Stock-Picking Strategies

Ever hear someone say that a company has "strong fundamentals"? The phrase is so overused that it's become somewhat of a cliché. Any analyst can refer to a company's fundamentals without actually saying anything meaningful. So here we define exactly what fundamentals are, how and why they are analyzed, and why fundamental analysis is often a great starting point to picking good companies.

The Theory
Doing basic fundamental valuation is quite straightforward; all it takes is a little time and energy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value, a fancy term for what you believe a stock is really worth - as opposed to the value at which it is being traded in the marketplace. If the intrinsic value is more than the current share price, your analysis is showing that the stock is worth more than its price and that it makes sense to buy the stock.

Although there are many different methods of finding the intrinsic value, the premise behind all the strategies is the same: a company is worth the sum of its discounted cash flows. In plain English, this means that a company is worth all of its future profits added together. And these future profits must be discounted to account for the time value of money, that is, the force by which the $1 you receive in a year's time is worth less than $1 you receive today. (For further reading, see Understanding the Time Value of Money).

The idea behind intrinsic value equaling future profits makes sense if you think about how a business provides value for its owner(s). If you have a small business, its worth is the money you can take from the company year after year (not the growth of the stock). And you can take something out of the company only if you have something left over after you pay for supplies and salaries, reinvest in new equipment, and so on. A business is all about profits, plain old revenue minus expenses - the basis of intrinsic value.

Greater Fool Theory
One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute.

The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool). On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies.

This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. As we mentioned in the introduction, every strategy has its own merits. In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies. (We'll talk more about technical analysis and how it works in a later section.)
Putting Theory into Practice
The idea of discounting cash flows seems okay in theory, but implementing it in real life is difficult. One of the most obvious challenges is determining how far into the future we should forecast cash flows. It's hard enough to predict next year's profits, so how can we predict the course of the next 10 years? What if a company goes out of business? What if a company survives for hundreds of years? All of these uncertainties and possibilities explain why there are many different models devised for discounting cash flows, but none completely escapes the complications posed by the uncertainty of the future.

Let's look at a sample of a model used to value a company. Because this is a generalized example, don't worry if some details aren't clear. The purpose is to demonstrate the bridging between theory and application. Take a look at how valuation based on fundamentals would look:



The problem with projecting far into the future is that we have to account for the different rates at which a company will grow as it enters different phases. To get around this problem, this model has two parts: (1) determining the sum of the discounted future cash flows from each of the next five years (years one to five), and (2) determining 'residual value', which is the sum of the future cash flows from the years starting six years from now.



In this particular example, the company is assumed to grow at 15% a year for the first five years and then 5% every year after that (year six and beyond). First, we add together all the first five yearly cash flows - each of which are discounted to year zero, the present - in order to determine the present value (PV). So once the present value of the company for the first five years is calculated, we must, in the second stage of the model, determine the value of the cash flows coming from the sixth year and all the following years, when the company's growth rate is assumed to be 5%. The cash flows from all these years are discounted back to year five and added together, then discounted to year zero, and finally combined with the PV of the cash flows from years one to five (which we calculated in the first part of the model). And voilà! We have an estimate (given our assumptions) of the intrinsic value of the company. An estimate that is higher than the current market capitalization indicates that it may be a good buy. Below, we have gone through each component of the model with specific notes:
Prior-year cash flow - The theoretical amount, or total profits, that the shareholders could take from the company the previous year.
Growth rate - The rate at which owner's earnings are expected to grow for the next five years.
Cash flow - The theoretical amount that shareholders would get if all the company's earnings, or profits, were distributed to them.
Discount factor - The number that brings the future cash flows back to year zero. In other words, the factor used to determine the cash flows' present value (PV).
Discount per year - The cash flow multiplied by the discount factor.
Cash flow in year five - The amount the company could distribute to shareholders in year five.
Growth rate - The growth rate from year six into perpetuity.
Cash flow in year six - The amount available in year six to distribute to shareholders.
Capitalization Rate - The discount rate (the denominator) in the formula for a constantly growing perpetuity.
Value at the end of year five - The value of the company in five years.
Discount factor at the end of year five - The discount factor that converts the value of the firm in year five into the present value.
PV of residual value - The present value of the firm in year five.

So far, we've been very general on what a cash flow comprises, and unfortunately, there is no easy way to measure it. The only natural cash flow from a public company to its shareholders is a dividend, and the dividend discount model (DDM) values a company based on its future dividends (see Digging Into The DDM.). However, a company doesn't pay out all of its profits in dividends, and many profitable companies don't pay dividends at all.

What happens in these situations? Other valuation options include analyzing net income, free cash flow, EBITDA and a series of other financial measures. There are advantages and disadvantages to using any of these metrics to get a glimpse into a company's intrinsic value. The point is that what represents cash flow depends on the situation. Regardless of what model is used, the theory behind all of them is the same.

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Fundamental analysis has a very wide scope. Valuing a company involves not only crunching numbers and predicting cash flows but also looking at the general, more subjective qualities of a company. Here we will look at how the analysis of qualitative factors is used for picking a stock.

Management
The backbone of any successful company is strong management. The people at the top ultimately make the strategic decisions and therefore serve as a crucial factor determining the fate of the company. To assess the strength of management, investors can simply ask the standard five Ws: who, where, what, when and why?

Who?
Do some research, and find out who is running the company. Among other things, you should know who its CEO, CFO, COO and CIO are. Then you can move onto the next question.

Where?
You need to find out where these people come from, specifically, their educational and employment backgrounds. Ask yourself if these backgrounds make the people suitable for directing the company in its industry. A management team consisting of people who come from completely unrelated industries should raise questions. If the CEO of a newly-formed mining company previously worked in the industry, ask yourself whether he or she has the necessary qualities to lead a mining company to success.

What and When?
What is the management philosophy? In other words, in what style do these people intend to manage the company? Some managers are more personable, promoting an open, transparent and flexible way of running the business. Other management philosophies are more rigid and less adaptable, valuing policy and established logic above all in the decision-making process. You can discern the style of management by looking at its past actions or by reading the annual report's management, discussion & analysis (MD&A) section. Ask yourself if you agree with this philosophy, and if it works for the company, given its size and the nature of its business.

Once you know the style of the managers, find out when this team took over the company. Jack Welch, for example, was CEO of General Electric for over 20 years. His long tenure is a good indication that he was a successful and profitable manager; otherwise, the shareholders and the board of directors wouldn't have kept him around. If a company is doing poorly, one of the first actions taken is management restructuring, which is a nice way of saying "a change in management due to poor results". If you see a company continually changing managers, it may be a sign to invest elsewhere.

At the same time, although restructuring is often brought on by poor management, it doesn't automatically mean the company is doomed. For example, Chrysler Corp was on the brink of bankruptcy when Lee Iacocca, the new CEO, came in and installed a new management team that renewed Chrysler's status as a major player in the auto industry. So, management restructuring may be a positive sign, showing that a struggling company is making efforts to improve its outlook and is about to see a change for the better.

Why?
A final factor to investigate is why these people have become managers. Look at the manager's employment history, and try to see if these reasons are clear. Does this person have the qualities you believe are needed to make someone a good manager for this company? Has s/he been hired because of past successes and achievements, or has s/he acquired the position through questionable means, such as self-appointment after inheriting the company? (For further reading, see: Get Tough on Management Puff and Evaluating a Company's Management.)

Know What a Company Does and How it Makes Money
A second important factor to consider when analyzing a company's qualitative factors is its product(s) or service(s). How does this company make money? In fancy MBA parlance, the question would be "What is the company's business model?"
Knowing how a company's activities will be profitable is fundamental to determining the worth of an investment. Often, people will boast about how profitable they think their new stock will be, but when you ask them what the company does, it seems their vision for the future is a little blurry: "Well, they have this high-tech thingamabob that does something with fiber-optic cables… ." If you aren't sure how your company will make money, you can't really be sure that its stock will bring you a return.

