Buying and holding high-quality growth stocks is a fantastic way to generate market-beating returns. But it's not always clear which of these stocks is worthy of owning for the long term.
So we asked three Motley Fool contributors to each pick a growth stock that they believe in-the-know investors can appreciate. Read on to learn why they like Splunk (NASDAQ: SPLK), A.O. Smith (NYSE: AOS), and Grubhub (NYSE: GRUB).
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Take advantage of this drop while you can
Steve Symington (Splunk): Splunk is up more than 20% over the past year on the heels of its 27th straight quarter of exceeding guidance. But it's also trading well off its recent highs, as the broader market's recent weakness tends to drag down this perennial outperformer without merit.
To be clear, Splunk's underlying business has never been stronger. As more people discover the power of its operational intelligence platform, Splunk continues to win new customers at a rapid clip. It added 500 enterprise clients in its most recent quarter alone, including industry giants like Jabil, Norfolk Southern, and Softbank in Japan. And even as it builds from its larger base, revenue next fiscal year is expected to climb nearly 24%, to $2.15 billion -- both as new customers continue to pile on and existing clients find new ways to leverage Splunk's solutions.
Of course, given Splunk's long streak of beating expectations, we can be fairly sure that Wall Street will be modeling even greater growth. But patient in-the-know investors who take advantage of this pullback realize that Splunk is a winner that should keep on winning.
This slowdown spells opportunity
Reuben Gregg Brewer (A.O. Smith Corporation): It has been a bad year for A.O. Smith investors, with the stock down more than 30% from early-year highs. One reason is a slowing Chinese economy. China accounts for roughly 34% of the company's business. A.O. Smith is expecting 2019 revenue growth to fall to a range of 4% to 5.5% from a 7% pace in 2018. That's not great news, but it is likely to be a short-term slowdown at a company with a still-robust future.
Revenue and earnings at the water heater maker have grown at a compound annual rate of 10% and 25%, respectively, since 2010, driven by 21% revenue growth in China. As consumers there moved up the socioeconomic ladder, they eagerly paid for hot water as soon as they could afford it. This trend isn't complete, either, since the country continues to advance economically, just at a slightly slower pace. That said, the next big opportunity is in India, which makes up less than 1% of sales today. As consumers in that nation start to become wealthier, they will jump on the opportunity to take hot showers, too.
Which is why A.O. Smith's long-term expectations haven't really changed. It is still looking for modest growth in developed markets (roughly 4% annually), which make up around 65% of its business, to underpin much higher growth (as much as 11%) in emerging markets like China and India. All in all, it expects to hit 7% revenue growth over the long term. Yes, a slowdown in China is a near-term headwind, but investors who step back and look at the big picture will see that A.O. Smith's future remains very bright.
America’s biggest food delivery platform
Leo Sun (Grubhub): Grubhub controlled 34% of the U.S. food delivery service market in July, according to Edison Trends, making it the top dog in an increasingly crowded market. Its closest rivals -- Uber Eats and DoorDash -- controlled 28% and 18% of the market, respectively.
Grubhub became the top delivery service by acquiring rival platforms, including Seamless, MenuPages, Eat24, and Tapingo. Surging demand for food deliveries boosted its total active diners by 67% annually to 16.4 million last quarter, as its daily average grubs (meals) rose 37%.
As a result, Grubhub's revenue grew 52% annually to $247 million last quarter. Its adjusted EBITDA rose 41% to $60 million, as its non-GAAP net income surged 72% to $42 million. Those figures beat analysts' expectations, but the stock slumped after that report due to its lackluster guidance for the fourth quarter, which called for 38% to 43% revenue growth and a 12% to 30% drop in EBITDA.
That forecast, which reflected bigger investments in tech and marketing, sparked concerns about tougher competition and pricing pressure, especially from Uber Eats. However, the bears often ignore the fact that Grubhub is leveraging its first mover's advantage to expand its services ecosystem -- which now includes LevelUp's payment and loyalty services -- and that it's locking in fast-food giants like Yum Brands.
Grubhub definitely isn't a cheap stock at nearly 40 times forward earnings, but it's a promising play on a high-growth market that could eventually generate multibagger returns.
The bottom line
Nobody can know for certain where the stock market is headed from here, or whether these three growth stocks will go on to deliver outsized gains. But coupling steep pullbacks from all three stocks with Splunk's increasingly popular platform and growing customer base, A.O. Smith's steady results, and Grubhub's enviable industry position, these contributors think chances are high that they'll do exactly that. And they believe investors would do well to put their money to work accordingly.
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Leo Sun owns shares of Grubhub. Reuben Gregg Brewer has no position in any of the stocks mentioned. Steve Symington has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Splunk. The Motley Fool has a disclosure policy.