5 Growth Stocks

India markets are embracing the oversold growth story as the reforms are hitting ground and corporates are seeing the rippling effects of the same. Leading economic indicator like Gross Domestic Product (GDP) came better than expected at 7.9 percent in March quarter and 7.6 percent for FY15-16, driven by the spurt in manufacturing (up 9.3 percent in 4Q16) and farm (up 2.3 percent in 4Q16). The core sector growth for month of April hit 8.5 percent the highest in the last four years. In 4QFY16, the sectors which showed growth more than 8.5 percent were mining and quarrying (up 8.6%); electricity, gas, water supply and other utility services (up 9.3 percent); trade, hotels, transport and communication (up 9.9 percent) and financial, real estate and professional services (up 9.1 percent).

Per capita income at current prices during FY15-16 increased to Rs 93,293 as compared to the first revised estimate for the year 2014-15 of Rs 86,879, darting up by 7.4 percent. This is positive for FMCG, construction, auto, consumer goods and travel sectors.

With the open ends of intent and actual growth tying up, we are comfortable assuming that we are residing on an island of growth surrounded by ocean of uncertainties on the global front. To single out and elaborate this word ‘growth’ we broached upon ‘growth investing’ as the topic for our reader-investors.

What is growth investing?

Growth investing, in most simple terms, means investing in stocks which are growing at a rate higher than the industry over the last 3 or 5 years. Going by the theory, it is based on the assumption that any growth in the earning is rewarded by market by equal proportion of increase in share price. “My definition of growth investing in simply to to choose companies with good key ratios & growth driven management for multi-year investment,” says Mohsin Chamadia, AVP of LKP Securities. “As the name suggests growth investing is focused on expected growth and future vs value investing where you look for value (available at deep discounts) of past performance. Growth investing is investment on emerging ideas which have tremendous growth potential vs value investing where you invest on proven companies available at discounted prices due to some or other reason. In layman language its something like buying a house in an emerging locality which has good potential or an existing locality which has very high appreciation scope (growth stocks) vs buying an existing house,” explains Deepak Narnolia, analyst with Birla Sunlife. “Growth and value are two mutually exclusive approaches to stock picking while both have the potential to generate handsome returns if picked rightly. Growth stocks are identified by above normal growth in earnings while value stocks are those which are at deep discount to its intrinsic value or undervalued and beg to be picked. Growth stocks are risky considering that the valuations (P/E or P/BV) would appear to be higher and one needs to be careful,” adds Paras Bothara

VP- Research Head of Ashika Security Research. We see in the chart below that P/E ratios mirror the share price and currently at lower earnings also the Sensex is in the higher range signalling the higher expected future earnings.

While analysing the companies, we observe that in Indian diaspora, the increase in share price for such growth stock is more than proportionate to the increase in earnings. And why is that so? Markets always factor in future growth earnings and the estimated growth drives the markets. As per Warren Buffet, “The investor of today doesn’t profit from yesterday’s growth”. Not surprising that growth investing philosophy differs for different research houses and make the process subjective and complex.

As per our observation, market rewards good performance however the other side of the coin, is obviously, any deceleration in earning is punished with even sharper fall in share prices. We have observed that such deceleration if temporary provides good entry point into the growth stocks.
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What are the characteristics of growth companies?

Growth companies are characterized by high sales growth, lower dividend payments and high P/E ratio. Companies are always on the lookout for improving their RoE and with the company in growth trajectory, it is but obvious that companies like to plough in the profits earned in the business and can generate higher returns on the same for investors. Though not a rule but dividend payment is either less or nil in many cases. Growth companies also doesn’t come cheap, they generally come with tag line “Buy high, Sell High”. In the early stages of growth, the premium earned by such growth stocks can be huge and perplex the investor as it being a “pricy bet”. However, with earnings picking up over the years, the P/E eventually moderates.

How is growth investing different from value investing?

Growth investing is all about estimating the future and eyeing future growth while value investing is about living in the current moment to check and ask “Is this the right price to enter”?

Though the line fades off as most companies start off as a growth company and then matures as a value company. As per Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, “Growth stocks can dominate value stocks over shorter time periods, even though value outperforms growth over long time periods. Growth investing does best in periods of slow earnings growth — when it has scarcity value — and when the yield curve is flat or downward sloping.” And active growth investors perform better against their passive counterparts than do passive value managers, suggesting that there is a bigger payoff for the successful growth investor. “Growth investing and value investing are not any different as the basic attempt in both is to see best source of capital appreciation. In growth, you are looking at significant momentum in revenue earnings or EPS growth. Here, you overlook the fact that stock earnings are higher and multiples are higher, you are chasing growth because you believe momentum is sustained,” says Narnolia. He also added value investing is a patient art, where you evaluate the earnings of the company and you feel that P/E or P/B multiples are much lower value or the value is not optimum vs market peers. So you are identifying stocks that are beaten down where there is no much investor fancy and you invest in these stocks so that you get dividend and there is chance of appreciation when market turns around. We make a sincere attempt here to pen down to some parameters that differentiates them.