One of the biggest lessons taught by the dotcom bust of the late '90s is that not understanding a business model can have dire consequences. Many people had no idea how the dotcom companies were making money, or why they were trading so high. In fact, these companies weren't making any money; it's just that their growth potential was thought to be enormous. This led to overzealous buying based on a herd mentality, which in turn led to a market crash. But not everyone lost money when the bubble burst: Warren Buffett didn't invest in high-tech primarily because he didn't understand it. Although he was ostracized for this during the bubble, it saved him billions of dollars in the ensuing dotcom fallout. You need a solid understanding of how a company actually generates revenue in order to evaluate whether management is making the right decisions. (For more on this, see Getting to Know Business Models.)

Industry/Competition
Aside from having a general understanding of what a company does, you should analyze the characteristics of its industry, such as its growth potential. A mediocre company in a great industry can provide a solid return, while a mediocre company in a poor industry will likely take a bite out of your portfolio. Of course, discerning a company's stage of growth will involve approximation, but common sense can go a long way: it's not hard to see that the growth prospects of a high-tech industry are greater than those of the railway industry. It's just a matter of asking yourself if the demand for the industry is growing.

Market share is another important factor. Look at how Microsoft thoroughly dominates the market for operating systems. Anyone trying to enter this market faces huge obstacles because Microsoft can take advantage of economies of scale. This does not mean that a company in a near monopoly situation is guaranteed to remain on top, but investing in a company that tries to take on the "500-pound gorilla" is a risky venture.

Barriers against entry into a market can also give a company a significant qualitative advantage. Compare, for instance, the restaurant industry to the automobile or pharmaceuticals industries. Anybody can open up a restaurant because the skill level and capital required are very low. The automobile and pharmaceuticals industries, on the other hand, have massive barriers to entry: large capital expenditures, exclusive distribution channels, government regulation, patents and so on. The harder it is for competition to enter an industry, the greater the advantage for existing firms.
Brand Name
A valuable brand reflects years of product development and marketing. Take for example the most popular brand name in the world: Coca-Cola. Many estimate that the intangible value of Coke's brand name is in the billions of dollars! Massive corporations such as Procter & Gamble rely on hundreds of popular brand names like Tide, Pampers and Head & Shoulders. Having a portfolio of brands diversifies risk because the good performance of one brand can compensate for the underperformers.

Keep in mind that some stock-pickers steer clear of any company that is branded around one individual. They do so because, if a company is tied too closely to one person, any bad news regarding that person may hinder the company's share performance even if the news has nothing to do with company operations. A perfect example of this is the troubles faced by Martha Stewart Omnimedia as a result of Stewart's legal problems in 2004.

Don't Overcomplicate
You don't need a PhD in finance to recognize a good company. In his book "One Up on Wall Street", Peter Lynch discusses a time when his wife drew his attention to a great product with phenomenal marketing. Hanes was test marketing a product called L'eggs: women's pantyhose packaged in colorful plastic egg shells. Instead of selling these in department or specialty stores, Hanes put the product next to the candy bars, soda and gum at the checkouts of supermarkets - a brilliant idea since research showed that women frequented the supermarket about 12 times more often than the traditional outlets for pantyhose. The product was a huge success and became the second highest-selling consumer product of the 1970s.

Most women at the time would have easily seen the popularity of this product, and Lynch's wife was one of them. Thanks to her advice, he researched the company a little deeper and turned his investment in Hanes into a solid earner for Fidelity, while most of the male managers on Wall Street missed out. The point is that it's not only Wall Street analysts who are privy to information about companies; average everyday people can see such wonders too. If you see a local company expanding and doing well, dig a little deeper, ask around. Who knows, it may be the next Hanes.

Conclusion
Assessing a company from a qualitative standpoint and determining whether you should invest in it are as important as looking at sales and earnings. This strategy may be one of the simplest, but it is also one of the most effective ways to evaluate a potential investment.

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Value investing is one of the best known stock-picking methods. In the 1930s, Benjamin Graham and David Dodd, finance professors at Columbia University, laid out what many consider to be the framework for value investing. The concept is actually very simple: find companies trading below their inherent worth.

The value investor looks for stocks with strong fundamentals - including earnings, dividends, book value, and cash flow - that are selling at a bargain price, given their quality. The value investor seeks companies that seem to be incorrectly valued (undervalued) by the market and therefore have the potential to increase in share price when the market corrects its error in valuation.

Value, Not Junk!
Before we get too far into the discussion of value investing, let's get one thing straight. Value investing doesn't mean just buying any stock that declines and therefore seems "cheap" in price. Value investors have to do their homework and be confident that they are picking a company that is cheap given its high quality.

It's important to distinguish the difference between a value company and a company that simply has a declining price. Say for the past year Company A has been trading at about $25 per share but suddenly drops to $10 per share. This does not automatically mean that the company is selling at a bargain. All we know is that the company is less expensive now than it was last year. The drop in price could be a result of the market responding to a fundamental problem in the company. To be a real bargain, this company must have fundamentals healthy enough to imply it is worth more than $10 - value investing always compares current share price to intrinsic value not to historic share prices.

Value Investing at Work
One of the greatest investors of all time, Warren Buffett, has proven that value investing can work: his value strategy took the stock of Berkshire Hathaway, his holding company, from $12 a share in 1967 to $70,900 in 2002. The company beat the S&P 500's performance by about 13.02% on average annually! Although Buffett does not strictly categorize himself as a value investor, many of his most successful investments were made on the basis of value investing principles. (See Warren Buffett: How He Does It.)

Buying a Business, not a Stock
We should emphasize that the value investing mentality sees a stock as the vehicle by which a person becomes an owner of a company - to a value investor profits are made by investing in quality companies, not by trading. Because their method is about determining the worth of the underlying asset, value investors pay no mind to the external factors affecting a company, such as market volatility or day-to-day price fluctuations. These factors are not inherent to the company, and therefore are not seen to have any effect on the value of the business in the long run.

Contradictions
While the efficient market hypothesis (EMH) claims that prices are always reflecting all relevant information, and therefore are already showing the intrinsic worth of companies, value investing relies on a premise that opposes that theory. Value investors bank on the EMH being true only in some academic wonderland. They look for times of inefficiency, when the market assigns an incorrect price to a stock.

Value investors also disagree with the principle that high beta (also known as volatility, or standard deviation) necessarily translates into a risky investment. A company with an intrinsic value of $20 per share but is trading at $15 would be, as we know, an attractive investment to value investors. If the share price dropped to $10 per share, the company would experience an increase in beta, which conventionally represents an increase in risk. If, however, the value investor still maintained that the intrinsic value was $20 per share, s/he would see this declining price as an even better bargain. And the better the bargain, the lesser the risk. A high beta does not scare off value investors. As long as they are confident in their intrinsic valuation, an increase in downside volatility may be a good thing.


Screening for Value Stocks
Now that we have a solid understanding of what value investing is and what it is not, let's get into some of the qualities of value stocks.

Qualitative aspects of value stocks:
Where are value stocks found? - Everywhere. Value stocks can be found trading on the NYSE, Nasdaq, AMEX, over the counter, on the FTSE, Nikkei and so on.
a) In what industries are value stocks located? - Value stocks can be located in any industry, including energy, finance and even technology (contrary to popular belief).
b) In what industries are value stocks most often located? - Although value stocks can be located anywhere, they are often located in industries that have recently fallen on hard times, or are currently facing market overreaction to a piece of news affecting the industry in the short term. For example, the auto industry's cyclical nature allows for periods of undervaluation of companies such as Ford or GM.
Can value companies be those that have just reached new lows? - Definitely, although we must re-emphasize that the "cheapness" of a company is relative to intrinsic value. A company that has just hit a new 12-month low or is at half of a 12-month high may warrant further investigation.

Here is a breakdown of some of the numbers value investors use as rough guides for picking stocks. Keep in mind that these are guidelines, not hard-and-fast rules:
Share price should be no more than two-thirds of intrinsic worth.
Look at companies with P/E ratios at the lowest 10% of all equity securities.
PEG should be less than one.
Stock price should be no more than tangible book value.
There should be no more debt than equity (i.e. D/E ratio < 1).
Current assets should be two times current liabilities.
Dividend yield should be at least two-thirds of the long-term AAA bond yield.
Earnings growth should be at least 7% per annum compounded over the last 10 years.



