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Growth
Stocks for a Strong Market
Although anything can happen, the market is usually
strong from now through year’s-end. Here’s a screen for finding stocks
likely to do well, assuming that the market performs as expected.
If you’re not familiar with the term, stock
screeners are programs that allow you to search the entire market for
stocks meeting your particular requirements. If you don’t want to run
the screen, you can manually apply my selection rules to any list of
stocks.
My screen looks for stocks with strong earnings
growth that are already outperforming the market. These 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.
I used MSN Money’s Deluxe Screener because it’s the
only free search program I’ve found that’s up to the task (disclaimer: I
also write for MSN Money).
Find it 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.
I’ll start with four
general requirements, that, in my view, you should apply to every stock
that you’re considering buying. 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).
Active Stocks Only
Daily trading volume is the average number of shares traded daily
over a specified timeframe. Trading volumes for most stocks range from
hundreds of thousands to millions of shares. Stocks with low trading
volumes are subject to price manipulation, and, equally bad, mutual
funds and other big buyers avoid them because can’t take meaningful
positions without upsetting the market. Specify a minimum 100,000
average daily volume over the past month (Trading & Volume).
High Profits
In stock market terminology, profitability means return on
shareholders’ investment. Low profitability stocks must continuously
raise additional cash to fund expansion. Return on equity (ROE), which
is net income divided by shareholders equity (book value), is the most
widely used profitability measure. Follow the pros and require a minimum
15 percent return on equity (Investment Return).
Follow the Big Players
“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 90 percent for most stocks.
Specify a minimum 30 percent institutional ownership (Trading & Volume).
Now that we’ve isolated
solid stocks, we’ll pick the fastest growers of the group.
Earnings Growth Rules
Stock prices typically follow earnings, so, all else equal; stocks
with the strongest earnings growth usually do the best. Most growth
investors prefer at least 20 percent recent annual earnings growth. So
require at least 20 percent earnings-per-share (EPS) growth over the
past year (Growth Rates).
Further, stocks with
already high, but accelerating earnings growth get the market’s
attention. Specify 25 percent minimum EPS growth for the most recent
quarter (Growth Rates).
To ensure that growth isn’t slowing, also require
that analysts must be forecasting at least 25 percent growth next year
(Analyst Projections).
Sales Power Earnings
Earnings growth can’t be sustained without sales growth. Require at
least 20 percent revenue growth over the past year (Growth Rates) and at
least 25 percent 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 percent six-month RS means that
the stock has outperformed 90 percent of all stocks over the past
six-months.
Since some experts say that the strongest prospects
are showing improving relative strength, require a minimum 80 RS
(Trading & Volume) for the past six months, but an 85 three-month (RS).
If you’re not running the screen, you can see the relative strengths on
MSN Money’s
Company Report.
Here's a
link to the complete screen.
My screen listed 13 stocks: 21st Century Holding,
Cognizant Technology Solutions, Copa Holdings, Crocs, Guess?, Hittite
Microwave, Homex Development, InterDigital Communications, International
Securities Exchange, The Knot, Quality Systems, Research in Motion, and
Superior Essex (disclosure: I own shares of Crocs).
Since the screen works mainly with historical
results, and wouldn’t know, for instance, that a firm’s new product is
registering disappointing sales, consider these stocks as research
candidates, not a buy list.
As mentioned earlier, this screen picks stocks that
should do well in a strong market.
You can gauge the market for growth stocks by
comparing the Nasdaq composite index to its 50-day moving average
(average of last 50-days closing prices). Most experts consider a stock
or index to be trending up when it’s above its moving average. You can
check for that condition on Yahoo (finance.yahoo.com)
by clicking on
Nasdaq
and then on
Technical Analysis. Buy only if the Nasdaq is trading above its
50-day moving average.
Also, the hot growth 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 percent from its recent
high.
published 10/29/06 |
