Companies with outsize growth prospects aren't hard to find. High-growth stocks that also are high on quality are another matter.
Seemingly every other week, a so-called unicorn files for an initial public offering. And yet more often than not, the stocks of these red-hot companies quickly disappoint investors. There's no point in betting on companies with high growth prospects if they don't have the quality to churn out such returns year after year.
When it comes to looking for high-quality companies, a good place to start is with return on equity. ROE measures how adept a company is at squeezing a return out of its net assets. It's often used as a shorthand for quality. Although ROE differs from industry to industry, a rule of thumb is that ROE should come to at least 15%.
Quality stocks can't be found by applying just a single measure, however. Balance sheets, fundamental performance and cash flow are critical too. As such, we scoured the Russell 1000 Growth Index (.RLG) of large- and midsize companies to find stocks with returns on equity of at least 15%. Additionally, these companies had to have positive free cash flow (FCF), healthy balance sheets and long-term growth rates of at least 20%.
Lastly, they had to have an average analyst score of less than 2.0 from S&P Global Market Intelligence. Any score below 2.0 equals a Buy recommendation on the part of Wall Street, and the lower the score, the better.
Here, then, are the 10 best-rated high-quality, high-growth stocks to buy.
Biotech company Vertex Pharmaceuticals is the leader in treatments for cystic fibrosis, a genetic lung disorder. The company has a new regimen — VX-445, tezacaftor and ivacaftor, referred to as the "triple combination" — that is expected to win U.S. regulatory approval next year.
The rest of Vertex's pipeline of developing drugs is likewise strong. Among them: a treatment that addresses AAT deficiency, an inherited condition that can lead to lung and liver disease.
"Our deep dive analysis suggests that AAT correctors could launch in the mid-2020s and offer multi-billion dollar peak sales potential," says Morgan Stanley, which rates shares at Overweight (equivalent of Buy).
What helps differentiate VRTX is its torrid growth rate and the high quality of its stock. Analysts expect earnings to grow at an average annual rate of 26% over the next three to five years, according to data from S&P Global Market Intelligence. And Vertex's return on equity of 56% for the 12 months ended June 30 dwarfs the average among the high-growth stocks of the biotech industry: 0.3% over the same time frame.
The balance sheet stands out, too. Vertex has nearly $4 billion in cash versus a mere $589 million in debt. And it generated $1.1 billion in free cash flow after paying interest on debt over the 12 months ended June 30.
How could a retailer rate among the best high-growth stocks to buy? After all, brick-and-mortar retailing is dead, or so they say.
Try telling that to Five Below, whose shares have more than tripled in value over the past five years. That's three times the S&P 500's (.SPX) total return in the same time frame.
Five Below has figured out how to make discount shopping fun for kids, teens and their parents. The retailer currently has more than 850 stores in 36 states and is aiming for a total of 2,500 over the long term. William Blair's equity research division says that might be conservative.
"The company has a pristine balance sheet and generates solid free cash flow despite its rapid store expansion," say Blair analysts, who rate shares at Outperform (equivalent of Buy).
In addition to the cleaner than clean balance sheet, FIVE does an admirable job of wringing returns out of its assets. The company's ROE of 27% is more than double that of the specialty store industry, which stands at 13%.
William Blair isn't the only analyst hot on FIVE's shares. S&P Global Market Intelligence tracks 24 analysts covering the stock. Of them, 13 call it a Strong Buy, four have it at Buy, six call it a Hold and only one rates it Sell.
PayPal lags the broader data processing and outsourced services industry when it comes to generating a return on equity, but the company still does a fine job. PYPL's ROE of 16%, while below the broader industry's 21%, clears the minimum level of 15% that Wall Street typically likes to see.
Where PayPal really stands out is with its growth profile. Global payments processing is a red-hot business, and PYPL is uniquely positioned to grab its share of the pie. Wedbush's Moshe Katri rates PayPal at Outperform, in part because of its ability to increase "average ticket prices and transaction volumes while creating a 'stickier' consumer/merchant relationship."
