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After the wild market swings of early 2018, being a forward-looking investor seems increasingly difficult. Will the rally continue after a brief hiccup…or is there another drop approaching?
Well, nobody knows, frankly, where the market will go next. The best bet for individual investors is to focus instead on picking high-quality businesses with good prospects for growth. We asked three of our contributing investors what stocks they might pick for other forward-looking investors, and they like Caterpillar (NYSE:CAT), Paycom Software (NYSE:PAYC), and Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B).
This cat only looks like it’s napping
Rich Smith (Caterpillar): Growth stocks for “forward-looking” investors, you say? If by that you mean stocks that look much more attractive based on their forward price-to-earnings ratios than they do based on earnings over the last 12 months — well, that sounds a lot like Caterpillar to me.
Valued on trailing profits, this industrial behemoth cost a whopping 120 times earnings, and doesn’t resemble a bargain in any respect. But here’s the thing: Thanks to rebounding demand for commodities — iron, coal, and the like, that Caterpillar’s machines help to dig out of the ground and haul around — the company’s prospects in the coming year look a whole lot brighter than they did even 12 months ago.
Analysts surveyed by S&P Global Market Intelligence are forecasting a surge of over 50% in Caterpillar’s earnings this year, and average earnings growth of 25% over the next three years. Meanwhile, Caterpillar’s cash profits have already recovered to the point where the stock is trading for just 23 times trailing free cash flow.
Pair those two numbers up, and what you’ve got is a fast-growing industrial stock trading for an EV/FCF (enterprise value to free cash flow) growth ratio of less than 1.0 — and paying a 2% dividend yield to boot. That should be good enough to convince growth investors to give Caterpillar a “forward-looking” look.
An expensive stock with plenty of potential
Tim Green (Paycom Software): Growth stocks often trade at very high multiples of earnings, assuming the underlying company has any earnings at all. Paycom Software, a provider of payroll processing and human resources solutions, is no exception. The stock trades for nearly 13 times trailing-12-month sales and 84 times GAAP (generally accepted accounting principles) earnings. Clearly, the market is pricing in an awful lot of optimism.
Optimism isn’t unwarranted. Paycom has been growing at a brisk pace, with revenue rising by 31% year over year in the third quarter of 2017. The fact that Paycom is squarely profitable, despite being a fast-growing software-as-a-service (SaaS) company, is notable. Similar companies tend to hurl so much money into sales and marketing, to drive growth, that the bottom line sinks deep into the red.
Paycom spent just 33.4% of revenue on sales and marketing through the first nine months of 2017. Compare that to 45.4% for SaaS giant salesforce.com. The difference is the reason that Paycom sports solid margins while Salesforce does not.
Because Paycom stock trades at a such a high valuation, you need to be willing to hold on for the long haul. The stock could very well crash if the market slumps, but the long-term prospects for the company are bright.
There’s more where that came from
John Bromels (Oshkosh Corporation): Not to toot my own horn, but I said that specialty-truck maker Oshkosh, with its exposure to the construction industry and its status as a military contractor, would be the perfect stock for a Trump presidency. Sure enough, the company has grown by leaps and bounds in 2017. And there’s good reason to think that there’s more growth in the engine for Oshkosh.
As Congress currently debates government funding, increases in defense spending seem all but inevitable, as they have broad bipartisan buy-in. That’s good for Oshkosh, which supplies a variety of light trucks to the military.
And while a big infrastructure spending package hasn’t materialized as quickly as Oshkosh investors might like, it’s still very much on the table. That would be a boon for Oshkosh’s access equipment segment, which manufactures telehandlers and aerial work platforms, among other construction-related vehicles, and its commercial segment, which manufactures cement mixers.
My biggest concern in recommending Oshkosh’s stock had been that its long run of growth — the share price had more than doubled in less than two years — had pushed its valuation up too high. The recent market pullback, however, makes me more confident that forward-looking investors can buy into Oshkosh’s great future at a reasonable price.
John Bromels has no position in any of the stocks mentioned. Rich Smith has no position in any of the stocks mentioned. Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Paycom Software. The Motley Fool recommends Salesforce.com. The Motley Fool has a disclosure policy.