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Picking Growth Stocks with More Room to Run

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It’s perhaps a little early to be talking about emerging from the pandemic, but certainly the economy does appear to be emerging. Whether it’s because of the timely stimulus or the strength in the economy when the pandemic hit, or the resilience of companies as they dealt with the crisis, or any combination of these factors, it is a fact that the earnings picture continues to improve.

And that isn’t just true for the S&P 500. A growing number of small and medium-sized companies are also reporting stronger numbers and seeing upward revision in their estimates.

But with so many companies coming out of the blues, how do we select the best? And how do we know if they have the firepower to meet the demand that continues to unfold? Especially since safety measures have been inflating operating costs for a while now and are likely to remain that way in the next few quarters.

So while I maintain that growth stocks must have revenue growth prospects (a strong demand environment that plays to the company’s strengths), in this environment, it’s a good idea to also check balance sheet strength.

One of the main things I check to determine balance sheet strength is the debt-cap ratio. Larger companies may be in a position to operate well enough even when they have a big debt load to service. But I always think that for the majority of companies, the additional risk is avoidable. Of course, growth stocks often refer to companies that are not mature. So, it’s understandable that they may need to raise cheap capital to fund the growth. And that’s fine. As long as the debt-cap ratio is under 60%.

Another thing I look at is the current ratio because it gives you an idea about the company’s liquidity. If a company has a low debt-cap but insufficient liquidity, it wouldn’t be able to function effectively and would perhaps not be able to fund its growth.

And, if a company has a low debt cap and current ratio that’s at least over one, it shows that the company is generating enough cash for its day-to-day operations.

Combining these criteria with the usual things we see, which are the Zacks Rank, the Growth Score, the most recent earnings beats, the estimate revision trend and the growth forecast gives you a list of stocks that are better positioned to grow. If the valuation also supports, these stocks are sure to outperform the market.

Here are a few examples-

Avnet, Inc. (AVT - Free Report)

Avnet is one of the world’s largest distributors of electronic components and computer products.

The Zacks Rank #1 (Strong Buy) company belongs to the Electronics - Parts Distribution industry, which is in the top 2% of Zacks-ranked industries. While the digital revolution has had a positive impact on most tech players, AVT shares have not appreciated as much. In fact, the company is trading at 13.1X forward earnings, which is below the tech sector’s 26.9X multiple and also below its own median level of 16.2X over the past year.

However, Avnet’s surprise history is super-impressive. In the March, June and September quarters, it beat the Zacks Consensus Estimate (an average of analyst expectations) by 31.0%, 1300.0% and 200.0%, respectively.

In the last 30 days, the fiscal 2021 (ending June) earnings estimate has jumped 24 cents (15.2%) while the 2022 estimate has jumped 34 cents (14.7%).

Avnet has been around for a while, so it’s extremely unlikely that the pandemic will have any lasting impact on its business. But it’s still worth noting that its debt-cap ratio is a mere 24.0% while its current ratio is 2.39X.

Management said on the earnings call that Texas Instruments transitioning away from Avnet will continue to negatively impact revenue next year although the rest of the business will continue to grow. And earnings will grow regardless, both this fiscal year and the next because of operational efficiencies.

The shares dropped on the news but the TI impact is temporary and the rest of the business remains very strong. So the shares have started appreciating again (up 10.6% in the last week).

The company has a Growth Score B and Value Score B.

Ultra Clean Holdings, Inc. (UCTT - Free Report)

The company is a developer and supplier of critical subsystems for the semiconductor capital equipment, flat panel, solar and medical device industries.

The Zacks Rank #1 company belongs to the Electronics - Manufacturing Machinery industry, which is in the top 22% of Zacks-classified industries. It is trading at a forward earnings multiple of 8.9X, which is below the tech sector’s 26.9X and also below its own median value of 13.2X.

The company’s surprise history is consistent, topping estimates in each of the last three quarters by a respective 26.8%, 66.7% and 14.1%.