The P/E and PEG Ratios
Contrary to popular belief, value investing is not simply about investing in low P/E stocks. It's just that stocks which are undervalued will often reflect this undervaluation through a low P/E ratio, which should simply provide a way to compare companies within the same industry. For example, if the average P/E of the technology consulting industry is 20, a company trading in that industry at 15 times earnings should sound some bells in the heads of value investors.

Another popular metric for valuing a company's intrinsic value is the PEG ratio, calculated as a stock's P/E ratio divided by its projected year-over-year earnings growth rate. In other words, the ratio measures how cheap the stock is while taking into account its earnings growth. If the company's PEG ratio is less than one, it is considered to be undervalued.

Narrowing It Down Even Further
One well-known and accepted method of picking value stocks is the net-net method. This method states that if a company is trading at two-thirds of its current assets, no other gauge of worth is necessary. The reasoning behind this is simple: if a company is trading at this level, the buyer is essentially getting all the permanent assets of the company (including property, equipment, etc) and the company's intangible assets (mainly goodwill, in most cases) for free! Unfortunately, companies trading this low are few and far between.

The Margin of Safety
A discussion of value investing would not be complete without mentioning the use of a margin of safety, a technique which is simple yet very effective. Consider a real-life example of a margin of safety. Say you're planning a pyrotechnics show, which will include flames and explosions. You have concluded with a high degree of certainty that it's perfectly safe to stand 100 feet from the center of the explosions. But to be absolutely sure no one gets hurt, you implement a margin of safety by setting up barriers 125 feet from the explosions.

This use of a margin of safety works similarly in value investing. It's simply the practice of leaving room for error in your calculations of intrinsic value. A value investor may be fairly confident that a company has an intrinsic value of $30 per share. But in case his or her calculations are a little too optimistic, he or she creates a margin of safety/error by using the $26 per share in their scenario analysis. The investor may find that at $15 the company is still an attractive investment, or he or she may find that at $24, the company is not attractive enough. If the stock's intrinsic value is lower than the investor estimated, the margin of safety would help prevent this investor from paying too much for the stock.

Conclusion
Value investing is not as sexy as some other styles of investing; it relies on a strict screening process. But just remember, there's nothing boring about outperforming the S&P by 13% over a 40-year span!

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In the late 1990s, when technology companies were flourishing, growth investing techniques yielded unprecedented returns for investors. But before any investor jumps onto the growth investing bandwagon, s/he should realize that this strategy comes with substantial risks and is not for everyone.

Value versus Growth
The best way to define growth investing is to contrast it to value investing. Value investors are strictly concerned with the here and now; they look for stocks that, at this moment, are trading for less than their apparent worth. Growth investors, on the other hand, focus on the future potential of a company, with much less emphasis on its present price. Unlike value investors, growth investors buy companies that are trading higher than their current intrinsic worth - but this is done with the belief that the companies' intrinsic worth will grow and therefore exceed their current valuations.

As the name suggests, growth stocks are companies that grow substantially faster than others. Growth investors are therefore primarily concerned with young companies. The theory is that growth in earnings and/or revenues will directly translate into an increase in the stock price. Typically a growth investor looks for investments in rapidly expanding industries especially those related to new technology. Profits are realized through capital gains and not dividends as nearly all growth companies reinvest their earnings and do not pay a dividend.

No Automatic Formula
Growth investors are concerned with a company's future growth potential, but there is no absolute formula for evaluating this potential. Every method of picking growth stocks (or any other type of stock) requires some individual interpretation and judgment. Growth investors use certain methods - or sets of guidelines or criteria - as a framework for their analysis, but these methods must be applied with a company's particular situation in mind. More specifically, the investor must consider the company in relation to its past performance and its industry's performance. The application of any one guideline or criterion may therefore change from company to company and from industry to industry.

The NAIC
The National Association of Investors Corporation (NAIC) is one of the best known organizations using and teaching the growth investing strategy. It is, as it says on its website, "one big investment club" whose goal is to teach investors how to invest wisely. The NAIC has developed some basic "universal" guidelines for finding possible growth companies - here's a look at some of the questions the NAIC suggests you should ask when considering stocks.

1. Strong Historical Earnings Growth?
According to the NAIC, the first question a growth investor should ask is whether the company, based on annual revenue, has been growing in the past. Below are rough guidelines for the rate of EPS growth an investor should look for in companies of differing sizes, which would indicate their growth investing potential:



Although the NAIC suggests that companies display this type of EPS growth in at least the last five years, a 10-year period of this growth is even more attractive. The basic idea is that if a company has displayed good growth (as defined by the above chart) over the last five- or 10-year period, it is likely to continue doing so in the next five to 10 years.

2. Strong Forward Earnings Growth?
The second criterion set out by the NAIC is a projected five-year growth rate of at least 10-12%, although 15% or more is ideal. These projections are made by analysts, the company or other credible sources.

The big problem with forward estimates is that they are estimates. When a growth investor sees an ideal growth projection, he or she, before trusting this projection, must evaluate its credibility. This requires knowledge of the typical growth rates for different sizes of companies. For example, an established large cap will not be able to grow as quickly as a younger small-cap tech company. Also, when evaluating analyst consensus estimates, an investor should learn about the company's industry - specifically, what its prospects are and what stage of growth it is at. (See The Stages of Industry Growth.)


3. Is Management Controlling Costs and Revenues?
The third guideline set out by the NAIC focuses specifically on pre-tax profit margins. There are many examples of companies with astounding growth in sales but less than outstanding gains in earnings. High annual revenue growth is good, but if EPS has not increased proportionately, it's likely due to a decrease in profit margin.

By comparing a company's present profit margins to its past margins and its competition's profit margins, a growth investor is able to gauge fairly accurately whether or not management is controlling costs and revenues and maintaining margins. A good rule of thumb is that if company exceeds its previous five-year average of pre-tax profit margins as well as those of its industry, the company may be a good growth candidate.

4. Can Management Operate the Business Efficiently?
Efficiency can be quantified by using return on equity (ROE). Efficient use of assets should be reflected in a stable or increasing ROE. Again, analysis of this metric should be relative: a company's present ROE is best compared to the five-year average ROE of the company and the industry.

5. Can the Stock Price Double in Five Years?
If a stock cannot realistically double in five years, it's probably not a growth stock. That's the general consensus. This may seem like an overly high, unrealistic standard, but remember that with a growth rate of 10%, a stock's price would double in seven years. So the rate growth investors are seeking is 15% per annum, which yields a doubling in price in five years.

An Example
Now that we've outlined the NAIC's basic criteria for evaluating growth stocks, let's demonstrate how these criteria are used to analyze a company, using Microsoft's 2003 figures. For the sake of this demonstration, we'll discuss these numbers as though they were Microsoft's most current figures (that is, "today's figures").



Both of these are strong figures. The annual EPS growth is well above the 5% standard the NAIC sets out for firms of Microsoft's size.



The projected growth figures are strong, but not exceptional.



There are two ways to look at this. The trend is down 5.08% (50.88% - 45.80%) from the five-year average, which is negative. But notice that the industry's average margin is only 26.7%. So even though Microsoft's margins have dropped, they're still a great deal higher than those of its industry.



Again, it's a point of concern that the ROE figure is a little lower than the five-year average. However, like Microsoft's profit margin, the ROE is not drastically reduced - it's only down a few points and still well above the industry average.



The average analyst projections for Microsoft suggest that in five years the stock will not merely double in value, but it'll be worth 254.7% its current value.




Is Microsoft a Growth Stock?
On paper, Microsoft meets many NAIC's criteria for a growth stock. But it also falls short of others. If, for instance, we were to dismiss Microsoft because of its decreased margins and not compare them to the industry's margins, we would be ignoring the industry conditions within which Microsoft functions. On the other hand, when comparing Microsoft to its industry, we must still decide how telling it is that Microsoft has higher-than-average margins. Is Microsoft a good growth stock even though its industry may be maturing and facing declining margins? Can a company of its size find enough new markets to keep expanding?

Clearly there are arguments on both sides and there is no "right" answer. What these criteria do, however, is open up doorways of analysis through which we can dig deeper into a company's condition. Because no single set of criteria is infallible, the growth investor may want to adjust a set of guidelines by adding (or omitting) criteria. So, although we've provided five basic questions, it's important to note that the purpose of the example is to provide a starting point from which you can build your own growth screens.