"Venmo monetization, further incremental revenues from Xoom, and continued hyper growth from mobile payment transactions" all prop up the bull case, Katri writes.
PayPal also sports a quality balance sheet and cash-flow statement. The company has $8.4 billion in cash but just $2.5 billion in total debt. Best of all, PYPL generated $8.2 billion in free cash flow after paying interest on debt for the 12 months ended June 30.
PYPL shares have lapped the market over the past year, up 35% versus a modest gain of less than 9% for the S&P 500. And PayPal should continue to hold its position among desired growth stocks should it meet analysts' profit expectations. The community sees earnings climbing 21% annually, on average, over the next three to five years.
World Wrestling Entertainment
World Wrestling Entertainment is a long-term growth story that is a "rare and precious stone" in media, says Wells Fargo's Steven Cahall, who rates shares at Outperform. In an age of streaming media and digital video recorders, anything that gets viewers to sit through commercials is something of a Holy Grail.
For all the glitter and drama, WWE has proven to be a high-quality stock. It generated a return on equity of 25% over the last 12 months. The entertainment industry generated a return of just 10% on its assets over the same time frame.
The balance sheet is likewise solid. WWE has $296 million in cash and just $23 million in long-term debt. Total debt is a still-manageable $228 million.
What analysts like best about World Wrestling Entertainment is its outsize growth profile. The company is projected to generate average earnings growth of 36% a year over the next three to five years. The majority of analysts have it on their lists of stocks to buy, too. Eight analysts rate WWE a Strong Buy, another three have it at Buy and the remaining four tracked by S&P Global Market Intelligence have it at Hold.
"Etsy Inc. has proven that the large conglomerate platforms don't always win, especially when the category is anything but a commodity."
That's what KeyBanc's Edward Yruma had to say about the leading marketplace for unique craft and vintage goods in a recent note, in which he maintained his Overweight rating.
Importantly for an online retailer, Etsy is FCF-positive. The company generated $143.1 million in free cash flow after paying interest on debt for the 12 months ended June 30. Its balance sheet is equally impressive, with $634 million in cash and investments versus total debt of just $351 million.
The traditional markers of a quality stock are present, too. Etsy's ROE for the 12 months ended June 30 came to 27%. For comparison's sake, the internet and direct marketing retail industry had an ROE of just 9.9%.
Wall Street clearly is bullish on this fintech stock. Of the 16 analysts covering the stock tracked by S&P Global Market Intelligence, nine call ETSY a Strong Buy, five have it at Buy and two rate it a Hold. And they expect Etsy to justify its favored status among growth stocks to buy going forward, projecting average annual earnings expansion of 20% over the next three to five years.
Aspen Technology — which creates software for the chemical, pharmaceutical, engineering and power industries, among others — generates steady free cash flow and carries just $148 million in net debt.
That's despite bulking up with acquisitions. In June, Aspen acquired Sabisu, an enterprise visualization and workflow specialist, and Mnubo, which provides AI and analytics infrastructure. Details of the Sabisu deal were not disclosed, but Aspen spent C$102 on Mnubo.
If past is prologue, Aspen will do a fine job in generating a return on its newest assets. The company's ROE came to a whopping 66% for the 12 months ended June 30, according to S&P Global Market Intelligence. The application software industry is hardly as efficient, with an ROE of just 4% over the same time frame.
Aspen is a growth machine, too. Analysts project average annual earnings growth of 20% for the next three to five years. The company's profit prospects help make it a Wall Street favorite. Seven analysts rate AZPN at Strong Buy, one has it at Hold and one calls it a Sell.
Although Mastercard is commonly viewed as a financial stock, it actually ranks among the largest tech stocks on Wall Street. That's because Mastercard is not responsible for, say, lending money. Instead, it's merely a payments processor that provides a technological service for banks and other financial businesses.
In that regard, Mastercard is one of the best. Indeed, it's harder to find a higher-quality stock. The company's ROE of 128% helps make it a favorite pick for analysts, hedge funds and mutual funds, not to mention Warren Buffett, who has MA shares stashed in the Berkshire Hathaway portfolio.
