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UBS picks the best growth stocks to back for the new financial year

It’s a tough time for bargain hunters as so-called “value” stocks that are trading at a discount to the market continue to underperform their more expensive “growth” peers.

Value stocks tend to outperform at a later stage of a bull market, but someone must have forgotten to tell them that!

You only need to look at the best non-resources blue-chip performers over the past three months to see what I mean as those with high price-earnings (P/E) multiples dominate the leaderboard.

These include Aristocrat Leisure Limited (ASX: ALL), CSL Limited (ASX: CSL), REA Group Limited (ASX: REA) and RESMED/IDR UNRESTR (ASX: RMD), more commonly called ResMed.

But experts have been warning about buying high P/E stocks this late in the cycle as they are particularly sensitive to any bad news. In a market sell-off, which could happen at any time given the increase in volatility, these stocks will be the first to get dumped.

UBS is also concerned about the valuation on many of these market darlings although the broker doesn’t think growth stocks will be handing the baton over to value quite just yet.

On that note, it might be worthwhile looking at stocks in the S&P/ASX 100 (Index:^ATIO) (ASX:XTO) with a good growth profile but that have lagged the rally of the market darlings – a group that’s better known as GARP, or growth at reasonable price.

“We restrict ourselves to the ASX 100 ex-mining and metals and ex-REITs universe and filter on a price-for-growth basis,” said UBS.

“While somewhat arbitrary we have used a cut of no more than a 20% PE premium to the industrials ex-financial universe which equates to a cut-off of circa 22x one-year forward earnings.”

The broker also added four filters to screen the best GARP stocks. It looked at the three-year price-earnings growth (PEG) ratio, the 12-month expected return based on UBS’ estimates, the stock relative P/E to its 10-year history and its earnings per share (EPS) revision momentum, which means it only included stocks with upward earnings revisions.

Based on these screens, toll road company Atlas Arteria Group (ASX: ALX) came out tops, with insurer QBE Insurance Group Ltd (ASX: QBE) and energy company Origin Energy Ltd (ASX: ORG) taking the second and third spot, respectively.

Other GARP buys worth highlighting are chemical and explosives maker Orica Ltd (ASX: ORI), share registry services group Computershare Limited (ASX: CPU) and engineering and construction firm Downer EDI Limited (ASX: DOW).

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Motley Fool contributor Brendon Lau owns shares of Aristocrat Leisure Ltd. The Motley Fool Australia has recommended Computershare, REA Group Limited, and ResMed Inc. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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