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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 |
