Why I'm Waiting to Buy These 3 Rocketing Revenue Growth Stocks

Includes: ARUN, ELGX, GMCR
by: Kurtis Hemmerling

Nothing speaks quite as loudly as the bottom-line profits that a company can generate. But the quality of earnings are also important as all profit isn't equal. You can only improve margins so far and gains from a one-time tax-break are not nearly as meaningful as gains made from a sustainable surge in sales.

But not all sales growth stocks are good buys either. Some stocks take the opportunity to dilute during periods of huge growth, especially during the early stages of its life cycle. Then you have to consider whether it's a good price if investors have gone wild buying into the shiny glamour stock status.

Here are a few stocks on my screener that are leaders among sales growth:

Aruba Networks (NASDAQ:ARUN) - A provider of next-generation network access solutions for mobile networks. First of all, the sales growth is outstanding on an absolute basis. 1-year sales growth at 33.7%, 3-year sales growth at 27.9%, and 5-year at 85.9% annualized. However, if you factor in dilution the sales growth is negative on a 5-year horizon. On a per share basis the sales growth over the last two fiscal years has a compound annual growth rate of 14.95%.

So while I like what this company has done on a business level, I am a little hesitant on the equity market side. This is a piping hot company, but with the amount of options being exercised and the latent ability of more dilution I choose to pass.

Endologix (NASDAQ:ELGX) - This company is a strong growing stock with a 56.8% sales growth average over the past 5 years. The earnings so far come from one isolated quarter. The price has risen 263% over the past 2 years.

While the price-to-sales has traded in the 3-4 range the past few years, it has shot up to well over 7 recently. It is possible that this stock could continue to grow its sales at 56.8% annually and keep the current price-to-sales multiple for a share price of almost $15 in 12 months. However, if you take a more conservative approach there is simply not enough of a margin of safety for my liking. If the sales growth rate is even at 30% and the P/S multiple drops to 4 (more in line with recent averages), then share prices could fall by 30% despite strong growth rates. It's not that I am betting against this stock but I find the risk too high for the reward.

Green Mountain Coffee Roaster (NASDAQ:GMCR) is a company that keeps wafting tempting smells my way. The sales growth is outstanding at a 1-year 72.6% increase and a 5-year 53.1% boost. The 5-year earnings growth sits at 46.1%.

Despite some dilution in shares, the revenue per share has climbed dramatically from $1.45 per share in 2004 up to $13.48 today.

Again, I think the share price is getting more than its fair share of appreciation from momentum because the price-to-sales ratio and price-to-earnings ratios have doubled. While I think this roaster definitely has more caffeine-boosted drive left in it, there is also a huge downside even if the fundamentals and future growth rates maintain its robust pace but investor sentiment sours dropping the price-to-sales ratios back to long-term averages of less than half of today's ratio... and even at that it would be many times higher than the industry average. While I might miss out on another leg up, I also would prefer to wait until the frenzy quiets down.

Wrap-up on High Sales Growth Stocks

By using fundamental back-testing service (portfolio123.com) I am able to determine that high sales growth stocks (plus a few other parameters including growing earnings) is a profitable way to invest. The holding period below is 6 months and this worked out to over 200% profit over the past 2 years.

Backtesting Rocketing Revenue Growth Stocks
(Click to enlarge)

On the other hand, these stocks also struggle during market declines, probably due to downward revised growth estimates which can bring them down fast.

While I like the idea of rocketing sales, it seems that lots of other people also like the idea thus making the relative valuations far less attractive.

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

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