One of the best hunting grounds for possible multi-year baggers is the world of small-cap stocks. However, there are many promotional companies that do not generate real cash flow and spend money on marketing their own stocks. To minimize the risk of falling into these companies, evaluating the company’s ability to grow its earnings or cash flow is the first step.
Another valuable metric (which the famed investor Peter Lynch likes) is called the price earnings to growth ratio or known as the PEG ratio. This combines the price of the stock relative to its earnings and expected earnings growth. In theory, the lower the ratio the more attractive the stock is.
One of the companies that falls into this low and attractive PEG ratio category is Newport Corporation (NASDAQ: NEWP). The company is a supplier of advanced technology products and systems in a wide range of industries such as scientific research, microelectronics, aerospace, defense and other industrial markets in the United States, Europe and Pacific Rim. It operates under three business segments; The Photonics and Precision Technologies (PPT) division, The Lasers Division and the Ophir Division.
Over the past five years, NEWP has grown sales by 3.69 percent a year. This is in line with the average growth rate of its industry of 3 percent to 5 percent. Company revenue growth rate in 2012 was right at 18 percent. The improved growth rate is attributed to acquisitions of companies, as well as introduction of new products. For example, it acquired ILX Lightwave Corp. in order to strengthen its laser diodes and photonics product portfolio. It also launched a new SA2 series of solid aluminum breadboards to expand its low-cost aluminum breadboards and accessories for basic research and OEM optical assemblies.
NEWP re-affirmed its sales guidance for operating income for the fourth quarter. It also announced that it expects to record a non-cash, non-deductible impairment charge in the range of $130 million to $140 million related to its acquisition of Ophir Optronics. Management said this impairment charge does not have an impact on the company’s liquidity, cash flow, or its future operations.
Analysts expect Newport Corp. to post earnings per share of $0.97 for this year. This translates to earnings growth of 19 percent compared to the same period last year. For the next five years, earnings are projected to grow by 10percent a year. At the current price, the stock trades at 9.87 times earnings and 0.98 times PEG ratio. This means that the market is not pricing the stock for future growth. In fact, it assumes zero or flat growth for the next five years. In contrast, the market valued its peers higher. Both Rofin-Sinar Technologies (NASDAQ: RSTI) and Coherent (NASDAQ: COHR) trade at 23 times earnings. Meanwhile, Rofin-Sinar has a negative PEG ratio of 2.43 from expected earnings decline and Coherent trades at 1.37 times expected growth rate.
The market can be irrational on occasion, but a growth stock like Newport is a viable long-term play.