With the economy finally showing signs of life, this might be a good time to consider growth stocks again. These are stocks that are growing sales and earnings at a faster than normal clip, typically at least 15% annually. Since share prices typically track earnings, fast growers usually outperform other stocks.
A little over two years ago, on January 31, 2010, I published an article describing how you could use the free and user-friendly stock screener provided by FINVIZ.com to find growth stock candidates (screeners are programs that you can use to scan the market for stocks meeting your selection criteria).
My January 2010 screen turned up five growth candidates that as a group averaged a 15% return over the next six months compared to the S&P 500's 1% return. Since growth stocks can be easily tripped up by a weak economy, I didn't feel that the time was right to produce another growth stock portfolio until now. Here's this year's version.
Start by going to the FINVIZ homepage (finviz.com) and then selecting Screener. FINVIZ calls its selection criteria "filters." On the Filters bar, select "All" to display all of the available filters. Use the associated dropdown menus to select the desired filter values.
Start With Fast Growth
Growth candidates should have a solid history of strong sales (revenue) and earnings growth, along with expectations that those growth rates will continue. Since the past few years have been tough, require "over 10%" earnings (NYSEARCA:EPS) and sales average annual growth over the past five years instead of the 15% or 20% you might specify in normal times. Looking ahead, require that analysts must be forecasting "over 20%" average annual EPS growth over the next five years.
The best growth stock candidates are "in-favor" with most market players. Stock analysts issue buy/sell ratings on the stocks that they cover. FINVIZ compiles them into five categories: strong buy, buy, hold, sell and strong sell. Require Analyst Recommendations of "buy or better" to limit your list to in favor stocks.
Average volume (number of shares traded daily) also measures market sentiment. Require over 200,000 (200k) average volume to assure that passing stocks are in-favor by that measure.
Don't Pay Too Much
The biggest pitfall of growth investing is arriving too late at the party and overpaying for a stock. While many use the price/earnings ratio (share price divided by the last 12-month's earnings) to measure valuation, it's better to use the forward P/E, which uses the forecast current fiscal year's earnings instead of the last 12-months. The forward ratio excludes non-recurring items that can distort historical earnings, and hence, the P/E ratio. Require an "under 35" forward P/E.
Follow the Big Players
Thanks to the huge trading commissions that they generate, institutional investors such as mutual funds have access to information that you and I never see. Thus, it makes sense to stick with stocks that the big money likes. Institutional ownership measures the percentage of shares held by these savvy players. Require "over 40%" Institutional Ownership.
There's more to profitability than reported earnings. For instance, earnings of $1 million doesn't mean much if its shareholders had to sink $2 million in new capital into the company to turn that profit. Return on equity (ROE), the most widely used profitability gauge, compares 12-months' net income to shareholders equity (book value). Require "over 15%" ROE and higher is better.
Firms loaded down with high debt are always riskier than those with little or no debt. The debt/equity ratio, which is total debt divided by shareholders equity, is a good debt measure. Zero ratios mean no debt and the higher the ratio, the higher the debt. Require a debt/equity ratio "under 0.1." .
Uptrending Stock Price
Strong growth candidates must be in uptrends, meaning that the share price is generally moving up. Comparing a stock's share price to its moving average (average closing price over a specified number of days) will tell you which way a stock is moving. Uptrending stocks are trading above their moving averages, while downtrending stocks are trading below.
The 50-day moving average gauges short-term price action, and the 200-day MA measures longer trends. Require that passing stocks must be trading above both (simple) moving averages (Price above SMA).
Not Too Cheap
Cheap stocks get that way because many investors see problems ahead. Whether they are right or wrong, low trading prices signal added risk, which you don't need. Require passing stocks to be trading "over $15."
My screen listed 10 stocks: Align Technology (NASDAQ:ALGN), Alexion Pharmaceuticals (NASDAQ:ALXN), Buffalo Wild Wings (NASDAQ:BWLD), F5 Networks (NASDAQ:FFIV), Gulfport Energy (NASDAQ:GPOR), IPG Phototroncis (NASDAQ:IPGP), Mercadolibre (NASDAQ:MELI), Silver Wheaton (NYSE:SLW), SolarWinds (NYSE:SWI) and VMware (NYSE:VMW). Buffalo Wild Wings was the only repeat from the January 2010 list. The screen will probably turn up different stocks when you run it. Consider these stocks to be research candidates, not a buy list.