By Jacob Sonenshine
Growth stocks are getting hammered by soaring bond yields.
That doesn't mean to scratch all of those fast-growing companies off your shopping list -- of course not. Just like with any selloff, the smart move is to look for the deals.
The deals are the names that are undervalued -- those that appear less expensive relative to their earnings potential.
First off, long-dated bond yields have taken a wrecking ball to the growth side of Wall Street. The Nasdaq Composite, comprised heavily of fast-growing tech companies, is down almost 7% from its record high, hit in December.
Those higher bond yields make future profits worth less, hitting valuations hard since these companies are valued on the basis that most of their profits will come years in the future.
That's what makes buying a brunch of them tempting. The idea is that once yields stabilize, so will valuations. From there, as earnings rise, the stocks should move higher.
In reality, it may not be so simple.
The Nasdaq is still really pricey, trading at 27 times analysts' aggregate expected earnings for the coming 12 months. That's still closer to the high end of its range in the past three years, according to FactSet, and it's several points above where it was when yields rose to this level back in October 2023.
That's why, instead of buying the Nasdaq outright, you should buy the names that look undervalued.
Citi strategists created a list of growth deals for bargain hunters.
Their criteria: companies with market capitalizations of at least $5 billion with analysts' estimates free cash-flow growth for the next three years that imply that their market caps "should" be above where their market caps are today.
Put more simply, Citi identified companies that are valued too low -- assuming analysts are fairly accurate in their forecasts.
Eight of the stocks: Pinterest, Etsy, DoorDash, Advanced Micro Devices, Adobe, Entegris, Corning, and Vertiv.
Vertiv is a 4$5 billion company makes products for AI data centers. As demand for artificial intelligence ramps up, so will the buildout of data centers -- and demand for Vertiv's equipment.
That's why analysts expect Vertiv to grow sales by just over 15% annually to $12.1 billion by 2027, according to FactSet, with the highest growth coming from its data-center business, which makes up the majority of its revenue.
That should drive profit growth even faster. Vertiv is one of just three companies that provides this equipment. It usually has strong pricing power and should see sales grow faster than its cost of products, employee pay, and marketing expenses, all culminating in rising profit margins.
That's why, even with management's ramp-up of capital investments, free cash flow is expected to grow 27% annually though 2027, to $2.06 billion.
That growth, if sustained for a few years, could bring the company's market value to closer to $50 billion, according to Barron's calculations of FactSet data.
The caveat is that Vertiv may not sustain that growth beyond the next three years as the growth of AI-related spending slows, but Vertiv still looks like an interesting trade. The growth isn't slowing down any time soon, so as long as the company reports earnings in line with or better than analyst's expectations this year, the market may bid the stock higher.
Corning, the $40 billion glass and basic materials maker, is another example. The company sells to telecoms, auto makers, and data centers -- one of its fastest-growing parts of its optimal communications segment. Analysts expect that segment to grow over 17% annually over the next few years, bringing total revenue up by 7% to over $17 billion by 2027.
That would drive high free-cash flow growth. Analysts expect margins to rise, while the company increases capital investments modestly, moving free-cash flow up by 20% annually to over $2 billion by 2027.
This outlook, if the company can prove to the market that it's sustainable, implies that the market cap could be $67 billion.
These stocks have the wind at their backs. Now is the time to go shopping. Go ahead, take a chance.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
January 13, 2025 14:09 ET (19:09 GMT)
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