One of the best books I read is ‘How to Make Money in Stocks’ from William O’Neil.
In that book, the author explains his methodology of analyzing fundamentals based
on factual evidence from past stock market winning stocks and teaches how to use
technical analysis to buy those stocks at the right time.
I call growth stocks to companies that show consistent earnings and sales growth
and in general have price-to-earnings ratios higher than those of the average stock
simply because they have a record of better than normal earnings performance.
Typically, growth stocks have a high-quality, repeat-type producto or service that
generates superior profit margins and a return on equity of at least 17% to 50%.
In addition, consensus earnings estimates for these stocks for the following year or
two are also up a significant amount.
From O’Neil’s book and others I separated 7 items to pay attention in growth
1. Quarterly Earnings and Sales Growth: I look for stocks that show a mínimum
of 25% increase in current quarterly earnings per share when compared to the
prior year’s same quarter.
Bill O’Neil mentions several examples of winning stocks, detailing that each stock
showed strong quarterly earnings and sales growth before they started the big
For example, Studebaker’s earnings were up 296% before it sped from $45 to $190
in eight months in 1914, and Cuban American Sugar’s earnings soared 1175% in
1916, the same year its stock climebd from $35 to $230. Other examples include
Dell, which showed earnings per share rises of 74% and 108% in the two quarters
prior its Price increase from November 1996. Also Priceline was showing earnings
up of 34% in the June quarter of 2006, when its stock began a move from $30 to
Many individuals and even some institutional investors buy stocks whose earnings
were down in the most recently reported quarter because they like to company
and think that its stock Price is “cheap”. Usually they accept the story that earnings
will rebound strongly in the near future. In some cases this may be true, but in
many cases it isn’t. The point is that you have the choice of investing in thousands
of companies, many of which are actually showing strong operating results. You
don’t have to accept promises of earnings that may never occur.
2. Annual Earnings and Sales Growth: Similar to quarterly earnings growth, I
look to select stocks with 25% to 50% and higher anual earnings growth rate.
There are several examples of great stocks that posted huge annual sales and
earnings growth before they started a big move. In other words they were proven
- Xerox was growing at a 32% annual rate before its shares soared 700% from March 1963 to June 1966.
- Wal-Mart, which consistently created an annual growth rate of 43% before rocketing 11200% from 1977 to 1990.
- Cisco Systems, whose earnings were exploding at a 257% rate in October 1990, and Microsoft, which was growing at a 99% clip in October 1986, before their enormous advances.
- Priceline, which from 2004 to 2006 more than doubled its earnings from 96 cents a sahre to $2.03, before it tripled in Price in the next five quarters.
3. Return on Equity(ROE): I look for ROEs of at least 17%. Agreeing with
Warren Buffett, I think that this ratio is the primary test of managerial economic
performance. It is important to know that this ratio can be increased if the
company also do the same with their debt-to-equity ratio. That is why it is always
great to select companies that earn a good return on equity without the aid of
4. Earnings Stability over a three year record: A company that has a durable
competitive advantage will show consistency in earnings overa n extended
number of years. This is reflective of the underlying economics of the business.
I have discovered that companies that don’t show a long-term consistency in
earnings usually make poor long-term investments. If a company has an erratic
earnings history, it is more likely the kind of company that produces what Warren
Buffett calls a “commodity”type product, a product that has no brand identification
and that competes in the marketplace solely on the basis of price.
5. New products, new markets or new industry conditions: It takes something
new to produce a huge rise in the price of a stock. It can be an important new
product or service that sells rapidly and causes earnings to accelerate faster than
provious rates of increase (think on the iPhone launch in 2007). Ori t can be a
change of management that brings new vigor, new ideas, or at least a new broom
to sweep everything clean (for example, when Howard Schultz came back to
Starbucks). New industry conditions, such as supply shortages, price increases, or
the introduction of a revolutionary technology- can also have a positive effect on
most stocks in an industry group.
It is essential to look at these new things when you analyze a growth stock.
6. The company buy backs its own shares: I like to see managers that buys its
own sotck in the open market consistently over a period of time. This reduces the
number of shares and usually implies that the company expects improved sales
and earnings in the future.
7. Ratio of debt/equity: Usually, the lower the debt ratio, the better and safer the
company. The earnings per share of companies with high debt-to-equity ratios
could be clobbered in difficult periods when interest rates are high or during more
severe recessions. The highly leveraged companies are generally of lower quality
and carry substantially higher risk.
I like to find strong companies that are poised to keep growing in the future. If you
also want to find these I would advice to subscribe to my newsletter and be ready
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