Conclusion
It's not too complicated: growth investors are concerned with growth. The guiding principle of growth investing is to look for companies that keep reinvesting into themselves to produce new products and technology. Even though the stocks might be expensive in the present, growth investors believe that expanding top and bottom lines will ensure an investment pays off in the long run.
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Do you feel that you now have a firm grasp of the principles of both value and growth investing? If you're comfortable with these two stock-picking methodologies, then you're ready to learn about a newer, hybrid system of stock selection. Here we take a look at growth at a reasonable price, or GARP.

What Is GARP?
The GARP strategy is a combination of both value and growth investing: it looks for companies that are somewhat undervalued and have solid sustainable growth potential. The criteria which GARPers look for in a company fall right in between those sought by the value and growth investors. Below is a diagram illustrating how the GARP-preferred levels of price and growth compare to the levels sought by value and growth investors:



What GARP Is NOT
Because GARP borrows principles from both value and growth investing, some misconceptions about the style persist. Critics of GARP claim it is a wishy-washy, fence-sitting method that fails to establish meaningful standards for distinguishing good stock picks. However, GARP doesn't deem just any stock a worthy investment. Like most respectable methodologies, it aims to identify companies that display very specific characteristics.

Another misconception is that GARP investors simply hold a portfolio with equal amounts of both value and growth stocks. Again, this is not the case: because each of their stock picks must meet a set of strict criteria, GARPers identify stocks on an individual basis, selecting stocks that have neither purely value nor purely growth characteristics, but a combination of the two.

Who Uses GARP?
One of the biggest supporters of GARP is Peter Lynch, whose philosophies we have already touched on in the section on qualitative analysis. Lynch has written several popular books, including "One Up on Wall Street" and "Learn to Earn", and in the late 1990s and early 2000 he starred in the Fidelity Investment commercials. Many consider Lynch the world's best fund manager, partly due to his 29% average annual return over a 13-year stretch from 1977-1990. (To learn more about Peter Lynch, check out Greatest Investors feature.)

The Hybrid Characteristics
Like growth investors, GARP investors are concerned with the growth prospects of a company: they like to see positive earnings numbers for the past few years, coupled with positive earnings projections for upcoming years. But unlike their growth-investing cousins, GARP investors are skeptical of extremely high growth estimations, such as those in the 25-50% range. Companies within this range carry too much risk and unpredictability for GARPers. To them, a safer and more realistic earnings growth rate lies somewhere between 10-20%.

Something else that GARPers and growth investors share is their attention to the ROE figure. For both investing types, a high and increasing ROE relative to the industry average is an indication of a superior company.


GARPers and growth investors share other metrics to determine growth potential. They do, however, have different ideas about what the ideal levels exhibited by the different metrics should be, and both types of investors have varying tastes in what they like to see in a company. An example of what many GARPers like to see is positive cash flow or, in some cases, positive earnings momentum.

Because a variety of additional criteria can be used to evaluate growth, GARP investors can customize their stock-picking system to their personal style. Exercising subjectivity is an inherent part of using GARP. So if you use this strategy, you must analyze companies in relation to their unique contexts (just as you would with growth investing). Since there is no magic formula for confirming growth prospects, investors must rely on their own interpretation of company performance and operating conditions.

It would be hard to discuss any stock-picking strategy without mentioning its use of the P/E ratio. Although they look for higher P/E ratios than value investors do, GARPers are wary of the high P/E ratios favored by growth investors. A growth investor may invest in a company trading at 50 or 60 times earnings, but the GARP investor sees this type of investing as paying too much money for too much uncertainty. The GARPer is more likely to pick companies with P/E ratios in the 15-25 range - however, this is a rough estimate, not an inflexible rule GARPers follow without any regard for a company's context.

In addition to a preference for a lower P/E ratio, the GARP investor shares the value investor's attraction to a low price-to-book ratio (P/B) ratio, specifically a P/B of below industry average. A low P/E and P/B are the two more prominent criteria with which GARPers in part mirror value investing. They may use other similar or differing criteria, but the main idea is that a GARP investor is concerned about present valuations.

By the Numbers
Now that we know what GARP investing is, let's delve into some of the numbers that GARPers look for in potential companies.
The PEG Ratio
The PEG ratio may very well be the most important metric to any GARP investor, as it basically gauges the balance between a stock's growth potential and its value. (If you're unfamiliar with the PEG ratio, see: How the PEG Ratio Can Help Investors.)

GARP investors require a PEG no higher than 1 and, in most cases, closer to 0.5. A PEG of less than 1 implies that, at present, the stock's price is lower than it should be given its earnings growth. To the GARP investor, a PEG below 1 indicates that a stock is undervalued and warrants further analysis.

PEG at Work
Say the TSJ Sports Conglomerate, a fictional company, is trading at 19 times earnings (P/E = 19) and has earnings growing at 30%. From this you can calculate that the TSJ has a PEG of 0.63 (19/30=0.63), which is pretty good by GARP standards.

Now let's compare the TSJ to Cory's Tequila Co (CTC), which is trading at 11 times earnings (P/E = 11) and has earnings growth of 20%. Its PEG equals 0.55. The GARPer's interest would be aroused by the TSJ, but CTC would look even more attractive. Although it has slower growth compared to TSJ, CTC currently has a better price given its growth potential. In other words, CTC has slower growth, but TSJ's faster growth is more overpriced. As you can see, the GARP investor seeks solid growth, but also demands that this growth be valued at a reasonable price. Hey, the name does make sense!



GARP at Work
Because a GARP strategy employs principles from both value and growth investing, the returns that GARPers see during certain market phases are often different than the returns strictly value or growth investors would see at those times. For instance, in a raging bull market the returns from a growth strategy are often unbeatable: in the dotcom boom of the mid- to late-1990s, for example, neither the value investor nor the GARPer could compete. However, when the market does turn, a GARPer is less likely to suffer than the growth investor.

Therefore, the GARP strategy not only fuses growth and value stock-picking criteria, but also experiences a combination of their types of returns: a value investor will do better in bearish conditions; a growth investor will do exceptionally well in a raging bull market; and a GARPer will be rewarded with more consistent and predictable returns.

Conclusion
GARP might sound like the perfect strategy, but combining growth and value investing isn't as easy as it sounds. If you don't master both strategies, you could find yourself buying mediocre rather than good GARP stocks. But as many great investors such as Peter Lynch himself have proven, the returns are definitely worth the time it takes to learn the GARP techniques.

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Income investing, which aims to pick companies that provide a steady stream of income, is perhaps one of the most straightforward stock-picking strategies. When investors think of steady income they commonly think of fixed-income securities such as bonds. However, stocks can also provide a steady income by paying a solid dividend. Here we look at the strategy that focuses on finding these kinds of stocks. (For more on fixed-income securities, see our tutorials Bond & Debt Basics and Advanced Bond Concepts.)

Who Pays Dividends?
Income investors usually end up focusing on older, more established firms, which have reached a certain size and are no longer able to sustain higher levels of growth. These companies generally no longer are in rapidly expanding industries and so instead of reinvesting retained earnings into themselves (as many high-flying growth companies do), mature firms tend to pay out retained earnings as dividends as a way to provide a return to their shareholders.

Thus, dividends are more prominent in certain industries. Utility companies, for example, have historically paid a fairly decent dividend, and this trend should continue in the future. (For more on the resurgence of dividends following the tech boom, see How Dividends Work For Investors.)

Dividend Yield
Income investing is not simply about investing in companies with the highest dividends (in dollar figures). The more important gauge is the dividend yield, calculated by dividing the annual dividend per share by share price. This measures the actual return that a dividend gives the owner of the stock. For example, a company with a share price of $100 and a dividend of $6 per share has a 6% dividend yield, or 6% return from dividends. The average dividend yield for companies in the S&P 500 is 2-3%.

But income investors demand a much higher yield than 2-3%. Most are looking for a minimum 5-6% yield, which on a $1-million investment would produce an income (before taxes) of $50,000-$60,000. The driving principle behind this strategy is probably becoming pretty clear: find good companies with sustainable high dividend yields to receive a steady and predictable stream of money over the long term.


