Growth Stocks for a Zero-Growth Economy

by Jack Robinson

With global economies at a standstill, no recovery in sight, and the stock markets in full retreat, the key question for equity investors is what stocks will be the next market leaders? The answer – at once obvious and complex – includes companies that can meet or beat their business milestones and financial expectations in a zero growth environment.

While economic growth will surely return at some point, nobody can predict when. Companies that are dependent on economic expansion to enhance their own revenue and profits will continue to struggle and disappoint investors. By contrast, companies that can prosper independently of the economy are sure to attract investors who are seeking superior returns.

What types of companies produce sustainable growth in an unsustainable economy? We believe the most likely candidates are firms in relatively new, small markets or emerging segments of large existing markets where demand is unhampered by a lackluster economy. Healthy Living and renewable energy are examples of the former while biotechnology and medical products – segments of America’s thriving healthcare industry – exemplify the latter.

Of course, being in an economically sheltered market category with the right product or service is not the only ingredient for leadership in the stock market. But it may tip the balance today when other critical attributes such as quality managements, strong balance sheets, and solid corporate governance are insufficient to generate uninterruptible growth. Some of the burgeoning markets we have identified include organic foods, green energy, biotechnology, and medical products. In the accompanying table, we have listed 11 companies in those segments whose growth rates are unfettered by the current global economic malaise. With market capitalizations ranging from a low of $40 million (Quantum Fuel Systems) to a high of $2.4 billion (Whole Foods Markets) for an average of $499 million, this Winslow growth portfolio is a small cap agglomeration. This shouldn’t be surprising since successful high growth companies targeting emerging markets tend to be small, creative, and very focused.

The valuation statistics for these 11 Winslow companies reflect average estimated earnings growth of +34% over 3-5 years. They boast a price-to-earnings ratio of 20x 2003 estimated earnings indicating that these stocks are selling at 60% of their growth rate, commonly referred to as a PEG ratio of .6. These statistics compare favorably to similar financial averages for the S&P; 500 index. Given that many of the companies in the S&P; 500 are closely aligned with the economy, we believe that they will be lucky to grow at 10%. With a PE of 17x, the S&P; is selling at a PEG ratio of 1.7, almost three times higher than this Winslow portfolio.

One of the companies in the portfolio is United Natural Foods (UNFI). Servicing a broad range of retailers that sell natural and organic foods to a small but increasing percentage of their customers, UNFI is expected to grow at +20% as U.S. consumers continue to demand safer, healthier foods and products.

Currently not followed by Wall Street analysts because of some prior and not yet fully resolved oversight issues with Medicare, Polymedica (PLMD) is perhaps the most undervalued growth company in the portfolio. Servicing less than 5% of the diabetes population in the U.S. through its Liberty Medical subsidiary, PLMD is selling at .14x its growth rate of +28%. With diabetes a growing problem in the U.S., Liberty Medical is providing health products and services that enhance the quality of life for hundreds of thousands of people.

With the overall economy stagnant, we believe companies such as these represent the investor’s best opportunity for generous returns in an otherwise disappointing stock market.

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Winslow is a Contibuting Partner to SustainableBusiness.com’s investing newsletter, Progressive Investor.

FROM Winslow Environmental News, a SustainableBusiness.com Content Partner.