Generally speaking, growth stocks are expensive. They trade for high multiples of everything, with prices based on potential rather than current results. Paying up for a growth stock makes sense if the price is reasonable based on the company’s growth prospects, but unchecked optimism can sometimes push growth stock prices beyond reason.
Occasionally, a growth stock falls out of favor. When that happens, the stock may start looking more like a value stock, even though the above-average growth potential is still there. Three of our Motley Fool contributors think Cypress Semiconductor (NASDAQ:CY), Skechers (NYSE:SKX), and Teva Pharmaceutical (NYSE:TEVA) fall into this category. Here’s what you need to know about these deep-value growth stocks.
A new commodity in the making
Nicholas Rossolillo (Cypress Semiconductor): After several years getting back on track, Cypress Semiconductor is a viable growth company again. Once a seller of commoditized chips, the company has transformed itself into a specialized maker of semiconductors for the burgeoning connected device movement, especially in the connected auto, industrial equipment, and consumer goods industries.
Year to date, Cypress’ revenues are up 7.1% compared with the first half of 2017. The company just recently returned to profitability — posting $0.10 in earnings per share after two quarters in 2018 as compared to an $0.18 loss last year — as is reflected in its 12-month-trailing price-to-earnings ratio of 356. When using 12-month forward expected earnings, the stock’s price to earnings is a mere 10.8. Price to free cash flow — money left over after basic operations and capital expenditures are paid for — is only 13.8.
That’s not bad considering the modest growth posted so far in 2018 and management’s expectation that sales will accelerate to 8% to 13% during the third quarter. That will help profit margins increase even more, and gives Cypress’ stock a PEG ratio of only 0.5 as of this writing. The PEG ratio measures the relative value of a stock’s expected earnings growth, and a ratio of less than 1.0 typically indicates shares are undervalued.
If all of that isn’t compelling enough, Cypress also pays a healthy dividend of 2.5% a year as an added bonus. The best reason to own this chipmaker, though, is the growing demand for connection-enabling semiconductors in just about everything. That could be a strong tailwind for Cypress for years to come.
A tumbling shoe stock
Tim Green (Skechers): Cycles of optimism and pessimism have pushed shares of footwear company Skechers up and down over the past few years. A dramatic surge in 2014 and 2015 came to an end when growth started to slow, dooming the stock to trade sideways for the better part of two years. It then recovered in late 2017 as growth picked up again, but a series of disappointing reports sent the stock tumbling anew.
Skechers is still growing, with revenue up 10.6% year over year in the second quarter. But the bottom line is lagging. Earnings per share fell by nearly 24% thanks to the company’s continued spending on growth initiatives. That’s a legitimate reason to be concerned, especially with the potential for a trade war to crimp demand.
But the stock price reflects these issues. Skechers stock trades for 14 times the average analyst estimate for 2018 earnings after backing out the net cash on the balance sheet. And remember, that ratio is based on earnings that are depressed by spending that has yet to bear fruit. If Skechers’ investments in its international and direct-to-consumer businesses pay off, earnings could rise considerably in the next few years.
Skechers is still a growth stock, but it’s trading like a value stock. The next few quarters may be a bumpy ride for investors, but I think the stock will eventually recover.
A turnaround story
Todd Campbell (Teva Pharmaceutical): Teva Pharmaceutical’s investors suffered setbacks following the company’s nearly $40 billion acquisition of Allergan’s (NYSE:AGN) generic drug business; the launch of a competing biosimilar to its best-selling drug, Copaxone, by Mylan (NASDAQ:MYL); and pushback on pricing.
However, there’s reason to believe this company is worth adding to portfolios. The company’s price-to-book and price-to-sales ratios remain near their lowest levels since 2000, despite a recent run-up due to Warren Buffett’s Berkshire Hathaway (NYSE:BRK.B) buying shares.
Berkshire Hathaway is known for its bargain-hunting savvy, and although Teva Pharmaceutical’s shares have rallied 80% since Berkshire first added Teva Pharmaceutical to its portfolio, Berkshire Hathaway still bought 2.7 million shares of it in the second quarter.
Clearly, there’s hope that Teva’s struggles will prove temporary. A restructuring to improve profitability that’s expected to wrap up next year should save $3 billion annually, and although Copaxone will be a drag on revenue because of new competition, Teva Pharmaceutical has a decision coming up in September from the U.S. Food and Drug Administration on a migraine drug, and phase 3 results on a pain drug are also expected soon.
Importantly, demographic tailwinds supporting demand for generic drugs are improving. Seniors fill two times the prescriptions of younger Americans, and aging baby boomers are forecast to nearly double the over-65 population in the U.S. by 2050. If so, Teva Pharmaceutical’s generic drug sales should benefit.
It’s anyone’s guess if Teva Pharmaceutical’s restructuring will succeed or how long Berkshire Hathaway will hold onto its shares, but I think the odds of this being a profit-friendly investment for long-term investors are good enough to add this company to portfolios.