Another factor to consider with the dividend yield is a company's past dividend policy. Income investors must determine whether a prospective company can continue with its dividends. If a company has recently increased its dividend, be sure to analyze that decision. A large increase, say from 1.5% to 6%, over a short period such as a year or two, may turn out to be over-optimistic and unsustainable into the future. The longer the company has been paying a good dividend, the more likely it will continue to do so in the future. Companies that have had steady dividends over the past five, 10, 15, or even 50 years are likely to continue the trend.

An Example
There are many good companies that pay great dividends and also grow at a respectable rate. Perhaps the best example of this is Johnson & Johnson. From 1963 to 2004, Johnson & Johnson has increased its dividend every year. In fact, if you bought the stock in 1963 the dividend yield on your initial shares would have grown approximately 12% annually. Thirty years later, your earnings from dividends alone would have rendered a 48% annual return on your initial shares!

Here is a chart of Johnson & Johnson's share price (adjusted for splits and dividend payments), which demonstrates the power of the combination of dividend yield and company appreciation:



This chart should address the concerns of those who simply dismiss income investing as an extremely defensive and conservative investment style. When an initial investment appreciates over 225 times - including dividends - in about 20 years, that may be about as "sexy" as it gets.



Dividends Are Not Everything
You should never invest solely on the basis of dividends. Keep in mind that high dividends don't automatically indicate a good company. Because they are paid out of a company's net income, higher dividends will result in a lower retained earnings. Problems arise when the income that would have been better re-invested into the company goes to high dividends instead.

The income investing strategy is about more than using a stock screener to find the companies with the highest dividend yield. Because these yields are only worth something if they are sustainable, income investors must be sure to analyze their companies carefully, buying only ones that have good fundamentals. Like all other strategies discussed in this tutorial, the income investing strategy has no set formula for finding a good company. To determine the sustainability of dividends by means of fundamental analysis, each individual investor must use his or her own interpretive skills and personal judgment - for this reason, we won't get into what defines a "good company".

Stock Picking, not Fixed Income
Something to remember is that dividends do not equal lower risk. The risk associated with any equity security still applies to those with high dividend yields, although the risk can be minimized by picking solid companies.

Taxes Taxes Taxes
One final important note: in most countries and states/provinces, dividend payments are taxed at the same rate as your wages. As such, these payments tend to be taxed higher than capital gains, which is a factor that reduces your overall return.
http://www.investopedia.com/university/stockpicking/stockpicking6.asp

Technical analysis is the polar opposite of fundamental analysis, which is the basis of every method explored so far in this tutorial. Technical analysts, or technicians, select stocks by analyzing statistics generated by past market activity, prices and volumes. Sometimes also known as chartists, technical analysts look at the past charts of prices and different indicators to make inferences about the future movement of a stock's price.

Philosophy of Technical Analysis
In his book, "Charting Made Easy", technical analysis guru John Murphy introduces readers to the study of technical analysis, explaining its basic premises and tools. Here he explains the underlying theories of technical analysis:
"Chart analysis (also called technical analysis) is the study of market action, using price charts, to forecast future price direction. The cornerstone of the technical philosophy is the belief that all factors that influence market price - fundamental information, political events, natural disasters, and psychological factors - are quickly discounted in market activity. In other words, the impact of these external factors will quickly show up in some form of price movement, either up or down."
The most important assumptions that all technical analysis techniques are based upon can be summarized as follows:
Prices already reflect, or discount, relevant information. In other words, markets are efficient.
Prices move in trends.
History repeats itself.

(For a more detailed explanation of this concept, see our Technical Analysis tutorial.)

What Technical Analysts Don't Care About
Pure technical analysts couldn't care less about the elusive intrinsic value of a company or any other factors that preoccupy fundamental analysts, such as management, business models or competition. Technicians are concerned with the trends implied by past data, charts and indicators, and they often make a lot of money trading companies they know almost nothing about.

Is Technical Analysis a Long-Term Strategy?
The answer to the question above is no. Definitely not. Technical analysts are usually very active in their trades, holding positions for short periods in order to capitalize on fluctuations in price, whether up or down. A technical analyst may go short or long on a stock, depending on what direction the data is saying the price will move. (For further reading on active trading and why technical analysis is appropriate for a short-term strategy, see Defining Active Trading.)


If a stock does not perform the way a technician thought it would, he or she wastes little time deciding whether to exit his or her position, using stop-loss orders to mitigate losses. Whereas a value investor must exercise a lot of patience and wait for the market to correct its undervaluation of a company, the technician must possess a great deal of trading agility and know how to get in and out of positions with speed.



Support and Resistance
Among the most important concepts in technical analysis are support and resistance. These are the levels at which technicians expect a stock to start increasing after a decline (support), or to begin decreasing after an increase (resistance). Trades are generally entered around these important levels because they indicate the way in which a stock will bounce. They will enter into a long position if they feel a support level has been hit, or enter into a short position if they feel a resistance level has been struck.

Here is an illustration of where technicians might set support and resistance levels:



Picking Stocks with Technical Analysis
Technicians have a very full toolbox. They literally have hundreds of indicators and chart patterns to use for picking stocks. However, it is important to note that no one indicator or chart pattern is infallible or absolute; the technician must interpret indicators and patterns, and this process is more subjective than formulaic. Let's briefly examine a couple of the most popular chart patterns (of price) that technicians analyze.

Cup and Handle
This is a bullish pattern that looks like a pot with a handle. The stock price is expected to break out at the end of the handle, so by buying here, investors are able to make a lot of money. Another reason for this pattern's popularity is how easy it is to spot. Here is an example of a great cup and handle pattern:



Head and Shoulders
This pattern resembles, well, a head with two shoulders. Technicians usually consider this a bearish pattern. Below is a great example of this particular chart pattern:



Remember, these two examples are mere glimpses into the vast world of technical analysis and its techniques. We couldn't have a complete stock picking tutorial without mentioning technical analysis, but this brief intro barely scratches the surface.
Conclusion
Technical analysis is unlike any other stock-picking strategy - it has its own set of concepts, and it relies on a completely different set of criteria than any strategy employing fundamental analysis. However, regardless of its analytical approach, mastering technical analysis requires discipline and savvy, just like any other strategy.
http://www.investopedia.com/university/stockpicking/stockpicking9.asp

Let's run through a quick recap of the foundational concepts that we covered in our look at the most well-known stock-picking strategies and techniques:

Most of the strategies discussed in this tutorial use the tools and techniques of fundamental analysis, whose main objective is to find the worth of a company, or its intrinsic value.

In quantitative analysis, a company is worth the sum of its discounted cash flows. In other words, it is worth all of its future profits added together.
Some qualitative factors affecting the value of a company are its management, business model, industry and brand name.

Value investors, concerned with the present, look for stocks selling at a price that is lower than the estimated worth of the company, as reflected by its fundamentals. Growth investors are concerned with the future, buying companies that may be trading higher than their intrinsic worth but show the potential to grow and one day exceed their current valuations.

The GARP strategy is a combination of both growth and value: investors concerned with 'growth at a reasonable price' look for companies that are somewhat undervalued given their growth potential.

Income investors, seeking a steady stream of income from their stocks, look for solid companies that pay a high but sustainable dividend yield.

Technical analysis, the polar opposite of fundamental analysis, is not concerned with a stock's intrinsic value, but instead looks at past market activity to determine future price movements.

thanks

In the late 1990s, when technology companies were flourishing, growth investing techniques yielded unprecedented returns for investors. But before any investor jumps onto the growth investing bandwagon, s/he should realize that this strategy comes with substantial risks and is not for everyone.

Value versus Growth

The best way to define growth investing is to contrast it to value investing. Value investors are strictly concerned with the here and now; they look for stocks that, at this moment, are trading for less than their apparent worth. Growth investors, on the other hand, focus on the future potential of a company, with much less emphasis on its present price. Unlike value investors, growth investors buy companies that are trading higher than their current intrinsic worth - but this is done with the belief that the companies' intrinsic worth will grow and therefore exceed their current valuations.

As the name suggests, growth stocks are companies that grow substantially faster than others. Growth investors are therefore primarily concerned with young companies. The theory is that growth in earnings and/or revenues will directly translate into an increase in the stock price. Typically a growth investor looks for investments in rapidly expanding industries especially those related to new technology. Profits are realized through capital gains and not dividends as nearly all growth companies reinvest their earnings and do not pay a dividend.

No Automatic Formula
Growth investors are concerned with a company's future growth potential, but there is no absolute formula for evaluating this potential. Every method of picking growth stocks (or any other type of stock) requires some individual interpretation and judgment. Growth investors use certain methods - or sets of guidelines or criteria - as a framework for their analysis, but these methods must be applied with a company's particular situation in mind. More specifically, the investor must consider the company in relation to its past performance and its industry's performance. The application of any one guideline or criterion may therefore change from company to company and from industry to industry.

The NAIC
The National Association of Investors Corporation (NAIC) is one of the best known organizations using and teaching the growth investing strategy. It is, as it says on its website, "one big investment club" whose goal is to teach investors how to invest wisely. The NAIC has developed some basic "universal" guidelines for finding possible growth companies - here's a look at some of the questions the NAIC suggests you should ask when considering stocks.

1. Strong Historical Earnings Growth?

According to the NAIC, the first question a growth investor should ask is whether the company, based on annual revenue, has been growing in the past. Below are rough

guidelines for the rate of EPS growth an investor should look for in companies of differing sizes, which would indicate their growth investing potential:



Although the NAIC suggests that companies display this type of EPS growth in at least the last five years, a 10-year period of this growth is even more attractive. The basic idea is that if a company has displayed good growth (as defined by the above chart) over the last five- or 10-year period, it is likely to continue doing so in the next five to 10 years.
2. Strong Forward Earnings Growth?

The second criterion set out by the NAIC is a projected five-year growth rate of at least 10-12%, although 15% or more is ideal. These projections are made by analysts, the company or other credible sources.

The big problem with forward estimates is that they are estimates. When a growth investor sees an ideal growth projection, he or she, before trusting this projection, must evaluate its credibility. This requires knowledge of the typical growth rates for different sizes of companies. For example, an established large cap will not be able to grow as quickly as a younger small-cap tech company. Also, when evaluating analyst consensus estimates, an investor should learn about the company's industry - specifically, what its prospects are and what stage of growth it is at.

3. Is Management Controlling Costs and Revenues?

The third guideline set out by the NAIC focuses specifically on pre-tax profit margins. There are many examples of companies with astounding growth in sales but less than outstanding gains in earnings. High annual revenue growth is good, but if EPS has not increased proportionately, it's likely due to a decrease in profit margin.

By comparing a company's present profit margins to its past margins and its competition's profit margins, a growth investor is able to gauge fairly accurately whether or not management is controlling costs and revenues and maintaining margins. A good rule of thumb is that if company exceeds its previous five-year average of pre-tax profit margins as well as those of its industry, the company may be a good growth candidate.

4. Can Management Operate the Business Efficiently?

Efficiency can be quantified by using return on equity (ROE). Efficient use of assets should be reflected in a stable or increasing ROE. Again, analysis of this metric should be relative: a company's present ROE is best compared to the five-year average ROE of the company and the industry.

5. Can the Stock Price Double in Five Years?

If a stock cannot realistically double in five years, it's probably not a growth stock. That's the general consensus. This may seem like an overly high, unrealistic standard, but remember that with a growth rate of 10%, a stock's price would double in seven years. So the rate growth investors are seeking is 15% per annum, which yields a doubling in price in five years.

An Example
Now that we've outlined the NAIC's basic criteria for evaluating growth stocks, let's demonstrate how these criteria are used to analyze a company, using Microsoft's 2003 figures. For the sake of this demonstration, we'll discuss these numbers as though they were Microsoft's most current figures (that is, "today's figures").

1. Five-Year Earnings Figures

• Five-year average annual sales growth is 15.94%.
• Five-year average annual EPS growth is 10.91%.

Both of these are strong figures. The annual EPS growth is well above the 5% standard the NAIC sets out for firms of Microsoft's size.

2. Strong Projected Earnings Growth


• Five-year projected average annual earnings growth is 11.03%.
The projected growth figures are strong, but not exceptional.

3. Costs and Revenue Control



• Pre-tax margin in most recent fiscal year is 45.80%.
• Five-year average fiscal pre-tax margin is 50.88%.
• Industry\'s five-year average pre-tax margin is 26.7%.

There are two ways to look at this. The trend is down 5.08% (50.88% - 45.80%) from the five-year average, which is negative. But notice that the industry's average margin is only 26.7%. So even though Microsoft's margins have dropped, they're still a great deal higher than those of its industry.

4. ROE


• Most recent fiscal year-end is ROE 16.40%.
• Five-year average ROE is 19.80%.
• Industry average five-year ROE is 13.60%.
Again, it's a point of concern that the ROE figure is a little lower than the five-year average. However, like Microsoft's profit margin, the ROE is not drastically reduced - it's only down a few points and still well above the industry average.

5. Potential to Double in Five Years


• Stock is projected to appreciate by 254.7%.
The average analyst projections for Microsoft suggest that in five years the stock will not merely double in value, but it'll be worth 254.7% its current value.

Is Microsoft a Growth Stock?
On paper, Microsoft meets many NAIC's criteria for a growth stock. But it also falls short of others. If, for instance, we were to dismiss Microsoft because of its decreased margins and not compare them to the industry's margins, we would be ignoring the industry conditions within which Microsoft functions. On the other hand, when comparing Microsoft to its industry, we must still decide how telling it is that Microsoft has higher-than-average margins. Is Microsoft a good growth stock even though its industry may be maturing and facing declining margins? Can a company of its size find enough new markets to keep expanding?

Clearly there are arguments on both sides and there is no "right" answer. What these criteria do, however, is open up doorways of analysis through which we can dig deeper into a company's condition. Because no single set of criteria is infallible, the growth investor may want to adjust a set of guidelines by adding (or omitting) criteria. So, although we've provided five basic questions, it's important to note that the purpose of the example is to provide a starting point from which you can build your own growth screens.

Conclusion

It's not too complicated: growth investors are concerned with growth. The guiding principle of growth investing is to look for companies that keep reinvesting into themselves to produce new products and technology. Even though the stocks might be expensive in the present, growth investors believe that expanding top and bottom lines will ensure an investment pays off in the long run.


http://www.investopedia.com/university/stockpicking/stockpicking4.asp

Thanks

This article summarises in points form the traits to pick a growth stocks.

1.EPS Growth
2.Future Growth (Forward Earnings)
3.Control of Costs By Management
4.Double within 5 years

If we look carefully we might be able to pick few.......

TJL is one that comes into mind, I am sure members can pick few more

You know what EPS is. It’s earnings per share. EPS-GR stands for Earnings per share growth rate. This estimated growth rate is an important figure for valuing a company. When you compare the EPS history with the stock price history, it helps you determine the most likely future direction of the stock price.
Take note: In calculating a company’s earnings growth rate, you need to decide whether growth should continue at that same rate. Studying the firm, its products, and its competitive environment will help guide your decision to adjust the growth rate up or down.
Why is EPS-GR important?

Let me clarify with an example.
Let’s compare two stocks – stock of AB Ltd with an EPS of 5 and stock CD ltd with an EPS of 7.
At once glance, you may think that stock CD Ltd is better since it has an EPS of 7
A year later, AB Ltd has EPS of 5.50 per share while CD Ltd has an EPS of 7.50 per share.
This means, AB Ltd has grown 10% whereas, CD ltd has grown only 7.14%
Naturally, the price of AB Ltd will increase higher than stock CD. The stock price has direct relationship with the EPS and hence you will be getting more profit from a stock that has higher EPS-Growth rate.
Stock with the highest EPSGR rises fastest in that year as compared to its competitors in the same industry. If a company maintains a 10% or more EPS growth rate, that company may be a good target. However, such growth rates in EPS are more reliable in the case of ‘matured companies’ which has experienced a complete economic cycle of expansion and contraction, through a bear market phase and a bull run. New and fast growing companies may not have such a financial history to rely upon and may exhibit greater volatility in earnings history. Earnings history of such new and fast growing companies is less reliable in projecting growth rates than large matured companies with a consistent earnings history of 10 years or more. So, the chances of accuracy in predicting EPS growth increases for companies with greater financial history.
Calculation.
To calculate the growth rate in earnings of a company, let’s take an example. Let’s assume that the earnings per share (EPS) of a company is as follows:
Year EPS
2011: 4.50
2010: 4.20
2009: 3.90
2008: 3.45
2007: 2.80
2006: 2.10
In the five years from 2006 to 2011 the earnings per share increased from 2.10 to 4.50 and the growth has been consistent. In such cases, the first step is to calculate the growth multiple.
Growth multiple = 4.50/2.10 = 2.14
Next we raise the growth multiple of 2.14 to the 1/5th power:
(2.14)1/5 = 1.164
1/5th power has been used because we are calculating for 5 years. If the time period was three years, we use the 1/3rd power.
Next we take the 1.164 figure and subtract 1:
1.164 – 1 = 0.164
As a final step, we multiply .164 by 100 to get the average annual growth rate.
0.164 x 100 = 16.40% is the average annual growth rate.
From the historical and qualitative analysis, you have to take a decision as to what would be the rate of growth for the company in future. It’s your call. You can assume it as 16.40% or you can play safe by assuming a lower growth rate of 12% or 10%. It’s your decision.

