Screening for Growth as Economy Sputters: 4 Finalists Near Fire-Sales Prices

 |  Includes: AMAT, KRO, OLN, STE
by: Erik Dellith

Concerns over both domestic and global economic growth abound. In fact, economists at big banks recently cut their estimates for future economic activity. These worries reverberated throughout the financial markets on Friday, contributing to a stock market sell-off and a rally in gold, which hit a record high price.

News that the market cap of Apple Inc. (NASDAQ:AAPL) is about the same as the combined value of the 32 largest banks in the eurozone does little to help allay fears about growth in that region. While this would simply be an interesting factoid if AAPL had been skyrocketing, its shares are up about “only” 10% so far this year (relative to an approximately 10% decline in the S&P 500 Index). As a result, there is a real concern, which arises from the loss of value in the European banks: the Euro STOXX Bank Index is down more than 30% so far this year.

Banks on this side of the pond also continue to face difficulties. For example, Bank of America Corp. (NYSE:BAC) is down about 50% this year. It plans on cutting positions in an effort to reduce costs. But BoA is not alone. Add in the lackluster job growth and continued weakness in housing, and I still have reservations about taking on any new exposure to this segment of the market.

I’ll take that a step farther and say that the general economic weakness, and spotty growth, makes me reluctant to play many sectors. Instead, I would rather focus on stocks of specific companies that are showing signs of growth. And, given the significant pull-back in stock prices, I would also like to pick up these shares at near-fire-sale prices. This is how I search today.

Searching for Growth

It seems that the pace of economic activity is easing from what we saw last year. As such, we want to focus on companies that are able to expand sales during this difficult climate. To accomplish this, we start by building a stock screen that requires sales growth in the most recent quarter be faster than the industry average.

Notice that we are not setting this growth rate equal to any specific amount. Different sectors and industries expand at different rates, and we don’t want to exclude a potentially good investment because the nature of its business might be a touch slower than other areas. For this reason, we focus on companies that are growing faster than their peers. Running this screen on Saturday afternoon yields nearly 2,500 companies.

Growth that is just slightly faster than average is not necessarily good enough; we want companies that are improving a bit faster than average. Hence, we require companies to grow at least 25% faster than their peers in the most recent quarter and over the last twelve months. This leaves us with a list of 1,614 companies.

There is no point in expanding if it is means that the revenue growth will be offset by higher expenses. With that in mind, we want to make sure that the top-line improvement translates into bottom-line gains. To accomplish this, we require earnings growth in the most recent quarter and in the trailing twelve months also better than the industry averages. This drops our list to 732 companies.

While there are no guarantees, we would like some indication that the general expectation is that the company will continue to expand its business. To accomplish this, we turn to analyst estimates. We require that the expected long-term EPS growth rate must be at least as fast as the EPS growth that the company has seen over the last five years. This slashes our list to 410 members.

Now we turn our attention to the price tag. The stock market has given up a lot of ground in recent weeks. For instance, the S&P 500 Index has lost about 15% over the last month. Stocks that might have been a bit over-priced several weeks ago might now be trading at more acceptable levels.

Many companies have recently posted solid earnings. Combine that with the market downturn, and it should be relatively easy to find names that are trading at relatively “cheap” valuations. For this reason, we do not focus on any particular number for a P/E ratio. Instead, we seek stocks that are priced at discounts to their peers, and require that both P/E and P/Sales ratios must be less than 85% of the industry average for each. This leaves us with 102 names.

Again, it is important to take into consideration estimates of future activity. We also require that a stock have forward P/E ratios, based on earnings estimates for this year and next, that are cheaper than the industry medians. At this point, we have 49 companies.

Using the forward P/E ratios and the expected long-term EPS growth rate together, we require that a company’s PEG ratio must be less than 1. This leaves us with 25 companies.

Domestic economic conditions are challenging enough; we don’t want to have to worry about international factors more than absolutely necessary. For this reason, we exclude any company that is domiciled outside of the US. Granted, many domestic companies conduct a significant amount of business overseas, but that is still considerably different from foreign companies that have ADRs. Removing non-US-domiciled companies brings the list to 21 names.

