In one of my first posts, I explained how essential it is to combine fundamental and technical analysis. In this article I detail one part of my stock fundamental analysis routine I use to understand the fundamental story of a stock. If you know why a company´s fundamentals will improve in the near future you will trade with much higher confidence levels.
Your first task is using a checklist. It is important to organize all your financial analysis, predictions, and information in one place and the majority of top institutional fundamental analysts uses a checklist to ignore distractions and focus on the essentials. A checklist or fundamental routine helps experienced investors to refine and enhance their current fundamental analysis strategy. I order my checklist in different sub-groups and each has its own questions/analysis that let me create a complete picture of the stock from different angles. In this article I focus on the earnings/sales analysis sub-group. Let´s get going!
Earnings & Sales Growth Analysis
In this sub-group I analyze the company´s current and future growth and how well the stock has been performing in a quarterly and annual basis. Strong sales and earnings were among the most important characteristics of winning stocks. This becomes obvious when you see what really great companies looked like in terms fo their sales, earnings and profit margins before they launched price increases of 200% to 800% or more. I look for strong increases in quarterly sales and earnings compared to the same quarter the year before. You also want to see acceleration in the percent increases in quarterly earnings over the most recent quarters.
Earnings & Sales Checklist Questions
I try to answer specific questions that help me understand the stock current and potential fundamental strenght.
1) Are quarterly and annual sales growing compared to the same period the year before ?
I am looking for companies that increaes its quarterly and annual sales more than 20% compared to the same quarter or year. Ideally, I am looking for +20% growth in quarterly annual or sales when I analyze growth stocks.
2) Are quarterly and annual EPS growing compared to the same period the year before ?
Similar to quarterly and annual sales, I am looking for companies that generates more than 20% EPS growth compared to the same quarter or year.
3) Are both sales and EPS increasing at similar growth rates ?
I do not like when a company generates 20% EPS growth but its revenue growth is a meager 3%. I should see a similar top and bottom line growth rates because earnings per share can be easily distorted from cost cutting measures or accounting tricks.
4) Is the company´s current growth at an early stage ?
In other words, is the growth story of this company ¨new¨ to the market or it is just the same story from the past 2 years? I like when the growth story is new to the market. Look at what is happening with Apple. The market considers the growth story of iPhone and iPads as an ¨old¨ story despite the company has ample potential growth from these products. In order for Apple to keep rising and break new highs it needs to create a new growth story not just releasing the iPhone 5S or the iPad 4, 5, 6, etc…
5) Is the company growing at record levels in terms of Earnings, Revenues and Cash Flow ?
It is important to invest in companies that generate records levels of cash and its business is performing at record levels. Pay attention to the company´s earnings transcript and earnings relese.
6) How simple or predictable are the earnings of this company ?
I like companies that operate businesses I can understand and generate predictable earnings. Hedge Funds portfolio managers like earnings predictability and will always favor stocks with solid business models.
7) Is the company developing new products or expanding into new markets ? How the company will growth in the future? How new is this expansion ? (key question!)
This is a very imporant question. A company can increase earnings from 6 ways:
- Reduce costs
- Raise prices
- Expand into new markets
- Create new products
- Sell more of its product in the old markets
- Revitalize or close a losing operation
Investors should understand why fundamentals will improve in the future. Ideally, the company has recently undergone a major change, which is often necessary for a company to become successful. Whether it is a new management team, a new product, a new market, or new industry conditions, the best growth stocks had experienced something new before its price advances.
How to get this information
I get all these information from different sources:
I recommend IBD to any kind of investor because it is a great source of ideas and stock market education. I get the sales and EPS growth from IBD Stock Checkup. You should create an account in order to get this simple but effective tool.
I take a look at two screens:
Earnings & Sales Growth screen:
In the case of HDFC Bank (HDB), the company has great growth metrics. The company has a 3 Year EPS and sales growth rates of 26% and 23%. HDB has also grew quarterly EPS and sales compared to the same quarter the year before.
IBD Ratings Screen:
I check how the stock is ranked and if the company is a leader in its group. HDB is a clear leader in the Emerging Markets banking sector.
By these two screens I can get a first picture of the kind of growth the company generated.
This is a superb source of fundamental information. In the first half of the transcript, management comments on quarterly results and provides guidance or projections. The second half is focused on a Q&A session with analyts. In each quarterly transcript you can get several fundamental items:
- Management explanations and highlights on overall quarterly results
- Economic comments and trends from the company´s executives
- New product developments
- Current and future strategies
- What matters most to Wall Street analysts
- EPS and revenue guidance
I like to complement the company´s earnings transcript with several presentations from past earnings report or investors/analysts events.
In almost every presentation the company explains its growth strategy and how well they are performing.
Once I have done the fundamental work and decidded to buy a stock, I will first look at the chart before putting on a position. The core is always fundamental but technical analysis is key for a correct risk-reward trade