Parameters	Value Investing	Growth Investing
Philosphy	Buy Low, Sell High	Buy High, Sell High
Key ratios	P/B, P/E (52 week L/H) and D/E	TTM P/E, forward P/E and PEG
Time period	Long	Medium/ Long
Returns	Better than benchmark	Exponential
Beta/ Risk	Low	High
Stock chart	Range bound over 3 years	Steep Upward sloping chart over 3 years

 

We see from the graph below that Reliance Industries from June 2004 till early 2008 was a growth stock with P/E climbing to 38.2x on Jan 2008 from the lows of 11x in mid-2004. Now with company maturing the P/E is in the range of 11-13x.

Is there a formula?

We so wish there was a magic formula to catch the growth stock. However, growth investing is subjective and highly judgemental and is based on the research a person does on the market. The recipe involves a combination of financial metrics along with your judgement works the best.

For the convenience of our readers, we enumerating some parameters that are we thought are used most commonly to decide on the growth stocks. This is however not an exhaustive list!

a) Growth (as the name suggests!) – To fish out growth companies, looking at growth rate is the simplest and most successful way. We pick out for our research 5 year sales and net income reported number. To this we apply simple CAGR formula to arrive at 5-year and 3-year CAGR growth for the stock.  We compare these numbers with the current year over year growth rate. If the current year growth rate is higher than five year CAGR and three year CAGR, then we have a stock which is on growth trajectory.

We have come across small cap companies that are witnessing high growth in sales but making losses or not yet reached break even. It is not uncommon that companies first strive to achieve a sales footprint and then focus on improving bottomline. As a researcher, we look for companies which at least are able to report a positive operating profit. An investor should be careful to read the trend and check if the losses are in decreasing trend and fixed costs are getting covered.

b) Industry growth: An important parameter is to benchmark company’s growth with industry. If the industry is growing at 3% while the company is growing at 8% then you have a stock which is due to its product leadership, pricing strategy or marketing reach is able to gain more market share in the space. We further research and find the USP of the stock to check the sustainability of the growth.

Though the competitive advantage might last for different time period depending on how competitive is the landscape along with entry and exit barriers. In heavy engineering industries, mining, infrastructure and aviation, the entry and exit barriers are high so the premium over the peers last for three to ten years while in Textiles, FMCG, Agro chemicals and consumer goods, it is low hence the premium might last less than three years. However, the first mover advantage usually pays off over a long term and gives investors handsome returns.

c) Margins: We use margins as another important parameter to check the management control systems in the company and benchmark it with the industry. For a growth stock with operations for more than 5 years, one might see that margins are usually higher than industry and the company is able to sustain the same. With every 20% growth in sales, it becomes even more difficult to grow the next 20% on higher base and then sustain the same cost structure or even reduce it. It’s the same as scoring every additional percentage over 90%. Those companies which succeed in balancing the revenue growth with margin growth usually earns a premium over its peers.

Coming to the ratio, investor should look at PBIDT margins and net profit margins. PBIDT margins helps to one to compare the margins across sectors except banking. Also, it is also a cash flow measure to check the profitability in real terms eliminating the notional charge of depreciation. Net profit margins gives investor a good idea of the interest and tax the company is paying. You will come across companies with high PBIDT margins but low net profit margins. Usually it will be due to higher interest or tax the company is paying or vice versa.

We like to see the trend of margins of the company over a period of time, say 5 years, and compare that with the industry. For example, in the chart below for Infosys we see that net profit margins are improving while for TCS and Wipro we see a declining or flat trend. We can draw inference that Infosys is performing better in an industry which is witnessing margins pressures.

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Flipkart, Jabong, Nestle, GE, Sony, Make My Trip, Nokia, PVR and Group On.

