Which blue-chip stocks have the fastest earnings growth?

By using market screening tools and comparing growth with valuation we have come up with some useful insights which could provide the basis for further research.

RELIABLE GROWTH OR DANGER AHEAD?

Employing data from Stockopedia we measured earnings growth for FTSE 100 constituents over two periods, five years and 10 years.

Using two sets of data tells us whether growth has been a) consistent over the past 10 years, b) faster over the first five years and slower over the last five years, or c) slower over the first five years and faster more recently.

This is crucial because the danger with ‘growth’ stocks is that eventually they tend to go ex-growth. When they do, in theory they should de-rate but well-loved stocks can sometimes defy gravity for quite a while, propped up by bullish broker reviews and a positive consensus among the fund management community.

When stocks which are trading on elevated multiples can no longer meet earnings estimates the market’s judgement is typically harsh. For example, in mid-April catering supplies company Bunzl (BNZL), for years the epitome of a reliable growth stock, disappointed investors. Its shares, which were trading on over 20 times forecast earnings, slumped by 12% and have yet to recover.

According to our screen there are 16 large-cap stocks trading on a rolling 12-month forward earnings multiple of 20 times or more, as per table A in this article. We have used a rolling 12-month basis as it smooths the transition from this financial year to the next by incorporating elements of both.

SOME STOCKS ARE CHEAP FOR A REASON

At the other end of the spectrum there are 13 stocks trading on nine times 12-month forward earnings or less with most more than 50% below their 10-year share price highs – see table B. To put this into perspective, a stock trading at a 50% discount to its highest price of the last decade would have   to more than double to make a new high.

In some cases these are serial low-growth stocks, such as cigarette-maker British American Tobacco (BATS), ex-monopoly telecom operator BT (BT.A) and medical and industrial equipment-supplier Smiths Group (SMIN). Stocks which barely grow their earnings typically trade at low multiples and they make up for the lack
of re-rating potential with chunky dividends.

Arguably some of the other names are former growth stocks which have gone ex-growth, such as budget airline operator EasyJet (EZJ) and tobacco-producer Imperial Brands (IMB). 

Not unreasonably, investors don’t pay high multiples for stocks once they are ex-growth.However, included in this group are a handful of stocks which are delivering growth but are trading at big discounts to their peers in terms of valuation. These include packaging outfit DS Smith (SMDS), life insurer Legal & General (LGEN) and housebuilder Taylor Wimpey (TW.) – with one in particular trading at an unusually large discount to its previous price peak.

Barclays (BARC) has seen a material improvement in its earnings over the last five years yet the market has totally ignored it.

Considering that rival HSBC (HSBA), which has a similar mix of retail, commercial and markets divisions, trades on over 11 times forward earnings yet has actually shrunk its profits by 3% a year for the last five years, on the face of it a re-rating of Barclays to say nine times earnings – or 36% higher than today’s price – doesn’t seem outlandish.

(HIGH) GROWTH AT AN UNREASONABLE (LOW) PRICE

The average rate of earnings growth across both five and 10-year periods in our screening is around 10%. Meanwhile the average 12-month forward rating is 15.5-times and the average discount to the 10-year share price peak is 23%. We should stress that these are mean or average values, not market capitalisation-weighted, but they are still useful for context.

Rather than just identify growth at a reasonable price, is it possible to find high growth stocks trading on below-average multiples?

Using our screen to look for stocks with consistent growth above the market average, a similar rating or better on forward earnings plus a similar discount to the price high does throw up some interesting names for further research – see table C.

UAE-based healthcare provider NMC Health (NMC) tops the list with a staggeringly high earnings growth rate and a surprisingly large discount to its previous price-high. The fact that it is slightly more expensive than the average stock on a forward earnings basis is neither here nor there in our book.

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