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Fast
Growing Stocks Best For Slowing Economy
Many analysts
are predicting a weakening economy, and hence, a falling stock market,
next year. They cite high
energy prices, rising inflation, and a slowing housing market as reasons
for their glum outlook.
Whether the
naysayers are on the mark or not is anybody’s guess. But, since
successful investing is about reducing risk, it pays to take their
concerns into account, just in case.
What kinds of
stocks should you have in your portfolio if the economy weakens?
Conventional
wisdom says stick with companies that make or sell the products
typically found in a grocery store such as food products, soap, and
bathroom tissues. Consumers can put off buying a new car or a flat-panel
TV, but they still have to buy the day-to-day necessities.
That may be
true, but I have a different take.
Fast
Growers Do Best
If the economy does slow, mature companies that are close to saturating
their markets such as the likes of Safeway or Proctor & Gamble will
likely still see their sales growth slow. But, a company with a hot new
product that is just coming to the attention of prospective buyers
probably won’t even notice that economy has turned down.
Thus, in a
slowing economy, you’ll do best owning small-companies that are in the
beginning stages of exploiting a new market opportunity. Another plus,
if the economy doesn’t slow, these stocks will still do even better.
Screen for
Fast Growers
You can use screening to find companies that fit that bill. If you’re
not familiar with the term, screening involves using search programs
available on several financial websites to find stocks that meet your
specific requirements.
I’ll use
Business Week’s Advanced Stock Search to demonstrate the process.
Business Week’s screener is free, and it’s more user-friendly than
most.
Note: as of 1/17/07,
Business Week's screeners were no longer available. You can run similar
screens using MSN Money's Deluxe Screener (moneycentral.msn.com)
or Reuters Investor's PowerScreener Lite (www.investor.reuters.com).
MSN's screener requires downloading special software and Reuters'
screener requires registration, but both are free.
Get there
from Business Week’s homepage (www.businessweek.com)
by selecting Investing
and then Stocks.
From there, scroll down to Investing Tools, select Stock
Screeners and then click on Advanced
Stock Search.
You program
the screener by filling in minimum and/or maximum values for data items
that you want to include in your screen. The program assumes that you
don’t care about any items that you left blank.
My screen
relies mainly on analyst’s earnings forecasts to identify fast growing
companies. But, stocks without a track record of strong recent earnings
growth are risky business.
Start With
Growth
So, we’ll start by specifying a minimum 20 percent annual earnings
growth for the last reported fiscal year. Do that by entering “20”
for the minimum value of the search parameter labeled “EPS Growth
1-Yr.”
For forecast
earnings growth, specify a minimum 25 percent year-over-year earnings
growth for the current quarter (Proj EPS %Change Cur Qtr), the current
fiscal year, and the next fiscal year (Don’t enter the ‘%’
symbol).
To insure
that the analysts’ expected earnings growth isn’t just a short-term
phenomenon, require at least 25 percent forecast average annual growth
over the next five years (Proj EPS Annualized 5-Yr). However, too much
forecast growth signals extra risk. Research has found that companies
with forecasted long-term annual earnings growth of 40 percent or higher
rarely live up to those expectations. Their stock prices usually crash
when the forecasts are reduced to more realistic levels. So, in addition
to the 25 percent minimum, specify 35 percent for the maximum acceptable
forecasted long-term earnings growth.
Out of the
6,000 or so U.S. listed stocks, only 34 met those earnings growth
requirements.
Reduce
Risk
Next we’ll add additional search requirements to eliminate the
riskiest candidates, starting with institutional ownership.
Institutional
buyers such as mutual funds and pension plans employ squads of analysts
to research stocks. So instead of reinventing the wheel, it makes sense
to piggyback on their efforts and avoid stocks that the big boys are
shunning.
Institutional
ownership is the percentage of a firm’s outstanding shares owned by
these big players. Institutional ownership typically ranges from 40
percent all the way up to 95 percent for in-favor stocks. Specify a
minimum 40 percent institutional ownership (labeled institutional
holdings).
Another way
of avoiding risky stocks is to pay attention to short-sellers’
activity. Short sellers sell shares they’ve borrowed from a broker in
the hopes that they can buy shares at a lower price later to replenish
the shares that they’ve borrowed. They make money if the stock price
drops during the time they are short and lose if the stock price moves
up.
Short-sellers
are usually expert at analyzing a firm’s fundamental outlook.
Consequently, it pays to avoid stocks with heavy short selling.
Short
interest is the number of shares that have been borrowed by short
sellers for their trades. The short-interest ratio is the number of days
it would take for the short sellers to buy back their borrowed shares,
based on the recent average daily trading volume.
Short
interest ratios run from zero to 20 days, and sometimes higher. The
higher the ratio, the higher the short interest. Usually, growth stocks
have ratios below five or six. Specify a maximum seven short-interest
ratio to rule out stocks in the short-sellers’ crosshairs.
Not Buy
& Hold
My screen turned up a total of 22 stocks, too many to list here. Not
surprisingly, considering energy prices, six of them were in the energy
industry. As is the case with all screens, the results are research
candidates, not a buy list. Another caveat, high-growth stocks are not
long-term buy and holds. They must be watched closely and sold when
anything goes wrong.
published 11/13/05 |
