After a rough first half of the year, high-growth technology and cyclical consumer stocks are once again leading the market. However, there are still high-quality growth names like MercadoLibre (MELI) and Salesforce (CRM) trade at steep discounts.
Growth stocks are up 18.0% since the June 16 bear market low as measured by the Morningstar US Growth Index, 6 percentage points ahead of the broader US market. But these stocks are still down 22.3% for the year through Aug. 10. That puts the growth index on track for its worst year since 2008. That leaves swaths of growth companies that trading below their fair value estimates from Morningstar stock analysts.
Growth stocks generally have higher readings on earnings and sales ratios than their value counterparts, as well as lower dividend yields. Valuations for growth stocks are largely based on expectations of their future earnings, so they are more affected by movements in interest rates than other areas of the market. That’s part of the reason growth stocks have performed so poorly at the start of the year, dragging down names like Salesforce, down 25.8% and Teradyne (TER)which fell 39.3%, as of August 10. Both stocks are undervalued according to Morningstar analysts, Salesforce by 38% and Teradyne by 41%.
To compile a list of the highest quality undervalued growth stocks, we examined the Morningstar US Wide Moat Focus Index, a group of companies with strong competitive advantages that also trade at the lowest prices relative to their fair value estimates as reviewed by the analyst. In addition to searching for undervalued names, the screen looked for stocks with Morningstar’s highest growth-value scores, in other words, the “biggest” undervalued stocks in the index.
7 Undervalued Wide Moat Growth Stocks:
- MercadoLibre
- Service Today
- Amazon
- Veeva Systems
- Salesforce
- Adobe
- Microsoft
Growth scores are based on the long-term expected growth of companies’ earnings, as well as the growth of their book values, sales, cash flow, and historical earnings. Growth companies score lower on price/book, price/sales, and price/cash flow ratios, and they tend to have lower dividend yields compared to value companies.
MercadoLibre
- (MELI)
- Industry: Internet Retailing
- 2022 Performance YTD: Down 21.1%
“While we expect [MercadoLibre’s] platform monetization to gradually increase, we expect that increasing customer expectations of sub-48 shipping hours, increased fulfillment penetration, and small merchant credit associated with sales on the platform should make MercadoLibre services are more accessible.
–Sean Dunlop, equity analyst
Service Today
- (NOW)
- Industry: Software – Applications
- 2022 Performance YTD: Down 20.5%
“ServiceNow will continue to use its position to acquire new IT-driven customers and upsell ITOM features on the platform, but we believe the company will increasingly cross-sell emerging products to HR and customer service, including platform as a service (PaaS ) offerings. In our view, product strength, market presence, and strong sales drive in areas outside of IT, will continue to drive solid growth.
–Dan Romanoff, senior equity analyst
Amazon
- (AMZN)
- Industry: Internet Retailing
- 2022 Performance YTD: Down 14.4%
“From a retail perspective, we expect continued innovation to help drive more revenue sharing. We are also looking [Amazon’s] continued entry into categories such as groceries and luxury goods, which have not yet translated to the same level of success as other retail categories. We see technological advances in AWS and a greater push to service enterprise customers as helping to maintain the company’s lead there. Overall, we expect strong earnings and free cash flow growth for the coming years.”
–Dan Romanoff, senior equity analyst
Veeva Systems
- (VEEV)
- Industry: Health Information Services
- 2022 Performance YTD: Down 10.7%
“Effective technology and dominant position enable Veeva to generate excess revenues consistent with a broad moat company. Its strong retention, continued development of new applications, increased penetration of existing customers, addition of new customers, and expansion into industries outside of life sciences should allow the company to extend its market leadership, in our view.
–Dylan Finley, equity analyst
Salesforce
- (CRM)
- Industry: Software – Applications
- 2022 Performance YTD: Down 25.8%
“We believe Salesforce.com represents one of the best long-term growth stories in software. Although revenue growth is likely to drop below 20% for the first time at some point in the next few years, we believe continued margin expansion should continue to compound the growth of these income of more than 20% annually for longer.
–Dan Romanoff, senior equity analyst
Adobe
- (ADBE)
- Industry: Software – Infrastructure
- 2022 Performance YTD: Down 22.7%
“In our view, there is no more comprehensive marketing platform. This approach makes sense to us because Adobe is leveraging its already strong position within the creative professional market. We believe that shifting costs are driving a narrow moat for Adobe’s digital experience segment. While we believe in strong and comprehensive solutions under this umbrella, we note that Adobe has not created the markets involved, has no first-mover advantage, and does not enjoy any quasi-monopoly status among product here.”
–Dan Romanoff, senior equity analyst
Microsoft
- (MSFT)
- Industry: Software – Infrastructure
- 2022 Performance YTD: Down 13.6%
“Office 365 maintains its virtual monopoly on office productivity software, which we don’t expect to change in the foreseeable future. we believe that [Microsoft’s] customers will continue to drive the migration from on-premises to cloud solutions, and revenue growth will remain robust with margins continuing to improve over the next few years.”
–Dan Romanoff, senior equity analyst