http://www.sharemarketschool.com/estimating-eps-growth-rate/

Stock investing strategy – Growth investing
by J Victor on September 23rd, 2011


In a nut shell….
Growth investors, invest in companies that exhibit signs of above-average growth. They don’t mind if the share price is expensive in comparison to its actual value. ‘Signs of above-average Growth’ is what growth investors try to spot. These signs gets revealed when you study the fundamentals. This is the exact opposite of ‘value investing’ approach. In a nutshell, the difference between ‘value’ investing and ‘growth’ investing lies in the methodology adopted by the investors. While the value investor looks for undervalued shares, the growth investor looks for shares with higher growth potential.
What exactly is ‘growth’?
Benjamin Graham defined a growth share as a share in a company “that has done better than average in the past, and is expected to do so in the future.” Any company whose business generates significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy, can be categorized under ‘growth’. A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Thus, it typically pays little to no dividends to stockholders, opting instead to plow most or all of its profits back into its expanding business. Software companies are examples of growth oriented companies.
What’s the concept all about?
Investors who follow this strategy look for companies that exhibit huge growth in terms of revenues and profits. Typically, this set of investors looks for those in sunrise sectors (those in the early stages of growth) hoping to find the next Microsoft. A growth investor may look into the past year’s data to recognize the past growth rates and based on his studies about the industry’s potential and company’s prospects; try to estimate the future growth of the company. Investors look to spot a company that grows at minimum 15% annually. If a stock cannot realistically double in five years, it’s probably not a growth stock. That’s the general consensus. This may seem like an overly high, unrealistic standard, but remember that with a growth rate of 10%, a stock’s price would double in seven years. So the rate growth investors are seeking is 15% per annum, which yields a doubling in price in five years.
What does a Growth Investor look for in a stock?
Low dividend yields, high price-to-earnings ratio or high sales-to-market capitalisation ratio or a mix of all. For identifying stocks with high potential, growth investors look at key variables such as rate of growth in per share earnings over the last five-10 years, expected growth in earnings over the next five years or so, operating and net profit margins and business efficiency. A growth investor would target a company that’s growing at 15%-40% year on.
On a macro level, factors such as the stage in business cycle in which the industry operates, its relative attractiveness, and the positioning of the company in the competition matrix form part of the investment analysis. They then look at the current price and determine if it reflects the growth potential of the company’s business.
Growth – the risky strategy.
As growth investing often involves taking exposure to companies that trade at high valuation levels, the downside risk is relatively high. Sometimes, owing to their unproven business models, these companies could be sensitive to changes in market movements and business cycles.
Is a sky rocketing share a growth share?
Not necessasarily. Share prices can move up due to various reasons including fraudulent practices. High price is never a criteria for spoting a growth share. What matters is the rate of growth in the past years and the future prospects of the industry in which the company is in.
What are the sources to find Growth shares?
The best method is to do your own research. Most growth stocks can be spotted in the small cap and mid cap indexes. It is the growth rate that finally makes them large caps. Try to spot new companies that come up with innovative ideas – for example in medical Pharma industry. Watch companies that have grown from small cap to mid caps. Watch companies that breach all time high levels. Investigate why the prices sky rocketed. You may also validate shares of Industries that are currently facing market overreaction to a piece of news affecting the industry in the short term and try to spot one.
Is this approach popular?
Yes. If warren buffet is popular for his value investing strategies, Peter lynch is one of the greatest growth investors. Both he strategies are being used by investors according to market conditions worldwide.
What are the Pros and cons of Growth investing?
Pros:The biggest advantage of this approach is Potential for incredible returns in a short period of time
Cons:On the negative side, these shares carry the potential for huge losses.
Market downturns hit growth stocks far harder than value stocks.
Failure to relate the stock price to the company value leads to purchasing overvalued stocks
Hot stock tips, rumors, hype, and market hysteria are not reliable sources of information to act upon
Which is better? Value or growth?
Both has its pros and cons as mentioned in our lessons. In value investing, the investor has to ensure correct stock valuation as well as the right time of entry – both being equally vital as he would not like to get too early into a stock.
In growth investing, it is essential for the investor to identify businesses that face little threat of erosion so that earnings growth of those companies is not impacted. Growth investors are generally in for short time frame compared to value investors. In general, value stocks tend to hold up better during stock market downturns.
An investor having a high-risk appetite is more likely to choose a growth strategy. While a defensive investor would choose to take the value investing route.

http://www.sharemarketschool.com/stock-investing-strategy-%E2%80%93-growth-investing/

Further Reading for the weekend

SHARK

SHARK wrote:You know what EPS is. It’s earnings per share. EPS-GR stands for Earnings per share growth rate. This estimated growth rate is an important figure for valuing a company. When you compare the EPS history with the stock price history, it helps you determine the most likely future direction of the stock price.
Take note: In calculating a company’s earnings growth rate, you need to decide whether growth should continue at that same rate. Studying the firm, its products, and its competitive environment will help guide your decision to adjust the growth rate up or down.
Why is EPS-GR important?

Let me clarify with an example.
Let’s compare two stocks – stock of AB Ltd with an EPS of 5 and stock CD ltd with an EPS of 7.
At once glance, you may think that stock CD Ltd is better since it has an EPS of 7
A year later, AB Ltd has EPS of 5.50 per share while CD Ltd has an EPS of 7.50 per share.
This means, AB Ltd has grown 10% whereas, CD ltd has grown only 7.14%
Naturally, the price of AB Ltd will increase higher than stock CD. The stock price has direct relationship with the EPS and hence you will be getting more profit from a stock that has higher EPS-Growth rate.
Stock with the highest EPSGR rises fastest in that year as compared to its competitors in the same industry. If a company maintains a 10% or more EPS growth rate, that company may be a good target. However, such growth rates in EPS are more reliable in the case of ‘matured companies’ which has experienced a complete economic cycle of expansion and contraction, through a bear market phase and a bull run. New and fast growing companies may not have such a financial history to rely upon and may exhibit greater volatility in earnings history. Earnings history of such new and fast growing companies is less reliable in projecting growth rates than large matured companies with a consistent earnings history of 10 years or more.  So, the chances of accuracy in predicting EPS growth increases for companies with greater financial history.
Calculation.
To calculate the growth rate in earnings of a company, let’s take an example. Let’s assume that the earnings per share (EPS) of a company is as follows:
Year    EPS
2011:  4.50
2010:  4.20
2009:  3.90
2008:  3.45
2007:  2.80
2006:  2.10
In the five years from 2006 to 2011 the earnings per share increased from 2.10 to 4.50 and the growth has been consistent. In such cases, the first step is to calculate the growth multiple.
Growth multiple =   4.50/2.10 = 2.14
Next we raise the growth multiple of 2.14 to the 1/5th power:
(2.14)1/5 = 1.164
1/5th power has been used because we are calculating for 5 years. If the time period was three years, we use the 1/3rd power.
Next we take the 1.164 figure and subtract 1:
1.164 – 1 = 0.164
As a final step, we multiply .164 by 100 to get the average annual growth rate.
0.164 x 100 = 16.40% is the average annual growth rate.
From the historical and qualitative analysis, you have to take a decision as to what would be the rate of growth for the company in future. It’s your call. You can assume it as 16.40% or you can play safe by assuming a lower growth rate of 12% or 10%. It’s your decision.

http://www.sharemarketschool.com/estimating-eps-growth-rate/

Thanks SHARK!

