3 stocks primed for over 10% sustainable EPS growth

What does Warren Buffett have to say about 'growth investing,' and are these companies undervalued?

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Far too often investors feel they need to choose between 'growth' or 'value' investing when in truth, the distinction is arbitrary. As Warren Buffett asks in his 1992 Letter to Shareholders: "What is investing if it is not the act of seeking value at least sufficient to justify the amount paid?"

It is therefore essential that investors consider likely earnings growth when investing. However, growth alone is only part of the equation. To quote Buffett again [my emphasis], "business growth, per se, tells us little about value. It's true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain."

And what is the main (but not only) factor that decides whether growth has a spectacular impact on value? "Growth benefits investors only when the business in point can invest at incremental returns that are enticing," says Buffett. As a starting point for further research, here are six companies that are likely to grow profits over 10% in FY2014, and will likely be able to reinvest some of those profits at enticing returns.

M2 Group Ltd (ASX: MTU) is an asset light telecommunications company that in large part just resells internet connectivity to retail customers. The company is quite indebted, and its assets are largely intangible. Over the last year, M2's share price has drastically under-performed compared to telcos with less debt and better assets, such as Vocus Communications Limited (ASX: VOC) and TPG Telecom Ltd (ASX: TPM).

In comparison, there's no doubt that M2's business has not performed well. Indeed, it is quite ironic that the share price is now lower than six months ago, despite the fact that the business is better: the acquisitions have boosted earnings, and the company has started to pay down debt. For the first half of FY 2014 profit was up about 25%, thanks mainly to recent acquisitions. This nearly guarantees earnings growth of over 10% in 2014, and it's likely that acquisition synergies and organic growth will allow the company to grow earnings by at least 10% per annum for the next few years at least.

CSL Limited (ASX: CSL) is a $32 billion company that provides blood plasma products designed to treat a range of diseases. By and large, demand increases with an ageing population, and CSL's constant innovation allows it generate sales from new products. The company's distribution network and intellectual property give it a competitive advantage, and the ageing population affords it a long-term tailwind.

In the first half of FY 2014, the company was only able to grow profits by 2% on a constant currency basis – so how could earnings per share grow 10% this year? The answer is by buying back shares. In order to return capital to shareholders, the company uses its formidable cashflows to purchase its own stock. Personally, I think that it shouldn't be buying shares when they are expensive, so I would view it as a positive for long-term holders if the share price continues to fall. The forecast is for 7% earnings growth over FY 2014 but combined with share buy backs, the total earnings per share growth should be at least 10%.

Software company Global Health Limited (ASX: GLH) provides electronic medical record software (as a service) to psychologists, psychiatrists, and other allied health professionals. In addition to that, it also provides software to a number of hospitals, although growth in that business is a bit harder to come by.

Global Health is likely to grow earnings by well over 10% because of operating leverage (it has only recently become profitable) and because electronic record keeping makes life easier for health professionals. Revenues are fairly sticky, and as long as the company continues to win new customers earnings should grow for years to come. In any event, the first-half profits strongly suggest the company will see profit growth of at least 15% in FY 2014. Traders, speculators and bandwagon investors are selling their shares as a result of the broader tech sell-off and the loss of share price momentum, not because of a change to the business itself. In my opinion, this gives long-term investors an opportunity to buy shares at the reasonably attractive price of 59c (though I'm holding out for a lower price).

Foolish takeaway

I think these three companies are fairly attractively priced. Indeed, a few months ago I bought shares in Global Health at 57.5 cents each, though my average buy price is considerably lower. M2 telecommunications has seen its share price bounce 2.5% today, but if the sell-off continues a bit longer, I could easily see it becoming a compelling buy. Meanwhile, CSL Limited has some way to fall before I'd consider buying shares, but it's hard to go past for investors looking for a blue-chip stock. Of these companies, I believe Global Health and CSL will find it easiest to continue to profitably reinvest in their existing businesses.

Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Vocus Communications and Global Health.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »