The Technique
Here at WorldBestPortfolio.com, I’m looking for growth stocks that have the potential to appreciate in price. Do not get me wrong. I’m not a short term CFD/Contra investor, but a fundamental stock investor with a longer term view in mind.
Here is a summary of what I look out for when I analyse a company’s stock.
The basics
Historical data and research has proved that when looked in a long term (definitely >1 year), stock prices will mimic the underlying company’s earnings.
So in theory, if a company’s earnings suddenly jumps 100% without anybody having any prior expectations, the stock price will jump 100% eventually. This theory is also practiced by P/E ratio analysts.
1st Criteria: Revenue Increase >25% Quarterly
A revenue increase would indicate growth in a company’s core business. If you were to look at large cap companies that started off as a small cap (ie Google.com, Keppel Corp), you will not see historical revenue growth of just 10% Quarterly. Most of them will exhibit an almost constant revenue growth of 25% every quarter.
2nd Criteria: Profits >25% Quarterly
There is no use having a revenue growth of 100% but a profit growth of just 25%. This would be an alarm bell for investors as it would suggest large cost increase for an growth in core business.
A good growth company must be able to keep cost in line with growth, hence a profit growth in line with revenue.
3rd Criteria: EPS growth >25% Quarterly
With an increase in profit of 25%, we must always look at the EPS. EPS is “Earning per share”, and is calculated by taking the company’s earnings divided by the number of shares.
What you’re buying on the stock market is the stocks of a company, not really the company itself.. The stock prices are affected by its own supply and demand. If a company had an increase in profits of 25%, but a EPS growth of 0%, it would indicate the company has probably issued too many shares over the 2 period, and the stocks are probably diluted.
Hence, a profit growth must be accompanied by an EPS growth.
4th Criteria: Asset vs Liabilities
Liabilities refer to a company’s debt. If a company had more liabilites than assets, it essentially means that if there is a need, a company would not be able to pay off all its debt even if it sold all its assets.
Growth is a dangerous game for growth companies. Many companies with good potential run themselves into large debt due to aggressive expansion. Its is hence important to ensure the company you are buying has a Asset:Liabilities ratio of >1 and an improving ratio Quarter on Quarter.
This will indicate to investors the management is careful of accumulating too much debt, in the pursuit of growth.