Our list now is short enough that we can stop here. This is a good starting point for further research. Still, I would like to take it a step farther. Given the wide swings in the market, I would like to focus on stocks that are generally less volatile. But, since we don’t want to exclude a stock that may be more volatile than the market simply because of the nature of its business, we again compare a company with its peers. As such, we add one more requirement to our screen: the beta of a stock must be less than the average beta for the industry. Running this screen on Saturday leaves us with only four companies:

With a market cap of about $14.3 billion, semiconductor-equipment company Applied Materials, Inc. (NASDAQ:AMAT) is the largest company highlighted on our screen. AMAT has a beta of about 1.0, in an industry with an average beta of about1.3. Still, shares have lagged the S&P 500 Index over the last three months, falling more than 20% versus a roughly 15% decline in the index. Yet, the company has done a good job growing its top line, especially relatively to its peers (24.7% versus the industry’s 13.6%), according to data from Reuters. cross the industry, operating margins have widened over the last year, relative to the five-year averages.

Applied Materials has similarly benefited and has been able to maintain margins that are considerably superior to the industry norm (20.3% versus 12.5%). We see that the company’s earnings have climbed considerably faster than the industry average (87.9% versus 9.6%). AMAT shares have a P/E ratio that is roughly half the industry average, and it has a PEG ratio of 0.8, well into value territory. The company is set to announce earnings on August 24.

Texas-based Kronos Worldwide, Inc. (NYSE:KRO) specializes in the production and marketing of titanium dioxide pigments, which are used to help whiten/brighten products; some products are used to treat industrial and municipal wastewater. KRO has a market cap of about $2.3 billion. Its stock has a beta of about 1.5, in an industry where the average beta is 2.6. Not surprisingly, then, the stock has been slammed in the recent downturn, plummeting more than 30% over the last three months, about double the decline in the S&P 500 Index over that time. This segment of the chemicals industry has not been growing too quickly: average top-line growth stood at 4.2% over the last year. Yet, Kronos has been posting stellar rates, advancing more than 30% over the same period, according to Reuters. In general for the industry, profit margins have improved modestly over the last year, relative to the five-year mean.

By comparison, Kronos has seen its margins improve considerably, from nearly an industry average operating margin of 6.4%, to an industry-leading 21.2% more recently. This has helped the company post stunning EPS growth rates. KRO has a P/E ratio of 10.3, relative to an industry norm of 11.6. Its PEG ratio is exceptionally low, placing it deep into the range acceptable to value investors. Yet, it is important to note that only two analysts seem to report their estimates to Reuters, and their expectations for long-term growth are considerably far apart.

Former Winchester rifle company Olin Corporation (NYSE:OLN) also came to light on our screen. In addition to ammunition, Olin is involved in the chemicals industry, producing chlorine, potassium hydroxide, and caustic soda. The company has a market cap of about $1.4 billion. OLN shares have a beta of about 1.3, in an industry with an average beta of 2.6.

Not surprisingly given its beta, shares are down more than market lately, losing 20% over the last three months, relative to the roughly 15% decline in the S&P 500 Index. The company has expanded its top line nicely of late, with revenue in the most recent quarter climbing 30.4% relative to an industry norm of 21.6%, according to Reuters. And, despite margin compression, the company has posted triple-digit earnings growth over both the trailing twelve months and in the most recent quarter.

By comparison, the industry average in the MRQ period is about 33.3%. With a P/E of 6.9, OLN shares are priced at a bargain relative to the industry’s P/E of 11. OLN has a PEG of 0.5, yet it is important to note that here, too, we see considerable difference in analyst expectations for long-term earnings growth. OLN is scheduled to next report earnings on October 24.

With a market cap of about $1.7 billion, Ohio-based Steris Corporation (NYSE:STE) is the smallest of the companies on our list today. It provides surgical products and services to help prevent contamination and infection. The stock has a beta of 0.79 in an industry where the average is 0.83. Nonetheless, shares have fallen more than the market, shedding about 20% of their value over the last three months, relative to a 15% slide in the S&P 500 Index. This segment of the medical equipment industry has seen revenue climb of late, posting average top-line expansion of 12.6% in the most recent quarter, relative to 1.6% over the last year. Steris ranks among the leaders pulling the average higher, with growth of 15% over the last year and 68% in the most recent reported quarter, according to Reuters.

The company has also experienced modest operating margin improvement. EPS growth, by comparison, comes in at triple digits, easily outpacing the industry’s 15% growth in the most recent quarter. Yet, with a P/E of 13.7, STE is priced at a bargain relative to its industry norm of 22.8. And it has a PEG just shy of 1.0. The company is scheduled to announce earnings on October 31.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.