Here’s why this Cheap Growth Stock can Easily Double
One of my all-time favorite investing articles talks about how important growth is when buying a stock. The author goes back in time and demonstrates that, by buying into leading growth companies, investors could garner incredible annual returns. A key takeaway is that even when you buy in when these stocks trade at sky-high price-to-earnings (P/E) ratios, they still make a killing — if you’ve picked the right stock.
Billionaire investor Warren Buffett has famously pointed out that growth and value are joined at the hip when it comes to investing. And rightly so: growth can actually create its own value. And while investors shouldn’t shy away from paying up for a company that should experience steady growth for many years, finding a growth stock that trades at a reasonable P/E can further put the odds in an investor’s favor.
I’ve found a stock that has strung together an impressive growth history: Handbag maker Vera Bradley (NYSE: VRA). The company was founded in 1982, which makes it a relative newcomer in fashion. Vera is even newer to investors; it became a publicly-traded company in October 2010.
Vera Bradley primarily sells its namesake purses through its own stores and a vast network of other retailers. The mix of indirect and direct sales is about equal, with half of sales stemming from Vera’s own website and its 52 retail stores, while the other half comes from selling handbags and related accessories to 3,000 outside retailers that include malls, retail stores and e-commerce websites.
To give you perspective on just how popular these handbags really are, I’ll tell you a little personal anecdote that really shocked me. I just recently got back from Berkshire Hathaway’s (NYSE: BRK-B) annual shareholder meeting in Omaha. The annual event, dubbed “the Woodstock of Capitalism,” attracted some 35,000 shareholders and fans (aside from hearing he Oracle of Omaha speak, shareholders can purchase some of the many items under the Berkshire umbrella — oftentimes at discounted prices). In contrast, Vera Bradley’s annual outlet sale recently attracted about 62,000 loyal customers who visited its Fort Wayne, Indiana, headquarters to snatch up bags that were marked down up to 90%.
Popularity can be fleeting in the retail industry, but Vera only looks to be experiencing increasing popularity. Sales have grown 64% in the past five years to a recent $461 million. Current expectations for 18% growth this year to $544 million and another 15% in 2013. Earnings per share (EPS) are expected to grow 19% from $1.43 per share last year to $1.70 this year, then another 19% to $2.02 in fiscal 2013.
Vera Bradley has big expansion plans. It wants to open as many as 20 stores annually, grow sales at existing stores and continually roll out its merchandise to outside retailers. Because Vera is a growth stock, investors are too laser-focused on its quarterly trends. These momentum-based investors aren’t very loyal and quickly jump ship if they think growth isn’t accelerating. This happened last quarter when Vera reported sales growth of “only” 26% for the full year. They may also have been spooked when reported profits grew only 14%, which was due to a new corporate tax payment structure.
Risks to Consider: Vera Bradley operates in the fickle fashion industry in which customers have been known to flock to a trendier alternative. But the company is still arguably in the very early stages of its growth curve. And judging by the recent pilgrimage to its outlet sale, its popularity is extremely robust.
Action to Take –> Vera Bradley’s current forward P/E multiple is about 12. I find this extremely reasonable, given its potential for a lot more growth. As my experience has taught me, companies that grow briskly are worth paying up for. In the case of Starbucks (Nasdaq: SBUX), for instance, investors could have paid a P/E as high as 300 and still made money during its growth heyday in the 1990s and through today. They could have paid a P/E up to 500 for women’s retailer Chico’s (NYSE: CHS) during this same period and still made money.
Clearly, Vera Bradley must continue to grow in order to make money for investors. At its current P/E ratio, I think the hurdle rate for investors to make a profit is very low. With just a couple of years of double-digit growth, investors could easily double their money within a few years. Not even a year ago, Very Bradley traded above $50 per share. The short-term blip to its growth trends represents a great buying opportunity, and it could only be a matter of time before the momentum crowd piles back into the name.