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As I hit the "filter" button on my growth scan, I fully expected the list to be chock full of micro-cap stocks that were little more than glorified lemonade stands. Creating large growth numbers is far easier for small companies aggressively expanding than it is for Exxon Mobil Corporation (XOM) with a market capitalization of almost 400 billion dollars. But what I found surprised me. Below is my criteria and my findings.

Criteria for Growth Stocks

Scanning for one year or one quarter of growth proved too unreliable as the recession hit companies hard and even the blue chips appeared to have massive growth rates as they sprung back up to former profitability levels. For example, Exxon Mobil appears to have quarterly year-over-year EPS growth of 55.4%, but if you project an income statement for the years end, they will likely be over 10 billion shy in net income when compared to 2007 or 2008.

  • The first criteria was to have average EPS growth over the last 5 years greater than 25%
  • The second was to screen for expected EPS growth over the next 5 years as being greater than 15%

Of course, new stocks without a 5 year track record of earnings would be excluded from this scan, as would small, high-growth companies without analyst earnings forecasts.

Increasing Sales, High Return on Equity, and High Profit Margin

Certain earnings reports can appear to grow by such creativity as stock buybacks, tax breaks, cutbacks or by simply increasing net profit margins. To know if there is backbone to the growth you need to look at increasing sales. Furthermore, a high return on equity shows that management is good at utilizing shareholder equity which relates directly to profitability. A decent profit margin also gives the company a little wiggle room to adjust prices when competition is fierce.

  • Third, we want the past 5 years of sales growth to be over 25%
  • Fourth, our return on equity needs to be over 20%
  • Fifth, net profit margins should be over 20%

Reasonably Priced with Good Recommendations

Is the stock reasonably priced based on expected growth? One way to measure this is using PEG ratios. We definitely want PEG ratios to be under 2, and closer to 1. Last, we want the average analyst recommendation to be a buy or better.

  • Sixth, PEG under 2
  • Seventh, buy or better recommendation

Scanned List of Growth Stocks

  • Apple (AAPL)
  • Baidu (BIDU)
  • China Information Technology (CNIT)
  • Ctrip.com International (CTRP)
  • First Solar (FSLR)
  • Gulf Resources (GFRE)
  • Google (GOOG)
  • Mindray Medical International (MR)
  • Myriad Genetics (MYGN)
  • NetEase.com Inc. (NTES)
  • Southwestern Energy (SWN)
  • WuXi PharmaTech (Cayman) Inc. (WX)

What is surprising about this list is how high the market cap is in some instances. AAPL has a current cap of over 300 billion dollars, and Google is over 200 billion. The only companies on the list under a billion are CNIT with 255 million, and GFRE with 334 million market cap. Another point that jumped out at me is how 7 of the 12 picks are China stocks. Definitely something to contemplate there.

The highest PEG ratios were in descending order BIDU, CTRP and GOOG with a range of 1.55 to 1.35. On the low end of PEG we had CNIT, GFRE, and MYGN with a range of 0.31 to 056.

The stocks expected to have the highest EPS growth over the next 5 years were BIDU, CTRP, and MYGN.

Although CNIT, BIDU, and FSLR topped the list for the past 5 years of EPS growth, next years EPS growth expectations go to BIDU, CTRP, and NTES.

When looking at a 9 month price chart, some stocks have proved to be rockets such as BIDU and AAPL, which others are simply trying to regain former levels such as NTES, GFRE, and FSLR. Still others are trading down significantly such as CNIT, SWN, and MR.

You can get a good feel for some channeling, trendlines, and moving averages on these stocks by looking here.

Will these stocks meet their lofty expectations and out-perform the market? Many analysts think so. But as always, due diligence is a must as screening for stocks and looking at a quick chart is only the starting point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Growth Stocks That Analysts Love