Within the context of Investing for Retirement or Investing for High Returns I’ve often get asked for my stock selection criteria. While I have a large number, let me give you my top 10 check boxes when determining what growth stocks to invest in.
To have a growth stock whose share price is rapidly growing you first need truly superior earnings. Current earnings per share should be growing at 30% or better. Likewise, over the past three years EPS should have grown on average better than 30%. Rapid growth in earnings drives ever higher stock prices. This attracts fund managers like a magnet. Once the fund managers start bidding the stock price up you win.
Rapid sales growth generally goes hand in hand with earnings growth. Again you want to target 30% or better sales growth, both currently and over the past three years. Rapidly growing the top line attracts the fund managers which in turn bids up the stock price. Make sure you have both sales and earnings growth. Sales growth without accompanying earnings growth means that the company has serious expenditure or pricing problems. You must have both.
- Industry Group
Industry groups go in and out of favor with investors. You want your stock pick to be from a group that’s in favor. Favored groups get all the attention from the fund managers. Groups that are out of favor get ignored. If you pick a stock from an out of favor industry you are really rowing against the current.
The more debt that a company carries the less flexibility the company has. Companies with high debt loads have to worry about servicing that debt and the associated interest payments are a drain on earnings. But how do you measure debt? The best way is the company’s debt to equity ratio this tells you whether or not the company’s accumulated earnings (equity) are overshadowed by an excessive debt load. A ratio of less than 1:1 is desirable, the lower the better.
- Fund Ownership
This is very important. What do the other funds think of your stock pick? You want them to drool over it to the point they need it in their portfolios. Fund portfolios are a game of follow the leader. Everyone is judged against everyone else. No one wants to be the one without the hot stock pick in their portfolio. You want your stock to have growing fund ownership both in the current quarter and over consecutive quarters.
- Management Ownership
I like management to have a stake in the stocks that I pick. The bigger the stake the better. Management needs to be motivated by self-interest, which in turn is also in my interest.
- 50 Day Moving Average
I like to see my prospective stock trading well above the 50 day line. To do this the stock price needs to be growing consistently with more buyers than sellers.
- 52 Week Range
I want to see my prospective stock approaching its prior 52 week high. Often a stock that breaks through this psychological barrier continues growing as funds accumulate shares. Stocks nearing their 52 week highs are candidates for future growth spurts.
- Chart Pattern
I love to see the classic cup and handle chart pattern when looking for prospective stock picks. I also love to see lots of shaking out of old shareholders along the handle preparing for a positive group of fund owners who want to hold, not sell my stock pick. Other favorable chart patterns are welcome as well but I like the classic cup and handle the best.
- Average Daily Volume
I want to see an average daily trading volume of at least 100,000 shares in stocks that I invest in. The reason is liquidity. High trading volumes equate to lots of buyers and sellers. I will be able sell off my position when I want at the price that I want.
There are of course other areas to investigate when looking for a stock to invest in but if you start with these 10 you’ll be well on your way to picking winners in the market.
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