Looking at the last 9 months of FY16, sales increased by 166% to touch Rs359.7 while and EBITDA was 50.4 crore (up 140%) and net income 30.9 crore (up 130%). Company is confident to achieve targets of 600cr in FY16 led by new projects and adding more 2000 d) Leverage: One thing we never miss out is to look at the debt to equity ratios for last three years. For starters, its best to avoid companies with debt to equity ratio of more than 2 for current year as a rule. A declining trend in debt to equity ratio is also a good indication of financial health of the company. During a growth stage, a high leverage company reaps benefit of tax saving however during declining sales it has potential to wipe out the earnings. Markets in bearish mode always punishes company with high debt. Recently, we have seen that due to heavy debt and large inventories, real estate and infrastructure companies are reeling under pressure and their earnings have got impacted.

e) Is the premium justified: As said earlier that growth stocks always trade at high multiples than peers, an investor is kept guessing with each new peak reached, whether it is the good time to enter. A quick way to check the premium is to check the TTM P/E ratios and forward P/E ratios. If increase in share price is proportional to the increase in forward EPS then you have the catch! If the premium is much higher than the expected growth in EPS then the stock may be risky to enter at the moment and one might include it under ‘watchlist.’ Whenever you see a correction in the market, it would be a good bet to enter the stock.

Another ratio to balance the P/E ratio to the growth is Price/Earnings to growth (PEG). The price/earnings to growth ratio (PEG ratio) is a stock's price-to-earnings ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock's value while taking the company's earnings growth into account, and is considered to provide a more complete picture than the P/E ratio. The lower the PEG ratio, the more the stock may be undervalued given its earnings performance. We use growth estimates based on historical growth rate or future estimated growth rate if the company is expected to grow at faster rate.

We also see that there is a perception that small caps are usually the growth stocks. Different research houses will have different ideologies. We would look at how the sector story is playing and the different players poised for growth within the sector rather than conservatively looking at just the market cap of the company.

Keeping our promise of increasing wealth to our readers, we have applied the parameter of growth investing discussed above and picked five growth stocks. Here you go:

1.    Kellton

Kellton Tech solutions is providing services in digital transformation space which involves the use of digital technologies such as mobility, analytics, social media, and cloud computing. MarketsandMarkets believes, the digital transformation market is expected to grow at CAGR of 19.6% to $369.22bn by 2020 over the next five years.

We see that Kelton is expecting to report more than 100% increase in FY16 revenue vs FY15 and is growing at above industry rate. To achieve this, company has been following inorganic growth model. The company has acquired ProSoft group to enhance capabilities in ERP-ERI space (Enterprise resource planning and Enterprise application integration) and Bokanyi consulting to provide edge in SAP area. Currently, enterprise applications and ISMAC (internet of things, Social, mobile, Analytics, cloud) business contribute 38% and 46% respectively to the topline. The company derives approximately 90% of its revenue from USA, by far the largest market by size and spending. It is working in onshore and offshore model with former contributing 86% of revenue and latter 6.3%; and rest is by domestic revenue. It also strengthened European operations by opening an office in Ireland.

Kelton has a diversified client base with Information and services contributes highest of 32.44% to the pie, followed by energy and utilities (14.9%), healthcare and lifesciences (13.7%) and energy and utilities (11.41%). The company has been consistently able to add clients over the quarters to augment its client base and its client include headcount. Company aims to become USD 306 mn company by 2019 led by strategic acquisition and consolidation in business unit across functional domain. Factoring in the growth, the TTM P/E of 21.3 looking comfortable and even after acquisitions the company had debt equity ratio of 0.6x.

2.    Deep Industries

Deep Industries has the first mover advantage and enjoys leadership position in outsources gas compression business. Deep Industries is one of the first companies in India to provide high pressure natural gas compression services and gas dehydration services on charter hire basis. With crude oil having recovered from its low and government taking initiatives like development of shale gas policy framework, import of LNG, exploration in the mining lease area with certain conditions and acquisition of overseas oil and gas assets, we see a great demand supply gap to be bridged.

The company’s gas compressors and rigs client base is increasing per year. Recently Deep was awarded the contract of Rs 2468 million in gas dehydration business. ONGC being a main client enjoys 80% of the pie of current order book of Rs 875 crore and awaits the result of bid worth Rs 600 crore from PSU and other private players.

On financial Front, we can see revenue growth of 67 per cent to Rs 169 crore in FY16 while operating profit margin was up by whooping 1200bps to reach 57%. Company expects to sustain the same trend in revenue and profit margins. Deep Industries enjoys PEG of 0.89.

