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Market Update

7 Undervalued Quality Growth Stocks

Growth stocks including MercadoLibre and Salesforce are available at a steep discount and look poised for long-term outperformance.

7 Undervalued Quality Growth Stocks
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After a brutal first half of the year, high-growth technology and consumer cyclical stocks are back leading the market. However, there are still high-quality growth names such as MercadoLibre (MELI) and Salesforce (CRM) trading at steep discounts.

Growth stocks are up 18.0% since the bear market low point on June 16 as measured by the Morningstar US Growth Index, 6 percentage points ahead of the broader U.S. 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 has left swaths of growth companies trading below their fair value estimates from Morningstar’s stock analysts.

Growth stocks generally have higher readings on earnings and sales ratios than their value counterparts, as well as lower dividend yields. The valuations for growth stocks are largely based on expectations of their future earnings, so they are more affected by moves in interest rates than other areas of the market. That’s part of the reason why growth stocks underperformed so much at the start of the year, dragging names like Salesforce, down 25.8%, and Teradyne (TER), which has tumbled 39.3%, as of Aug. 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 screened the Morningstar US Wide Moat Focus Index, a group of companies with durable competitive advantages that are also trading at the lowest prices relative to their analyst-assessed fair value estimates. In addition to searching for undervalued names, the screen looked for stocks that have the highest Morningstar growth-value scores, in other words, the “growthiest” undervalued stocks in the index.

7 Undervalued Wide Moat Growth Stocks:

  1. MercadoLibre
  2. ServiceNow
  3. Amazon
  4. Veeva Systems
  5. Salesforce
  6. Adobe
  7. Microsoft

Chart of the Performance of the Morningstar US Growth Stocks Index vs. the Morningstar US Market Index.

Growth scores are based on long-term projected earnings growth of the companies, 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 with value companies.

  A Table of Undervalued Growth Stocks With Wide Economic Moats.
 

MercadoLibre

  • (MELI)
  • Industry: Internet Retail
  • 2022 Performance YTD: Down 21.1%

“While we expect [MercadoLibre’s] platform monetization to increase only gradually, we anticipate that swelling customer expectations around sub-48-hour shipping times, increased fulfillment penetration, and small merchant credit tied to platform sales should render MercadoLibre's services increasingly sticky.”

--Sean Dunlop, equity analyst

ServiceNow

  • (NOW)
  • Industry: Software - Application
  • 2022 Performance YTD: Down 20.5%

“ServiceNow will continue to use its position to land new IT-driven customers and upsell ITOM features on the platform, but we believe the company will increasingly cross-sell emerging products in HR and customer service, along with the platform as a service (PaaS) offering. In our view, product strength, market presence, and a strong sales push into areas outside of IT, will continue to drive robust growth.”

--Dan Romanoff, senior equity analyst

Amazon

  • (AMZN)
  • Industry: Internet Retail
  • 2022 Performance YTD: Down 14.4%

“From a retail perspective, we expect continued innovation to help drive further share gains. We also look for [Amazon’s] continued penetration into categories such as groceries and luxury goods, which have not previously translated into the same level of success as other retail categories. We see technology advancements in AWS and a bigger push to service enterprise customers as helping to maintain the company’s lead there. Overall, we expect strong revenue and free cash flow growth for years to come.”

--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 returns commensurate with a wide-moat company. Its strong retention, continued development of new applications, increasing penetration with 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 – Application
  • 2022 Performance YTD: Down 25.8%

“We believe Salesforce.com represents one of best long-term growth stories in software. Even as revenue growth is likely to dip below 20% for the first time at some point in the next several years, we believe ongoing margin expansion should continue to compound earnings growth of more than 20% annually for much 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 in that Adobe is leveraging its already strong position within the creative professional market. We believe switching costs drive a narrow moat for Adobe's digital experience segment. While we believe in the strong and comprehensive solutions under this umbrella, we note Adobe did not create the markets involved, does not have a first-mover advantage, and does not enjoy any quasi-monopoly status with products here.”

--Dan Romanoff, senior equity analyst

Microsoft

  • (MSFT)
  • Industry: Software – Infrastructure
  • 2022 Performance YTD: Down 13.6%

“Office 365 retains its virtual monopoly in office productivity software, which we do not expect to change in the foreseeable future. We believe that [Microsoft’s] customers will continue to drive the transition from on-premises to cloud solutions, and revenue growth will remain robust with margins continuing to improve for the next several years.”

--Dan Romanoff, senior equity analyst

Lauren Solberg does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.