In the last 30 days, the fiscal 2020 earnings estimate has jumped 28 cents (11.6%) while the 2021 estimate has jumped 45 cents (18.0%).

Revenue is expected to be up 30.5% this year, improving 9.5% in 2021. Earnings are also expected to grow, jumping 196.7% this year and 9.4% in the next.

Its debt-cap ratio is 34.5% and its current ratio is 2.6X. So there’s sufficient liquidity and flexibility to navigate through the current environment and grow.

The shares are up 9.3% appreciation over the past month and there’s much more room to run.

The company has a Growth Score A and Value Score B.

Alpha and Omega Semiconductor Limited (AOSL - Free Report)

The company designs, develops and distributes a broad range of power semiconductors globally, including Power MOSFET and Power IC products.

The Zacks Rank #2 company belongs to the Electronics – Semiconductors industry, which is in the top 9% of Zacks-classified industries. It is trading at a forward earnings multiple of 13.4X, which is below the tech sector’s 26.9X and also below its own median value of 18.7X.

AOSL’s surprise history is consistent, topping estimates in each of the last three quarters by a respective 175.0%, 61.1% and 7.8%.

In the last 30 days, the fiscal 2021 earnings estimate has jumped 41 cents (29.9%) while the 2022 estimate has jumped 26 cents (15.6%).

Revenue is expected to be up 26.5% this year, improving 4.1% in 2021. Earnings are also expected to grow, jumping 102.3% this year and 8.2% in the next.

The company has a debt-cap ratio of 21.6% and its current ratio is 1.7X. So there’s sufficient liquidity and flexibility to navigate through the current environment and grow.

Despite the 20.4% appreciation in shares over the past month, they remain undervalued.

The company has a Growth Score A and Value Score B.

Healthcare Services Group, Inc. (HCSG - Free Report)

Healthcare Services Group provides housekeeping, laundry, linen, facility maintenance and food services to the health care industry, including nursing homes, retirement complexes, rehabilitation centers and hospitals.

The Zacks Rank #2 (Buy) company belongs to the Business – Services industry, which is in the top 37% of Zacks-classified industries. The company is trading at 19.6X forward earnings, which is below the Business - Services sector’s 30.3X multiple and also below its own median level of 21.6X over the past year.

The company’s surprise history is consistent, topping estimates in each of the last three quarters by a respective 8.0%, 19.2% and 37.0%.

In the last 30 days, the fiscal 2020 earnings estimate increased 8 cents (7.1%) while the 2021 estimate increased by a penny.

Revenue is expected to be down 4.0% this year, improving in 2021. But the 39.1% increase in 2020 earnings will drop off significantly next year as the business normalizes.

This may have brought share prices to the current attractive level.

The company has no debt and its current ratio is 4.0X. So it has significant liquidity and flexibility in navigating through the current environment.

The company has a Growth Score A and Value Score B.

Lifetime Brands, Inc. (LCUT - Free Report)

Lifetime Brands is a leading designer, marketer and distributor of kitchenware, cutlery & cutting boards, bakeware & cookware, pantryware & spices, tabletop and bath accessories.

The Zacks Rank #2 company belongs to the Consumer Products – Discretionary industry, which is in the top 20% of Zacks-classified industries. It is trading at a forward earnings multiple of 13.4X, which is below the Consumer Discretionary sector’s 31.8X and just above its own median value of 11.1X.

After missing the Zacks Consensus Estimate for two straight quarters, Lifetime Brands came back strongly to beat the June and September quarter estimates by 58.3% and 30.0%, respectively.

In the last 30 days, the fiscal 2021 earnings estimate has jumped 18 cents (26.1%) while the 2022 estimate increased a couple of cents.

Revenue is expected to be up 2.9% this year, improving 2.6% in 2021. Earnings are also expected to grow, jumping 93.3% this year followed by 23.0% in the next.

The company has a debt-cap ratio of 55.4% and its current ratio is 1.99X.

The shares are up 7.9% in the past month and there’s room for further appreciation.

The company has a Growth Score A and Value Score A.

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