By Eric Bleeker | More Articles
June 17, 2011

We're all on the lookout for great stock picks. In a perfect world, investors would get great companies trading for bargain-basement prices. However, the market rarely works that way. Great companies seeing strong growth most often trade for extremely high P/E multiples; you have to pay up for the possibility of outsized growth. Likewise, companies with bargain basement P/Es are often the result of recent sluggish growth -- and trouble ahead.

But what if we could have the best of both worlds? I set a list of criteria seeking out companies that weren't only bargain priced but also had strong recent earnings and revenue growth and a history of earnings growth rates that smashed market averages.

This wasn't an easy benchmark for stocks to reach; out of the 1,926 stocks that are worth at least a billion dollars and listed on U.S. exchanges, precisely seven companies fit my criteria. That's an exacting enough standard that only 0.4% of stocks pass the test!

Finding high growth and cheap share prices
So, what exactly was I searching for?

• Normalized net income growth of at least 35% in the past year. Using a normalized figure helps weed out stocks that have been cheapened by artificially low tax rates coming out of the recession.
• Revenue growth of at least 25% in the past year. I want to see strong top-line growth illustrating that the company is doing more than just cost-cutting to show growth. We're looking for companies that can sustainably keep growing.
• A normalized P/E of less than 10. P/Es less than 10 are generally considered the zone where companies are priced for no future growth.
• A five-year compounded net income growth rate of 15%. Setting a long-term net-income growth rate helps weed out flash-in-the-pan companies that rebounded strongly out of the recession but haven't been able to grow over the years.

7 stocks passing the test
After setting these criteria seeking out fast growers trading on the cheap, only seven stocks remained:

Source: Capital IQ, a division of Standard & Poor's.

There's a little bit of something for everyone here, with industries spanning the globe. However, the market's not just handing out deals here; the stocks are cheap for a reason, having caveats or warts to go along with their cheap share prices:

• Central Fund of Canada is a closed-end fund that's trading for a miniscule three times earnings. On paper, that's a blockbuster deal! However, the profits are just that -- on paper. Earnings in the last year were from unrealized gains in the company's gold and silver holdings.
• Despite recent profits, Suntech Power has a shaky balance sheet loaded with debt and faces continuing competition from rival low-cost Chinese peers.  Its situation is also difficult to get a handle on because the company is shifting assets and debt to a new joint venture, obscuring the company's true financial state.
• MKS Instruments sells components to large semiconductor equipment makers like Applied Materials. The company has been extremely profitable lately, but consolidation in the industry means that its future is increasingly in the hands of a few key customers.

And the list goes on.

The challenges present opportunity
However, challenges ahead were expected. The purpose of screening out these companies is to "sort through the trash," find companies priced for no growth that have a history of moving through a challenging environment (the recession) and coming out better on the other side. If the market's overly bearish on their future, you can be well-rewarded in the years ahead even if these companies only eke out a fraction of their past five-year growth rates.

One to watch
So what companies look attractive? Several look deserving of more attention, but here's one I'm taking a closer look at:

Vale
One trend I found while seeking out high-growth, low P/E companies was that most were centered abroad, specifically in China. If I eliminated requiring stocks listed on U.S. exchanges and searched stocks from around the world, 30 of them met my criteria. And 43% of those 30 were Chinese. That's partially the result of recent Chinese governance scandals and fraud allegations, but it's also a reflection on investor fears about Chinese growth.

With Vale being a key supplier of the iron ore that's at the center of China's insatiable build-out, these fears have struck the stock. However, the company also has a fall back with a domestic infrastructure build-out ahead of several notable events such as the 2014 World Cup and 2016 Olympics.

That's not to say fears over China should be discounted; the majority of shipped iron ore heads to China. However, of Vale's total sales, only 33% is shipped to China. That's a very heady number for sure, but it's one that can be buffered in part by growing domestic demand. Last year, domestic revenues increased 98%, far outpacing growth in China.

Vale's ridden a wave of emerging market growth to its fantastic past results. While its amazing growth rates of the last decade are over, the stock is priced as if there's no growth ahead of it. If you're underweight on emerging market stocks, or believe China and Brazil's growth is likely to continue and want a way to play the trend, Vale looks intriguing at today's prices.

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