"We believe Mastercard continues to enjoy substantial competitive advantage due to its massive scale and global reach, leading security and data management skills, information intelligence, brand recognition, and trust," says William Blair, which rates shares at Outperform.
Mastercard has $6.5 billion in cash and investments versus a manageable $8.2 billion in total debt. It gushes cash flow too, generating more than $5.7 billion in FCF over the past 12 months.
Looking forward, analysts expect MA to enjoy average annual profit growth of more than 20% over the next three to five years. That should keep it perched among analysts' favorite growth stocks for some time.
IAC/InterActiveCorp, whose online brands (either through direct or majority ownership) include Angie's List, Vimeo and The Daily Beast, is a high-quality growth stock with strong profits and hefty free cash flow.
Analysts, who are highly bullish on the name, think IAC could get a big boost from spinning off its Match Group (MTCH) and Angi Homeservices (ANGI) stakes, which the company said it was exploring in August. And indeed, IAC officially announced on Oct. 11 that it plans on spinning off Match; it will wait to complete that transaction before spinning off ANGI.
Cowen, which rates the stock at Outperform, said in September that spinoffs could unlock another $3 billion in equity value. "In the event of the dual spin, we believe IAC will be well-capitalized through the spin transactions, whereby they can continue to make acquisitions to build out the portfolio, buyback stock and possibly reinstate the dividend," its analysts wrote.
Meanwhile, IAC delivered a return on equity of 18% for the 12 months ended June 30, slightly better than the industry-wide 16%. It generated free cash flow of $667 million while doing so.
Looking forward, analysts expect average annual earnings growth of 39% for the next three to five years. They're also overwhelmingly bullish about the stock, with 14 Strong Buys and five Buys versus just two Holds and no Sells.
Nexstar Media Group
Nexstar Media Group is one of the most under-the-radar names in this group of growth stocks. But it's a standout in the broadcasting industry, in more ways than one.
Nexstar recently was recently given regulatory approval for its $4.1 billion acquisition of Tribune Media. "As a reminder, the acquisition makes NXST the largest owner of local TV stations in the country, now reaching just under 39% of U.S. households," notes B. Riley FBR's Zachary Silver, who calls the stock a Buy.
Stephens analyst Kyle Evans, who rates shares at Overweight, adds that "excitement is growing around a strong 2020 political advertising cycle," which will lead to a windfall in advertising dollars.
In addition to having a long-term growth forecast of more than 22% a year for the next three to five years, and ample and steady free cash flow, NXST's ROE topped 21% for the 12 months ended June 30. That compares to just 12% for the broadcasting industry as a whole.
Seven of the nine analysts tracking the stock call it a Strong Buy, one has it at Buy and one calls it a Hold.
It shouldn't come as a surprise that the 800-pound gorilla of e-commerce sits atop a who's who list of analyst-loved growth stocks to buy. But the margins by which Amazon.com are remarkable nonetheless.
Amazon generated an ROE of 28% for the 12 months ended June 30. Meanwhile, the internet and direct marketing retail industry has an uninspiring ROE of 9.9%.
And as much as AMZN is known for plowing profits back into the business, it's still sitting on $41.5 billion in cash. The retail giant's net debt comes to a more-than-manageable $30.2 billion. Heck, Amazon generated $23.4 billion in free cash flow over the past year (ended June 30) alone!
Naturally, analysts love AMZN stock. A company with a market value of $850 billion and expected earnings growth of 37% a year for the next three to five years almost defies the laws of mathematics.
But the prize is there for Amazon's taking. Cowen, which rates the stock at Outperform, notes that "61% of consumers aged 18-34 and 55% of those aged 35-54 indicated that Amazon was their preferred shopping channel."
Piper Jaffray, with an Overweight rating, points out that Amazon's "massive scale is an ongoing competitive differentiator and will continue to make it difficult for competitors to gain significant traction."