Challenger Ltd, Asciano Ltd: 2 bargain growth stocks

Insurance, retirement annuities and rail transport can make good long-term returns.

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When we think of investing, we consider three things, according to Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B) chairman Warren Buffett – How much does it cost? What am I going to get? When will I get it? That's why companies with high earnings growth expectations get a higher multiple for their PE ratios than others – potentially those shareholders are going to get more and at a faster pace. Your earnings yield from lower PE stocks can increase as long as the growth is sustained over a number of years.

Buffett's company has made a lot of money from its insurance businesses and more recent investments into rail transport have made a good return.

In Australia, investors can take advantage of the same kinds of businesses, and I have chosen two I believe offer a good potential return over the long-term based on the growth they have achieved over the past five years.

Challenger Ltd (ASX: CGF) PE: 10.6. Dividend yield: 3.24%.

This company deals in insurance and funds management, especially with its annuity investment products, which are geared for retirement.

Over the last five years, NPAT has risen from $231 million to $353 million with an annual median change of 12%, so there is consistent growth. Its dividend payout ratio has usually been 30%-35%, but in its FY2014 outlook it plans to increase that to 35%-40% of normalised NPAT.

Also, it plans to partially frank the final FY2014 dividend by 40%-50%, currently its dividends have 0% franking. These changes may add up by compounding over the years.

Its funds under management (FUM) grew by 30% from $27.7 billion in 2012 to $35.9 billion in 2013. For FY2014, it expects FUM to open 15% higher than the FY2013 average.

Life insurance, which makes up about 82% of total revenue, had a 13% increase in assets under management (AUM) to $10.2 billion, from which it was able to make $365 million in normalised EBIT. The cash operating earnings (COE) margin is expected to be about 4.5%, the same as 2013. No big change, but a good spread, and if the AUM continue rising, earnings may rise proportionately.

Asciano Ltd (ASX: AIO) PE: 15.9. Dividend yield: 2.02%

The national rail freight and cargo port operator has grown NPAT by about nine times in the last five years, from $38.4 million to $350.4 million. In the earlier years, it had very heavy abnormal charges, but now they are tapering off to more manageable, less surprising figures.

Adjusted earnings per share were 35.63 cents per share in 2013, up from 25.56 cps previously. Dividends per share were 11.5 cps, keeping the high rate of dividend growth up from 2cps in 2011 and 7.5cps in 2012, fully franked for the past three years.

Analyst forecasts point to a steady increase in earnings per share, so dividend growth will rise accordingly with a payout ratio of around 32%.

The company's growth after its de-merger from Toll Holdings Limited (ASX: TOL) has been successful, so one thing I would like to see happen is long-term debt whittled down. Net gearing is high, and I understand how infrastructure like rail lines are costly to create, so applying its increased free cash flow to its borrowings would be appealing.

Foolish takeaway

Predicting what a company may do in terms of earnings and growth in the short-term is difficult, so we need to look at a company's propensity to grow based on its business model, industry, etc. That's why learning about them is important because it is the only way you can even make a calculated estimate of what to expect.

Annuities and life insurance are designed to go on and on, and rail transport is about the cheapest form of goods transport there is on land, so there will be need for it yet.

Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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