Harry Domash's Winning Investing

Growth Stock Scorecard

Growth stock investors buy stocks they think will grow sales and earnings faster than inflation. Here’s a scorecard for comparing growth stock candidates.

I’ll demonstrate the process using MarketWatch (marketwatch.com) and Zacks (zacks.com) to research two candidates: Monolithic Power Systems (MPWR), and Lumentum Holdings (LITE). Both are tech stocks. Monolithic makes power supplies for electronic devices and Lumentum makes lasers, including those used in fast growing 3D sensing applications.

1) How Much Growth? 

All else equal (of course it never is), over time, share prices more or less track per share earnings, and to a lesser extent, per share revenues (sales). Thus, your best stocks will often be those generating the fastest earnings and sales growth while you hold them.

How do you determine which stock’s have the best growth prospects? Although far from perfect, unless you have better information, stock analyst’s sales and earnings forecasts are a good place to start.

Zacks is a good resource for that information. It lists both EPS and revenue forecasts for the current and next quarters and fiscal years. Find that information by getting a price quote and then selecting “Detailed Estimates.” Scroll down to the Sales Estimates and Earnings Estimates sections and pay most attention to the Current Year growth forecasts.

Score one point each for This Year’s EPS and This Year’s Sales growth forecasts above 10%, and subtract point each for growth values below 5%. 

When I checked; for Monolithic, Zacks was forecasting 24%t sales growth and 27% earnings growth for 2018. For Lumentum, analysts were forecasting 29% sales growth and 16% higher EPS for its June 2019 fiscal year.

Both stocks scored two points each for the Growth category.

2) Too Much Debt?

You’ll always do better by sticking with low-debt stocks. The debt/equity (D/E) ratio, which compares a firm’s total debt to shareholders equity (book value), is a widely used valuation gauge. Values below 1.0 signal low-debt firms and lower is better.

Zacks lists D/E ratios in the Fundamental Ratios section of its Full Company Report page. Score one point for D/E ratios below 1.0 and subtract one point for values above 2.0.When I checked, Zacks showed D/E’s of 0.0 (no debt) for Monolithic and 0.4 (very low debt) for Lumentum.

Score one point each for both Monolithic and Lumentum. 

3) How Profitable?

For stocks, profitability means more than not losing money. Here’s why.

Consider two hypothetical companies, Company A and Company B. Both earned $10 million last year. However Company A’s shareholders only had to invest $30 million to turn that profit compared to $60 million for Company B. Thus, Company A’s investors realized twice the return of Company B for each invested dollar. 

Return on assets (ROA), the ratio of a company's month net income to its total assets, is a popular profitability gauge. For best results, require ROAs above 5%, and higher is better.

Use MarketWatch to check ROA. Start by entering your stock’s ticker symbol into the search box at the top of MarketWatch’s home page. MarketWatch lists ROA in the Profitability section below the Company Description.  Subtract one point for ROAs below 5.0% and add one point for ROAs above 10.0%.

MarketWatch listed Monolithic’s ROA at 11.2%, and Lumentum at 17.6%, so each earned one point for Profitability.

4. Too Late to the Party? 

It’s easy to get carried away and overpay for a hot growth stock. The price/earnings ratio (P/E), which is the recent share price divided by the last 12-month’s EPS, is the most popular valuation gauge. However, EPS often varies widely from quarter to quarter, making P/E an unsteady measure. By contrast, the price/sales ratio, which is the share price divided by 12-month’s per share revenues, provides more consistent numbers. For growth stocks, P/S ratios mostly range between 5 and 10, but sometimes much higher.

MarketWatch lists P/S ratios under Valuations, next to the Profitability section. Add one point for P/S ratios below 5.0, and subtract one point for P/S ratios above 10. MarketWatch listed Monolithic’s P/S at 10.4, and Lumentum at 2.9.  

Subtract one point for Monolithic and add one point for Lumentum.

5) Follow the Cash  

Reported earnings are subject to a variety of arbitrary accounting decisions and can be misleading. By contrast, operating cash flow, which measures the cash that moved into, or out of, a firm's bank accounts attributable to its business operations, is a more reliable measure.

On MarketWatch, Select Financials from the main menu, and then select Cash Flow Statement. Scroll down to the Net Operating Cash Flow (OCF) line and check the most recent year’s cash flow number. At a minimum, operating cash flow should be positive, but it’s best to stick with stocks whose operating cash flow exceeds the net income (top line of cash flow report) for the same period. Add one point when OCF is positive and exceeds net income. Subtract one point when OCF is negative. Score zero points when OCF is positive, but is less than net income.

Monolithic’s operating cash flow totaled $134 million vs. $65 2 million net income for 2017. Lumentum recorded a -$103 million net income loss in fiscal 2017, but it earned a hefty $85 million when you counted the cash. So, both stocks scored one point in this category.

For the five checks, Lumentum scored six points vs. four points for Monolithic, the difference being valuation.

Checking these five items will help you make better investing decisions, but they are just a start. Do your due diligence. The more you know about your stocks, the better your results.

Published 8 20/18

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