Finding growth in a slow economy

First-quarter GDP numbers are disappointing and government spending is contracting, but some companies are thriving -- and looking cheap.

By John Reese May 8, 2013 3:00PM

 Arrow Up copyright Image Source, PhotolibraryWith first-quarter U.S. GDP growth falling short of expectations and few expecting much in the way of broader economic expansion for the rest of the year, investors are once again considering a troubling question: Where will the growth come from?

 

In recent months, we have seen some nice progress in the housing sector -- real residential fixed investment jumped 12.6% last quarter after increasing 17.6% in the fourth quarter -- and some decent growth from the tech sector and auto industry. But other areas remains sluggish -- and the government sector has been contracting sharply. Real federal government consumption expenditures and gross investment fell 8.4% last quarter and nearly 15% in the fourth quarter. 

 

But while the broader economy continues its muddle-through advance, many individual companies are putting up some very impressive numbers. And with so many fearful about the overall economy, a lot of these fast-growing companies' shares are significantly cheaper than they might otherwise be. My Guru Strategies, each of which is based on the approach of a different investing great, have been finding a number of them lately. Here are some favorites. (As always, you should invest in stocks like these within the context of a broader, well-diversified portfolio.)

 

MWI Veterinary Supply, Inc. (MWIV): This Idaho medical equipment small-cap ($1.5 billion) keys on a very specialized group of end-users: animals. It sells its products, which include pharmaceuticals, vaccines, parasiticides, diagnostics, capital equipment, and pet food and nutritional products, to veterinarians in the U.S. and U.K. It's been a stellar growth story, increasing EPS and sales in every year of the past decade. Its long-term sales and EPS growth rates are both 26%, and sales growth actually accelerated last year to 33%.

 

MWI gets strong interest from my Peter Lynch-based model. The Lynch strategy considers the firm a "fast-grower" -- Lynch's favorite type of investment -- thanks to that 26% long-term EPS growth rate. Lynch famously used the P/E-to-Growth ratio to find bargain-priced growth stocks, and when we divide MWI's 25.6 price/earnings ratio by its long-term growth rate, we get a PEG of 0.97. That comes in just under this model's 1.0 upper limit, a good sign.

 

ResMed Inc. (RMD):  This San Diego medical technology company ($6.8 billion market cap), which makes devices used to treat sleep disorder breathing and respiratory problems, fell a bit short of Wall Street's revenue projections in the most recent quarter, but still increased sales by nearly 10%. Over the long term, it's been growing revenues at a 14% clip, and earnings at a 26% pace, both of which more than double its industry average.

 

Given its growth, my Lynch-based model thinks ResMed's 22.5 P/E ratio is reasonable, as it makes for a 0.86 PEG. In addition, the company has a debt/equity ratio below 20%, which the model likes.

 

Panera Bread Co. (PNRA): This St. Louis bakery/restaurant chain began as an offshoot of another bakery/restaurant chain, Au Bon Pain. It became so successful, however, that the company's owners decided to focus solely on Panera, and sold off the rest of the Au Bon Pain business. The $5.4-billion-market-cap firm has more than 1,600 locations across the U.S. and Canada.

 

Warren Buffett is typically thought of as a value investor. But in her book Buffettology, Mary Buffett (Warren's former daughter-in-law and colleague) explained that strong, persistent growth in earnings was a key to Buffett's approach. The model that I base on that approach likes that Panera has increased earnings in every year of the past decade, doing so at a rate of more than 23%. The strategy also likes that Panera has no long-term debt, $4.66 in free cash flow per share, and a 15.5% average return on equity over the past 10 years.

 

EPAM Systems Inc. (EPAM): While growth in the U.S. has been slow, it's been worse in Europe. But this I/T company, which is based in Pennsylvania and provides software engineering solutions through its Central and Eastern European service delivery platform, has been a strong grower despite all the economic headwinds.

 

EPAM ($1 billion market cap) gets strong interest from the strategy I base on the writings of Martin Zweig, an exceptional growth-focused investor who sadly passed away earlier this year. My Zweig-based model looks for firms whose earnings aren't just growing, but growing at an accelerating rate, and EPAM delivers. The firm has grown EPS at an exceptional 81% rate over the long term (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate), and an even-better 540% in the most recent quarter. It's also been growing its top line at a strong pace, with revenues growing at a 33.6% pace over the long haul and a 32% rate in the most recent quarter. EPAM also has no long-term debt and trades for a reasonable 19.3 times trailing 12-month EPS.

 

Syntel, Inc. (SYNT): Syntel, based in Michigan, provides business analytics, cloud computing, IT infrastructure management, and other services. The firm ($2.7 billion market cap) has grown EPS at a 20% pace over the long term, and revenues at a 17% pace.

 

Syntel gets strong interest from my Buffett-based model, which likes that it has upped EPS in all but two years of the past decade, has no long-term debt, and has a 10-year average return on equity of 28.6%. 

 

My Lynch-based model also likes Syntel. Its 14.5 P/E ratio and 20.0% long-term growth rate make for a solid PEG of 0.72, and the strategy also likes Syntel's 8.1% debt/equity ratio.

 

I'm long SYNT, PNRA, EPAM, and MWIV.


John Reese is the founder and CEO of Validea Capital Management and Validea.com and the author of The Guru Investor: How to Beat the Market Using History's Best Investment Strategies.

 

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