We examined the 500-plus holdings in the Morningstar US Growth Index and found some stocks with good growth prospects selling at reasonable valuations.
By Karen Wallace | 03-07-18 | 05:00 AM | Email Article

Growth companies are generally thought of as high-quality firms with an above-average chance of growing their earnings faster than industry peers or the market as a whole. That growth can come at a price, though, with these stocks often trading at high price/earnings and book/value ratios.

Karen Wallace is a senior editor with Morningstar.com. Follow her on Twitter @KarenW60602.

But paying a high price for growth isn't always a great idea. If there is no margin of safety (in other words, a discount to the stock's fair value estimate) built in to the share price, everything has to go smoothly in the company’s growth path in order to justify the premium valuations. 

That's why it's important to be valuation-conscious when growth investing. Sometimes referred to as "growth-at-a-reasonable-price" investing, this philosophy strives to combine strong earnings growth prospects and good value. A quarter or two (or even three) of disappointing earnings may cause an erstwhile growth darling to be shunned by momentum investors, at which point the stock may look more enticing to a GARP-style investor. Like value investors, growth-at-a-reasonable-price investors are usually looking for companies whose shares are temporarily depressed, but that have some catalyst for growth in the works. GARP investors are sensitive to high prices--they hunt for stocks that feature lower than average price multiples than those of more traditional growth stocks.

To find some companies that might appeal to growth-at-a-reasonable-price investors, we examined the more than 500 constituents of the Morningstar US Growth Index. First we removed companies that our analysts do not cover. Then we focused only on firms that have economic moats of wide or narrow, which means our analysts think the company has a durable competitive advantage that will allow it maintain its profitability over the long term. Finally, we sorted the stocks that passed our screen by lowest price/fair value to find the 10 cheapest growth stocks. The results are listed, along with some highlights from our research reports on three of the companies.

In the middle of the last decade, Imax reinvented itself by embracing the digital video revolution, allowing the firm to digitally remaster blockbuster films into its proprietary large-screen format, says equity analyst Neil Macker. As a result, Imax is now the dominant player within the premium large-format cinema marketplace and, in Macker's view, has carved out a narrow economic moat. 

Imax has become more asset-light in recent years: It's now primarily a technology hardware and brand-licensing company that does not operate the vast majority of Imax theaters. Instead, the firm generates revenue by selling and leasing the required proprietary equipment and via fees for digitally remastering standard films into the proprietary Imax format, Macker said. At a 30% discount to our fair value estimate, we think the stock offers an attractive entry point to investors.

 Under Armour
Analyst John Brick assigns Under Armour a narrow economic moat rating for its brand-intangible asset. The primary factor behind our rating is the company's well-respected brand, with a reputation for performance and innovation, which has resulted in pricing power, Brick says. 

Our narrow moat rating assumes retailers continue to support the brand as an alternative to Nike and Adidas, the number-one and -two players in the space. Brick views this brand presentation as reinforcing the company's intangible asset moat source, with the strength evident in its returns on invested capital, which have averaged 17% annually over the past five years, outpacing our 9% cost of capital estimate. Brick expects Under Armour to return toward 10% over the next few years and generate excess returns for shareholders. At a 25 discount to our fair value estimate, the shares look undervalued. (Read more on Under Armour's valuation here.)

 Biomarin Pharmaceutical
Commercialization and research and development expenses have kept BioMarin in the red. But healthcare sector strategist Karen Andersen remains confident in the profit-generating power of the company's rare-disease treatments. She views the firm's orphan drug focus and productive pipeline as warranting a narrow moat rating.

In the long run, Andersen says, the firm is still guiding to a top-line growth rate around 15% through 2020 and expenses shrinking as a percentage of sales, with products like achondroplasia drug vosoritide and hemophilia A gene therapy val-rox driving stronger growth beyond 2020. She expects midteens growth in 2018 and 2019, with an increase in growth likely in 2020 as vosoritide and val-rox could launch. 

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