PER= Market Price/EPS
PEG Ratio= PER/Growth
Value Companies = PEG <1.3
I have found few in the current market! Thanks again for the article.

We need to remember the key elements when picking Growth Stocks ......
I am bringing this thread up from time to time so we remember ..... and for Reading purposes

SHARK

SHARK wrote:You know what EPS is. It’s earnings per share. EPS-GR stands for Earnings per share growth rate. This estimated growth rate is an important figure for valuing a company. When you compare the EPS history with the stock price history, it helps you determine the most likely future direction of the stock price.
Take note: In calculating a company’s earnings growth rate, you need to decide whether growth should continue at that same rate. Studying the firm, its products, and its competitive environment will help guide your decision to adjust the growth rate up or down.
Why is EPS-GR important?

Let me clarify with an example.
Let’s compare two stocks – stock of AB Ltd with an EPS of 5 and stock CD ltd with an EPS of 7.
At once glance, you may think that stock CD Ltd is better since it has an EPS of 7
A year later, AB Ltd has EPS of 5.50 per share while CD Ltd has an EPS of 7.50 per share.
This means, AB Ltd has grown 10% whereas, CD ltd has grown only 7.14%
Naturally, the price of AB Ltd will increase higher than stock CD. The stock price has direct relationship with the EPS and hence you will be getting more profit from a stock that has higher EPS-Growth rate.
Stock with the highest EPSGR rises fastest in that year as compared to its competitors in the same industry. If a company maintains a 10% or more EPS growth rate, that company may be a good target. However, such growth rates in EPS are more reliable in the case of ‘matured companies’ which has experienced a complete economic cycle of expansion and contraction, through a bear market phase and a bull run. New and fast growing companies may not have such a financial history to rely upon and may exhibit greater volatility in earnings history. Earnings history of such new and fast growing companies is less reliable in projecting growth rates than large matured companies with a consistent earnings history of 10 years or more.  So, the chances of accuracy in predicting EPS growth increases for companies with greater financial history.
Calculation.
To calculate the growth rate in earnings of a company, let’s take an example. Let’s assume that the earnings per share (EPS) of a company is as follows:
Year    EPS
2011:  4.50
2010:  4.20
2009:  3.90
2008:  3.45
2007:  2.80
2006:  2.10
In the five years from 2006 to 2011 the earnings per share increased from 2.10 to 4.50 and the growth has been consistent. In such cases, the first step is to calculate the growth multiple.
Growth multiple =   4.50/2.10 = 2.14
Next we raise the growth multiple of 2.14 to the 1/5th power:
(2.14)1/5 = 1.164
1/5th power has been used because we are calculating for 5 years. If the time period was three years, we use the 1/3rd power.
Next we take the 1.164 figure and subtract 1:
1.164 – 1 = 0.164
As a final step, we multiply .164 by 100 to get the average annual growth rate.
0.164 x 100 = 16.40% is the average annual growth rate.
From the historical and qualitative analysis, you have to take a decision as to what would be the rate of growth for the company in future. It’s your call. You can assume it as 16.40% or you can play safe by assuming a lower growth rate of 12% or 10%. It’s your decision.

http://www.sharemarketschool.com/estimating-eps-growth-rate/

Thanks Shark Valuble reading.

SHARK wrote:Stock investing strategy – Growth investing
by J Victor on September 23rd, 2011


In a nut shell….
Growth investors, invest in companies that exhibit signs of above-average growth. They don’t mind if the share price is expensive in comparison to its actual value. ‘Signs of above-average Growth’ is what growth investors try to spot. These signs gets revealed when you study the fundamentals. This is the exact opposite of ‘value investing’ approach. In a nutshell, the difference between ‘value’ investing and ‘growth’ investing lies in the methodology adopted by the investors. While the value investor looks for undervalued shares, the growth investor looks for shares with higher growth potential.
What exactly is ‘growth’?
Benjamin Graham defined a growth share as a share in a company “that has done better than average in the past, and is expected to do so in the future.” Any company whose business generates significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy, can be categorized under ‘growth’. A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Thus, it typically pays little to no dividends to stockholders, opting instead to plow most or all of its profits back into its expanding business. Software companies are examples of growth oriented companies.
What’s the concept all about?
Investors who follow this strategy look for companies that exhibit huge growth in terms of revenues and profits. Typically, this set of investors looks for those in sunrise sectors (those in the early stages of growth) hoping to find the next Microsoft. A growth investor may look into the past year’s data to recognize the past growth rates and based on his studies about the industry’s potential and company’s prospects; try to estimate the future growth of the company. Investors look to spot a company that grows at minimum 15% annually. If a stock cannot realistically double in five years, it’s probably not a growth stock. That’s the general consensus. This may seem like an overly high, unrealistic standard, but remember that with a growth rate of 10%, a stock’s price would double in seven years. So the rate growth investors are seeking is 15% per annum, which yields a doubling in price in five years.
What does a Growth Investor look for in a stock?
Low dividend yields, high price-to-earnings ratio or high sales-to-market capitalisation ratio or a mix of all. For identifying stocks with high potential, growth investors look at key variables such as rate of growth in per share earnings over the last five-10 years, expected growth in earnings over the next five years or so, operating and net profit margins and business efficiency. A growth investor would target a company that’s growing at 15%-40% year on.
On a macro level, factors such as the stage in business cycle in which the industry operates, its relative attractiveness, and the positioning of the company in the competition matrix form part of the investment analysis. They then look at the current price and determine if it reflects the growth potential of the company’s business.
Growth – the risky strategy.
As growth investing often involves taking exposure to companies that trade at high valuation levels, the downside risk is relatively high. Sometimes, owing to their unproven business models, these companies could be sensitive to changes in market movements and business cycles.
Is a sky rocketing share a growth share?
Not necessasarily. Share prices can move up due to various reasons including fraudulent practices. High price is never a criteria for spoting a growth share. What matters is the rate of growth in the past years and the future prospects of the industry in which the company is in.
What are the sources to find Growth shares?
The best method is to do your own research. Most growth stocks can be spotted in the small cap and mid cap indexes. It is the growth rate that finally makes them large caps. Try to spot new companies that come up with   innovative ideas – for example in medical Pharma industry.  Watch companies that have grown from small cap to mid caps. Watch companies that breach all time high levels. Investigate why the prices sky rocketed.   You may also validate shares of Industries that are currently facing market overreaction to a piece of news affecting the industry in the short term and try to spot one.
Is this approach popular?
Yes. If warren buffet is popular for his value investing strategies, Peter lynch is one of the greatest growth investors. Both he strategies are being used by investors according to market conditions worldwide.
What are the Pros and cons of  Growth investing?
Pros:The biggest advantage of this approach is Potential for incredible returns in a short period of time
Cons:On the negative side, these shares carry the potential for huge losses.
Market downturns hit growth stocks far harder than value stocks.
Failure to relate the stock price to the company value leads to purchasing overvalued stocks
Hot stock tips, rumors, hype, and market hysteria are not reliable sources of information to act upon
Which is better? Value or growth?
Both has its pros and cons as mentioned in our lessons. In value investing, the investor has to ensure correct stock valuation as well as the right time of entry – both being equally vital as he would not like to get too early into a stock.
In growth investing, it is essential for the investor to identify businesses that face little threat of erosion so that earnings growth of those companies is not impacted. Growth investors are generally in for short time frame compared to value investors. In general, value stocks tend to hold up better during stock market downturns.
An investor having a high-risk appetite is more likely to choose a growth strategy. While a defensive investor would choose to take the value investing route.

http://www.sharemarketschool.com/stock-investing-strategy-%E2%80%93-growth-investing/

Further Reading for the weekend

SHARK

Thanks shark. Very Clear.

good one. Cheers!

These stratrgy guides are extremely interesting! Thanks for sharing!

Welcome .....NG

There are other Strategies as well.

Technical
Qualitative
Growth etc... Please refer to the Expert Chamber

thank you all. good stuff.

I am revisiting the thread

Please read during the week-end