For many investors, the task of scouring the market for companies that look poised for rapid growth is the holy grail of stock selection. The stocks chosen by growth investors boast an air of anticipation as finding a long term winner can transform the value of the smart investor’s portfolio. But how do you capture a potential ‘tenbagger’ before it gets away from you?
Growth investing has inspired acres of research and writing and elevated a handful of successful investors to near-celebrity status for their screening strategies. Dig deep and you’ll find there are some common themes that lie at the heart of growth stock selection. We highlight the top 4 common themes here.
1. Fast and Persistent Earnings Growth
Studying a company’s historic and projected profitability is a central plank in every growth investing strategy because without earnings it is near impossible to assess or benchmark the growth potential of a stock.
Back in the 1930s, US asset manager T. Rowe Price (known as the father of growth investing) put earnings front and centre of his buying strategy and stipulated long term earnings per share (EPS) growth as a buying requirement, together with forecasts that EPS will continue to grow ahead of inflation. More recently, US investors William O’Neill and Martin Zweig have been among those to adopt the same tactic.
According to O’Neill – whose CANSLIM investing technique and now legendary book “How to Make Money in Stocks” earned wide acclaim in investing circles –winning stocks generally have strong quarterly earnings per share performance prior to their most spectacular price run ups, as well as a history of steady and significant annual earnings. He puts a particular emphasis on the importance of sales growth in his screen and stipulates that sales should be rising by at least 25% year-on-year (or at least accelerating over the last three periods). Considering that O’Neill studied the history of 40 years of the greatest stock market winners these findings are worth noting.
Zweig’s strategy is even more demanding and calls for stocks to pass numerous earnings related criteria. Among them, EPS growth and sales growth should each have grown by at least 20% over the previous four years. And to insulate against more recent wobbles, the EPS should have been accelerating in the most recent quarters.
