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Growth Stocks for a Strong Market

Although early October can be bumpy, the market is usually strong from mid-October through the end of the year.

If the market performs as expected, stocks with strong earnings and sales growth expectations will be your best bets during that period. Screening is the best way to find stocks in that category.

If you’re not familiar with the term, stock screeners are programs available on financial sites that you can use to search the entire market for stocks meeting your particular requirements.

MSN Money Screener
I’ll describe how to use MSN Money’s Deluxe screener to find growth stock candidates worthy of further research.

Find the screener from MSN Money’s homepage (moneycentral.msn.com) by selecting Investing and then Stock Screener. If you’re a first-time user, you’ll have to download free special software. Also, the screener only works with Microsoft’s Internet Explorer browser.

Also, first-time users will probably need to spend some time learning how to use the screener. But stick with it. Once you get the hang of it, the screener will be your best friend (disclosure: I also write for MSN Money).

My screen looks for stocks with strong earnings growth that are already outperforming the market. These are only suitable for an strong market and are not long-term buy-and-hold candidates.

I’ll describe how to know when the market is strong enough to buy these stocks, and when to sell, after I describe the screen.

Locating the suggested screening factors within the MSN screener can be tricky, so I’ve included the category where you’ll find each specified factor in parenthesis.

Avoid Cheap Stocks
Low-priced stocks are usually cheap because many investors see fundamental problems. Buying these stocks adds unnecessary risk. There is no hard and fast rule, but $15 is a reasonable cutoff. Specify a minimum $15 “last price” (Stock Price History).

Reasonably Priced
Valuation ratios such as price to earnings (P/E), gauge market sentiment. High valuations reflect market player’s enthusiasm, a positive factor. By contrast, low valuations warn that a stock is out of favor, probably because savvy investors see problems down the road.

Thus, it’s important to pick stocks that aren’t overvalued, but are not too cheap either. The forward P/E ratio is the recent price divided by current fiscal year’s forecast earnings. It’s the most appropriate measure for fast earnings growers. Forward P/Es below 20 reflect out-of-favor stocks and those above 45 signal potentially overvalued stocks. Specify forward P/E greater than 20 and below 45 (Analyst Projections)

Profitable
Profitability measures the return on investment for shareholders. Low profitability stocks don’t generate enough cash to fund growth, so they must frequently raise additional cash. Return on equity, which is net income divided by shareholders equity (book value), is a popular profitability measure. Require a minimum 15% return on equity (Investment Return).

Follow the Big Money
 “Institutional ownership” is the percentage of a firm’s outstanding shares held by institutional buyers such as mutual funds. Low institutional ownership means that the big players don’t think they can make money holding the stock, so you probably can’t either. Institutional ownership ranges from 30% to 95% for most stocks. Specify a minimum 30% institutional ownership (Trading & Volume).

These tests pinpointed profitable companies that are in-favor with big investors. Next, we’ll pick the fastest growers of the group.

Earnings Growth Rules
Earnings growth usually triggers share price appreciation, so, as a rule, stocks with the strongest earnings growth do the best. How much is enough?  I’ve found that stocks growing earnings at least 20% annually are your best bets. So require at least 20% earnings-per-share (EPS) growth over the past year (Growth Rates).

From that group, stocks recording accelerating earnings growth will likely do the best. Pinpoint those stocks by requiring 25% minimum EPS growth for the most recent quarter (Growth Rates).

To guard against slowing growth, also require that analysts must be forecasting at least 25% growth next year (Analyst Projections).

Sales Power Earnings
Although a firm can temporarily boost earnings but cutting costs, in the end, earnings growth comes from sales growth. Require at least 20% revenue (sales) growth over the past year and at least 25% revenue growth for the last quarter (Growth Rates).

Buy Winners
Since we’re told to “buy low,” this may sound counterintuitive, but stocks that are already outperforming the market are your best prospects. Relative strength (RS) measures a stock’s return compared to the overall market. For example, a 90% six-month RS means that the stock has outperformed 90% of all stocks over the past six-months.

Require a minimum 80 RS (Trading & Volume) for the past six- and 12-months. If you’re not running the screen, you can see the relative strengths on MSN Money’s Company Report.

My screen listed 9 stocks: Bucyrus International, Crocs, Hansen Natural, Flotek Industries, Suntech Power Holdings, KMG Chemicals, Interactive Intelligence, Smith & Wesson, and Sun Healthcare Group. 

Here's a link if you want to run the screen today to see the current picks. As is the case with all screens, consider these stocks as research candidates, not a buy list.

The screen picks stocks for a strong market. So it’s important to gauge market strength before you buy. Do that by comparing the Nasdaq composite index to its 50-day moving average (average of last 50-days closing prices). You can do that on Yahoo (finance.yahoo.com) by clicking on Nasdaq and then on Technical Analysis (select 50-day simple moving average under Technical Indicators).

Consider the market strong if the Nasdaq is trading above its moving average and weak if it isn’t.

The stocks pinpointed by this screen can drop quickly when something goes wrong. Consider selling on any bad news, or when a stock drops more than 10% from a recent high.
published 9/30/07

 

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