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Growth is the new value (SDGL.OB, AIRI.OB)
Topics: airi, sdglI’m generally a value investor. I love a great balance sheet and fat dividends even if the underlying business shows little growth. But as the economy weakens, it seems that many of these are just value traps, and the true values are in what are traditionally called growth stocks.
At least for microcaps, the growth premium is as small as it has ever been. There are scores of promising companies that can be bought at valuations just slightly higher than their stodgy, underperforming counterparts.
Ideally, here are the criteria I like to see:
- strong year-over-year sales growth
- low, or at least reasonable price-to-sales and enterprise value-to-sales ratios (a nod to my value side)
- UPOD: under-promise, over-deliver. Executing on a fixed strategy is very important to both future growth prospects and management credibility.
- positive earnings. I don’t need to see huge earnings growth, as long as revenues are moving. But if margins are slipping I want it to be for a strategic reason, not because the company was forced to discount or had too much inventory, etc.
- No debt handcuffs. That means that debt must be manageable in amount, maturity and covenants. If its not shareholders will be diluted.
- Reasonable year-over-year growth in the # of shares. Why buy shares in a 50% grower if its share count is also growing by 50%? Obviously this consideration has to be flexible where acquisitions are involved, but beware of huge option grants.
Two examples of growth gems are Secured Digital Applications (SDGL.OB) and Air Industries (AIRI.OB).
Secured Digital, a microcap provider of mobile communications services and business process outsourcing (BPO), just announced stellar 2007 earnings. Revenues grew 30% year-over-year to $47.7 million, and net income grew a whopping 147% to $1,622,621. SDGL reaffirmed its previously announced 2008 revenue forecast between $55 - $60 million and net income in the range of $2.5 – $3.5 million.
What kind of multiple would you be willing to pay for that growth? Yahoo! indicates that the market cap. is only $16.89 million, giving Secured Digital a price-to-sales ratio of less than 0.4 on 2007 revenues and around 0.3 on 2008 projections.
Aerospace equipment manufacturer Air Industries also reported strong results this week. Net sales increased to $46.1 Million, up 40% year-over-year (versus a market cap. of only $16.59M). Gross profit margin shot up from 15.2% to 27.6%. While net income was only $627,900, at this trajectory it should grow pretty quickly. Air Industries has a record backlog, and that’s before the pending acquisition of Blair-HSM, which could add another 30% to revenues. Sure, there is some debt, but it appears manageable.
With stocks like AIRI.OB and SDGL.OB trading at such cheap prices, why bother with no-growth companies?
DISCLOSURE: Long AIRI.OB and SDGL.OB.
You say that you only like stocks with reasonable year-over-year growth in the # of shares, but both of the stocks you recommend have diluted their shares outstanding 40% and 369% respectively in a 5 year period effectively imprisoning these stocks to a rangebound pergatory. Steer clear of these “growth” stocks IMO.
@Jeff: While I’d prefer 0% share growth, 40% over 5 yrs is not out of line with most growth stocks. For example, Apple had 367M in 2003 and now has 875M. As you point out, AIRI is much higher. That’s because they used shares for transformative acquisitions.
So to clarify you don’t automatically reject a stock if it has 50% or close to 50% year-over-year growth in shares if the purpose for such dilution is in the name of the companies growth. Also quick question. SDGL’s margins look thin well below the industry average, is this as well as their high capital expenditures typical growth stock characteristics?
@Jeff: you are correct - I listed some of the metrics I look at, but I try to put each one in context. I don’t use any particular formula or screen as an acid test. Where shares are used to fund acquisitions I want to look at whether the acquisitions make the company stronger, whether the deals were structured efficiently (shares vs cash), and whether the company overpaid. For AIRI, I think its recent acquisitions were wise for the reasons discussed in prior articles. Regarding your question on margins and capital expenditures, they are secondary metrics for growth stocks, less important to me than whether revenues and income are demonstrating strong absolute growth.