The common wisdom among most professional investors right now is that growth stocks are overvalued.
If you look at the top-tier big-name growth stocks, there is some truth to that. The coronavirus stocks like Zoom Video Communications Inc. (NASDAQ: ZM), DocuSign Inc. (NASDAQ: DOCU), Amazon.com Inc. (NASDAQ: AMZN), PayPal Inc. (NASDAQ: PYPL), and others are indeed at nosebleed valuation levels.
These stocks have seen a massive upswing as we all stayed home more and looked for ways to avoid the virus. While they are all wonderful businesses, many of them currently trade for multiples of sales and cash flows that would make the Internet bubble stocks of the late 1990s blush with envy.
As big a story and as exciting as the coronavirus stocks have been, they are not the whole American business story. There are still plenty of companies that are growing cash flows and earnings at a robust pace…
The businesses may not be as exciting, but ultimately the profits earned by these companies’ owners should be fantastic.
Rather than using price/earnings ratios to value the best cheap growth stocks, we find that price to free cash flow is a much more accurate indication of value.
A good accountant can make earnings per share pretty much whatever their boss wants it to be… but cash flow numbers are almost impossible to fudge.
We want to buy companies that are growing free cash flows at a high rate and are trading at reasonable multiples of the cash the business is producing.
Specifically, we want stocks to buy with less than 10 times free cash flow.
By comparison, most sectors of the S&P 500 trade for 20 times or more.
Here are three of the best cheap growth stocks to buy now…
No. 3: The Best Cheap Growth Stock for the Building Boom
Beacon Roofing Supply Inc. (NASDAQ: BECN) is a perfect example of an undervalued growth stock in today’s market. Beacon sells roofing supplies and related materials like siding windows and doors. It is not exciting, and it’s not flashy.
It is a great business.
We have a building boom going on in the United States, and it’s not going to end soon. We had a shortage of houses before the pandemic hit, and the almost panic level of home buying as people fled dense urban areas has made it worse.
Beacon has been growing free cash flow by 25% a year for the past five years, while sales have increased by 22% annually.
The fourth quarter was a record quarter for profits as demand for Beacon’s products continued to grow. Earnings exceed analyst estimates for the fourth quarter in a row, and Wall Street is scrambling to raise forecasts for 2021 and 2022 profits.
Despite the company’s outstanding performance and the increased prospects, BECN shares traded for just 5.9 times free cash flow right now.
No. 2: This Growth Stock Is Dirt Cheap
Patrick Industries Inc. (NASDAQ: PATK) is also in what can be considered a very boring business.
The company makes component and building products for the Recreational Vehicle, Marine, and Manufactured Housing industries.
This includes world-changing things like countertops, bathroom fixtures, cabinets, and other fancy material to put in your RV or boat.
These are pretty boring things to make and sell, but Patrick Industries is a market leader in everything it sells. Sales have been growing by 26% a year for the past five years, and free cash flow has increased by over 30% annually.
Patrick Industries has posted four consecutive positive earnings surprises, and Wall Street has raised estimates for 2021.
In spite of the great numbers and projections, you can buy the stock for just 9.4 times free cash flow right now.
No. 1: The Best Cheap Growth Stock to Buy Now
Sprouts Farmers Market Inc. (NASDAQ: SFM) is a fantastic store that sells fresh and organic groceries in 350 stores in 23 states nationwide.
It emphasizes fresh, healthy foods, which has been very well received in recent years. People are more health-conscious today than ever before, and Sprouts benefits from that trend.
Sprouts aims for a farmer’s market-type experience in its stores. The company hosts events and puts on healthy eating workshops to attract and retain customers. It has been working as Sprouts is increasing its market share a little at a time, and it’s growing sales and cash flows rapidly.
In the future, Sprouts plans to open 300 to 400 new stores in expansion markets. These markets include California, Florida, Georgia, New York, and Texas. To support that growth, the company has already added distribution centers in California, Georgia, and Texas.
Sprouts plans to add new distribution centers in Florida and Colorado in 2021 and a new mid-Atlantic center in 2022.
This is a tremendous growth story, with free cash flow growing by more than 25% annually. It is not a stay-at-home technology or 5G story, so very few investors seem to care.
That’s exactly where the opportunity lies, however, as you can buy shares of SFM for less than eight times free cash flow right now.
— Money Morning Staff
Source: Money Morning