonetheless, the screening method should only serve as a basis for further research.
The screen's formula requires all stocks to comply with all the following demands:
- Earnings growth estimates for the next 5 years (per annum) of greater than 20%.
- Price to free cash flow of less than 10, (many investors prefer using free cash flow instead of net income to measure a company's financial performance, because free cash flow is more difficult to manipulate. Free cash flow is the operating cash flow minus capital expenditure).
- Long-term debt to equity of less than 0.1.
- The PEG ratio of less or equal 0.60.
I used finviz.com's free screener to perform the search. After running this screen on December 01, 2012, I obtained as results the 3 following stocks:
Globecomm Systems Inc. (GCOM)
Globecomm Systems Inc. provides satellite-based managed network solutions to government, communications service providers, commercial enterprises, and media and content broadcasters in the United States, Europe, South America, Africa, the Middle East, and Asia.
Globecomm Systems has a very low debt (total debt to equity is only 0.09) and it has a very low trailing P/E of 12.38 and a forward P/E of 15.43; the PEG ratio is very low at 0.93. The price to free cash flow for the trailing 12 months is very low at 8.35 and the price to sales ratio is also very low at 0.71. The average annual earnings growth for the past 5 years was very high at 20.29% and the average annual earnings growth estimates for the next 5 years is also very high at 20.29%. The company is trading 25.75% below its 52-week high and has 28% upside potential based on the consensus mean target price of $15.20. On November 29, 2012, Globecomm Systems announced that the company has been awarded option year two of a five year contract from a US Government agency valued at $6.8 million. Globecomm previously announced approximately $6.0 million in contracts from this US Government agency, bringing the combined contract value to approximately $12.8 million. GCOM shares displayed both attractive valuation metrics and strong growth metrics. All these factors should push the stock higher.
RELM Wireless Corp. (RWC)
RELM Wireless Corporation engages in the design, manufacture, and marketing of wireless communications products in the United States and internationally.
RELM Wireless has no debt at all and it has a very low trailing P/E of 12.07 and even a lower forward P/E of 8.45, the PEG ratio is very low at 0.54. The price to free cash flow for the trailing 12 months is very low at 7.36. The company has a very strong growth prospects; the EPS growth for this year is 25.49% and the expected EPS growth for the next year is very high at 100%, and the average annual earnings growth estimates for the next 5 years is also very high at 22.50%.
The RWC stock is trading below book value, the price to book value ratio is only 0.77 and the current ratio is very high at 5.14. The company is trading 19.52% below its 52-week high and has 314% upside potential based on the consensus mean target price of $7.00. On November 14, RELM Wireless reported its 3Q financial results. On that occasion, the company said that for the quarter ended September 30, 2012, sales totaled approximately $8.1 million, compared with approximately $7.0 million for the third quarter last year. Pretax income for the quarter ended September 30, 2012 was approximately $1.4 million, compared with approximately $939,000 for the third quarter last year. The very low multiples and the strong growth prospects make the RWC stock very attractive.
Travelzoo Inc. (TZOO)
Travelzoo Inc., an Internet media company, publishes travel and entertainment deals from travel and entertainment companies, and local businesses in North America and Europe.
Travelzoo has no debt at all. The company has a low trailing P/E of 13.51 and a low forward P/E of 14.28; the PEG ratio is very low at 0.39. The price to free cash flow for the trailing 12 months is very low at 9.85.
The company has strong growth prospects; the average annual earnings growth estimates for the next 5 years is very high at 35%. The company is trading 44.5% below its 52-week high and has 11% upside potential based on the consensus mean target price of $19.50. On October 25, Travelzoo reported its Q3 financial results; the company reported revenue of $35.4 million, down 8% year-over-year and net income of $3.4 million, down 42% year-over-year. Despite the disappointing Q3 results, due to the very low multiples and the strong growth prospects, I think the TZOO stock still has a lot of room to move up.