Some companies are still growing strongly, yet trade at bear market valuations. This is your opportunity to take advantage of the market’s amnesia.
This bear market has taught investors many harsh lessons…
- No company is too big to fail.
- Banks are highly leveraged, extremely complex organisations.
- Too much debt can cripple a company.
- Never forget that recessions are an inevitable part of the economic cycle.
- Share prices can fall far further than you could imagine is possible.
Whilst it is key to learn from these lessons, all this happened in the past. If, like me, you lost thousands of pounds when shares in Lloyds Banking Group (LSE: LLOY) collapsed, all you can put it down to is experience. Only time might bring back those losses, if at all.
There are several one other very important lessons that can be learnt from the past. One is that during good economic times, companies can and do grow strongly. Another is that high quality growing companies can and do trade on price to earnings ratios (P/E) of 15, 18, 20 and even more.
As I look though the wreckage of the stock market today, I see high quality companies trading on P/E ratios of 8, 10 and 12. In The Biggest Investing Conundrum Facing You Today, I mentioned Tesco (LSE: TSCO) was trading on a P/E of 11 and a dividend yield of 4%. You can't get a much higher quality company than Tesco.
Growth Companies At Bear Market Valuations
Yet it wasn't too long ago when companies like Tesco, Astrazeneca (LSE: AZN) and Man Group (LSE: EMG), for example, traded on P/E ratios closer to 20 than the closer to 10 they trade on today.
I'm not saying those stocks will trade, or deserve to trade, on P/Es of 20. All are impacted by the slowing economy, and all are simply not going to grow as quickly as they have in the past. Their pure size, amongst other things, naturally puts a cap on future growth rates.
In contrast, even in this bear market and this recessionary environment, there are quite a few medium size companies that are both growing strongly and trade on bear market P/E ratios.
I'm not talking about recovery stocks either – companies that are set to grow strongly only because their profits have been decimated during this recession. Sure, you can make a fortune out of buying shares in beaten down companies like Yell (LSE: YELL) and ITV (LSE: ITV), but you can also lose the lot, as witnessed by shareholders in Woolworths and Jessops (LSE: JSP).
Five Growth Companies
I'm talking about proper growth companies. Believe it or not, they do exist. Here is a selection taken from the FTSE 350 index…
| Company | Share Price | Forward P/E | Forecast Growth Rate |
|---|
| QinetiQ Group (LSE: QQ) | 140p | 7 | 12% |
| Smith & Nephew (LSE: SN) | 460p | 10 | 15% |
| Connaught (LSE: CNT) | 339p | 12 | 20% |
| Serco Group (LSE: SRP) | 391p | 12 | 18% |
| Babcock International (LSE: BAB) | 482p | 9 | 12% |
Eighteen months ago, all these companies traded on P/E ratios significantly higher than they do today.
That fact on its own means nothing, because the companies themselves could have been significantly over-valued. Also, as we now know, the whole stock market was previously over-valued, because it was factoring in continued economic growth when in fact we are now in the midst of one of the most savage recessions of our lifetime.
But that was in the past. Looking forward from today, based on their relatively lowly P/E ratio and especially when compared to their forecast growth rate, the five shares look cheap.
Use The Market's Amnesia To Your Advantage
The market has forgotten about growth stocks such as these five larger companies. It has forgotten that in better times, such companies can trade on higher P/E ratios. Far-sighted investors should use the market’s amnesia and stock up on quality growth companies whilst they remain cheap.
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> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in Lloyds Banking Group.