The company aims at increasing market share in gas compression business, expanding rig business, expansion on assets by catering new opportunities while maintaining margins. Promoters have also increased their holding from 70 per cent to 75 per cent in coming year which increases our confidence in the stock.  With long term contracts with ONGC, GSPL, OIL, NIKO Selan, RIL, ESSAR & Cairn, company has huge growth potential. At FY16 EPS of 14.02, the P/E ratio is 12.2 a significant discount compared to Gagan and Gujarat Gas of 53.9x and 71.8x respectively.

3.    BEML

BEML has its three key business movers in place to be a growth stock - Metro, Mining and Defence. BEML being the low cost player to supply coaches and metro cars, company has an ocean of opportunity in Metro projects. Recently, BEML bagged contract of Rs 900 crore from Kolkata Metro. BEML has increased visibility on metro orders with Delhi, Bangalore phase 1, Jaipur and Kolkata on its plate and company is heavily booked up to 2018-2019.

On mining side, BEML is focusing on exports on mining equipment targeting African continent because of encouraging lines of credit. The company’s 53-54 per cent revenue comes from mining, 11 per cent from defence and 30 per cent from railways. BEML has improved expenditure cost and aims on same line of action going forward. BEML’s order book stands at Rs 6500 crore which is 2.18x of the FY16 revenues and company is fully occupied till 2020. On the defence segment too, the company expects double fold growth backed by ‘Make in India’ campaign.

On Financial front, BEML had reported moderate increase in sales of 4% and PAT by over 700% due to reduction in debt. We believe it is at the juncture of embracing growth and will see sales improve in high single digit and this will percolate in better earnings compared to its peers TATA Motors, Ashok Leyland and Escorts.

4.    Alembic Pharma

Alembic Pharma being a market leader in the macrolides segment of anti- infective drugs in India and has been witnessing 3 year CAGR topline growth of 27%. It is a leading pharmaceutical company in India. Company generated 85 per cent of revenue from US market in FY16 and rest pie from other global geographies. Alembic Pharma’s Indian branded formulation business in India and international formulation business grew by 12 and 20 per cent respectively. The Vadodara-based company expects to grow at the CAGR of 15 and 30 per cent in the domestic and international market under the brand formulation respectively over next few years. Till date the company has filed 76 products, received 47 approvals and launched 29 products in the market. The company also launched 18 products till date since last fiscal year through its own front end in the US.

The company aims capex of Rs 400+ crore in FY17 and also targets to spend additional Rs400+ crore on R&D activity. Alembic’s focus is on new product launches and continued spend on capex and R&D t augment its position. This can affect dividend payout and stretch profit margins in short term however in long run race we believe company’s investments are going to bear sweets fruits on back of growing demand in Indian and global market.

Alembic Pharma enjoys higher standalone net profit margin and operating profit margin of 23.33 and 33.01 per cent respectively as compare to CIPLA and Natcopharma. The pharma major also looks attractive at P/E of 14.65x as compare to peers CIPLA (27.84x), Sun Pharma (33.93x) and Natco Pharma (58.18x). There has been recent share price correction and we believe it is a good entry point.

 

 

5.    Ujjivan Financial Services

Ujjivan financial Services is operating in an NBFC space and enjoys market share of 11.15% by AUM. The company recently had an initial public offering and the issues was subscribed more than 40 times. With government impetus on small finance banks and increasing rural inclusion there is huge potential to grow.

We believe company with its PAN India presence, strong management and risk management systems in place, Ujjivan will be able to ride on the micro finance growth. Company is structurally fit to embrace the opportunity of Small Finance bank for which it is one of few to receive the license.

With strong customer base of over 3.05 million active customers as of March 2016 and 86.3 customer retention ratio, company is expanding fast. The company's gross AUM is Rs 53.89 billion spread across 24 states and 209 districts. Company enjoys 11.15 per cent market share. Ujjivan has shown increased growth momentum in last five years, both in terms of customer and AUM.

The company expects robust growth in AUM's of MFIs. with CAGR of 30 per cent over FY17-18E. Ujjivan also enjoys 7 per cent AUM share in MFI Industry which is high as compare to Equitas (5 %), ESAF (2%), Utkarsh (2%); as per a CRISIL research Report. The company has aims at going beyond this market share in coming years. Company also focuses to target under banked districts with 91 currently on its plate. It is third largest NBFC- MFI in India in terms of loans disbursements as of Sep 2015. Company also enjoys a low cost to income ratio at 51 per cent in FY16. Ujjivan enjoys healthy operating margin at 68.16 per cent in Q4FY16 and this increased bottom line to Rs 54.91 crore in Q4FY16. Net interest margins is at healthy 12.3 per cent in FY16 with Net interest income of Rs 5099 crore.