What to Buy?

How to select a Growth Stock?

I use the following criteria to select the stock for my portfolio.

  • Set minimum level of earnings increase  to > 20%.  Last Quarter over quarter eps should be > 25%
  • Look if stock with annual Eps growth > 20%, Again this is not a restriction.
  • Check the trend of earnings surprise. Ensure that it’s over 5%.
  • Make sure that this EPS growth is supported by Revenue growth. Quarter over quarter sales increase should be at least  positive or greater than 10%.
  • Look at company’s previous 4 qtr growth , try to purchase company whose earnings growth is accelerating or at least has the earnings growth in 3 of 4 quarters (average if last 4 quarters >20)
  • Once above the criteria are filtered look at future 2 years estimate to get an idea of what future has in store. e.g. JAZZ had mind-blowing last 2 years but the revenue growth will hit a wall from next year.
  • Look at the CAGR for over last 5 years.
  • See the eps rating of ibd as well- pick company with EPS rating > 80 (above Filter will do that automatically)
  • Always prefer stocks with  accelerating revenue and earnings growth.
  • Keep an  eye out for 3 digit sales growth
  • Return on equity should be > 10
  • Try to pick the stocks in good sectors. Generally we will see sector rotation in stocks. In other words-pick leader in leading sector. RS has to be > 75
  • Look at the company’s products, where they are used and how does company stand in competition
  • Compare the  Margins  with competitors.
  • Are the profit margins improving?
  • See how many company uses its cash? How many acquisitions does it make? Do they buy back to Increase the value? e.g Apple gave out dividends recently and announced buy backs. or Qualcomm bought Atheros Communication last year to step into wireless processor market.
  • See if MFS are buying or dumping the stocks – Ensure that number of funds owing the stock have gone up in at least 3 out of 4 quarters, especially the latest quarter.
  • Volume of stocks outstanding and what is the short ratio – This ensures that there is liquidity and on breakout the stock will be a hit.
  • See the quality of Mutual Funds which own the stock. One of the reasons for buying SXCI. The funds owning it should be top funds. All smart managers think alike.
  • Are they working on new product? Apple TV
  • The latest new product they launched – what %age of total sale does it make up? Mac, Ipad and Iphone – does it ring a bell.
  • Existing store/restaurant sale? Is it improving? This is a critical number for retailers and food chains. e.g. My wife was surprised when I told her that ULTA has had 10% same store sales increase for over 4 quarters now.
  • Are they expanding their stores/restaurant ? CMG plans on opening 70 new stores in coming quarter.
  • Are the production units running full capacity ? How is the Capex trend? e.g. Is CLR planning on new wells?
  • How is inventory turnover/accumulation compared to sales? More so – how is the inventory turnover trend in last few quarters? Is it slowing down or picking up? e.g Deckers inventory numbers fell short and stock took the beating.
  • What is the backlog and how quickly can it be wiped off? e.g. Order cancellations such as drilling equipment not needed any more.
  • Role of product ? Is it in demand? e.g. Iphone and it’s suppliers.
  • Look at the balance sheet can to see if the company is generating Free Cash Flow and has little or no debt.
  • Can it generate recurring revenue ?
  • Stock growth rate >= forward P/E. If the price multiple exceeds the growth then the stock is expensive indeed. But don’t drop the stock just because of this reason.

I know that it’s a long list but it is not necessary that all the criteria be fulfilled – more the merrier.


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