February 24, 2017 STANDARD NEWSLETTER MY FAVORITE …

February 24, 2017

STANDARD NEWSLETTER

MY FAVORITE CHEAP STOCK...

The phrase "cheap stock" means different things to different people. For some it conjures up a stock trading at less than $1.00. I normally avoid penny stocks like the plague, however.

Believe it or not, a $1,000 per share stock can be actually be a lot cheaper than a $0.50 stock. That is right, it all comes down to value. How much are you paying for those assets? How much are you paying for those earnings? How much are you paying for that growth?

I like growth stocks that are still trading at a reasonable price. Here is one of the best examples that I can find in this current market...

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Before I get to why I think this stock is still cheap, let's first take a look at some particulars of it. Applied Materials (AMAT) is not a new name. Nor, is it a small, undiscovered stock that is flying under the radar, but as I will illustrate in a bit, I think it is still cheap.

Date from The company is a large-cap growth stock with a current market capitalization of $39.2 billion. It is headquartered in Santa Clara, CA. The company manufactures deposition, inspection and etching and cleaning equipment used in IC and flat panel display fabrication. Their annual revenue is $11.85 billion. As you can see from the five-year chart below, the shares have been on a tear since the fall of 2016. How can it still be cheap then? Don't worry, we will get to that in a moment.

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The stock has put up some very good absolute and relative (alpha) performance numbers over the years.

Date from As you can see from the screen shot above, the shares of AMAT are up 97% over the last twelve months, while the market is up 22.7%. That is obviously some serious alpha. Over the last three years the stock has delivered an average annual return of 26.2%, while the market has delivered 8.6%. Finally, over the last five years the stock has delivered an annual average return of 26.2%, while the market has averaged 11.6%. The alpha has been around for quite some time, can it continue however? How can the stock still be cheap after five years of superior performance to the market? This is where valuation comes in. In my early years in this business, I split my time between being a professional money manager and a research analyst. I am based on the west coast so I spent a lot of time in the bay area.

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The main objective of my research work was to find undervalued stocks to present to hedge funds and mutual funds. I particularly liked growth stocks that were still trading at a reasonable price. This remains my main objective today in the growth funds that I manage. It one thing to find superior performers with good growth, but it is quite another challenge to find cheap ones. At a forward PE of 17.8X, this is the most expensive market since 2004. I can still make a value case for the market, but I have to look out over the next 6-12 months however. The first thing that we can do in our search for cheap stocks is look for ones that are trading at a discount to the overall market.

Date from Applied Materials (AMAT) is currently trading at a forward PE ratio of just 12.78 times. This is obviously a steep discount to the market. One could argue that the semiconductor equipment makers have historically traded at a discount to the market. This is true, but AMAT is also trading a discount to its growth rate. We call this growth at a reasonable price or "GARP." There are not a lot of high-quality "GARP" stock in this current market, but my Premier Growth and Ultra-Growth portfolios contain many of them. You just have to dig a lot deeper right now.

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Over the last five years, the earnings at Applied Materials have been growing at an average annual rate of 19% per year. No wonder the stock has been delivering alpha to shareholders. It has been a superior grower. Stocks follow earnings! But, how much are we paying for those earnings? Now consider that the consensus growth estimate for the next five years is 15.6% per year. Not bad for a $39 billion dollar company. With a forward PE ratio of just 12.78, we get a current forward PEG ratio of 0.82X. Anything less than 1X is quite good. This is one of the best forward PEG ratios in the market right now, especially amongst large-cap tech stocks. Furthermore, when I carry earnings estimates out over the next five years, I come up with a five-year target price of $68 per share. This represents almost 93% upside potential over the next 3-5 years. There is also a small dividend yield of 1.1% that comes with the shares. The company obviously has to do its part in meeting those expectations, but right now the stock still looks cheap to me based on its current numbers.

Date from I currently have 4,188 stocks, exchange traded fund, mutual funds, and closed-end funds in my proprietary database. My rankings are based on performance, value, safety, and technical patterns. Applied Materials is currently ranked at #14 overall. It is one of the stocks that I currently own in my Premier Growth Portfolio.

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