You ask a simple question, sometimes you get an answer so complicated that you’re sorry you asked. That’s one of the discouraging truths about the universe.
Here’s the simple question: “How do I find great growth stocks?”
Since I work for a company that sells advice on stock investing, I have a couple of obvious suggestions, but I’ll keep them to myself for a while.
The real question is, how can an individual investor find leading growth stocks?
A few obvious choices probably don’t work.
For instance, you probably won’t find great growth stocks by scanning the lists of the day’s biggest gainers. All too often, the stocks making the biggest leaps during the day are low-priced issues that are rebounding after big losses. Plus, even if a stock trades at 10 or higher, a 20% gain (or more) often signals a climax in price action, at least short-term.
It’s also difficult to find stocks with big growth potential by watching the parade of fund managers on financial TV shows. In the first place, most big fund managers use a valuation approach to stocks, so their recommendations focus on cheap stocks, rather than those with a chance at rapid price appreciation.
Financial blogs and the columnists on financial Web sites are fun and fascinating, but they’re too hit-or-miss to use as guidance in putting your hard-earned money to work.
No, the best way for the individual investor to find great growth stocks (short of using Cabot’s services) is to screen the markets for growth characteristics.
The Wilshire 5000 Index was established in 1974 to track the value of every stock on the market that represents a firm headquartered in the United States and that trades on U.S. exchanges and has widely available pricing information. The market has grown since the Index was established, and now includes about 6,700 stocks.
So your job is to pick out 50 candidate stocks from among those 6,700 for further study and analysis.
What do you screen for?
Your most important screen is for price appreciation. You should set your screening characteristics to show you stocks that have risen 20% or more during the previous month (at least during the present market environment). This will eliminate stocks that are losing value, ones that are trading in a range and ones that are appreciating only gradually.
If you only have one screen, that’s the one you would use. The most bullish thing a stock can do is to go up in price. Price appreciation represents an improving opinion of the stock on the part of the investing community. And by keeping your time period at a month, you will exclude the one-day flash-in-the-pan stocks that rise and fall like mayflies.
If the markets are in generally good health, as they are now, you will need more screens to whittle down your list. I would suggest setting your screens to eliminate any stocks that trade under 10. Low-priced stocks are just too volatile. I would also look for stocks that trade with adequate volume to ensure that you can buy and sell easily. Your liquidity screen should exclude stocks that trade fewer than 300,000 shares a day.
Once your list becomes manageable, you can begin to look for the fundamentals that support price appreciation. These supporting numbers include revenue and earnings growth (both in recent quarters and over the years), growing institutional sponsorship and healthy after-tax profit margins.
Finally, you will want to begin researching the business prospects of the companies you have selected. Are their products and services innovative, revolutionary and with potential appeal to a huge mass market? Are they the best in their industry? Is management seasoned, responsive and able to juggle the rise and fall of costs, demand and competition?
You need to consider everything before you put your money down. But the place to start is with price appreciation. The market is constantly processing all of the information I’ve talked about here, and the movement of a stock’s price is like a running tabulation of the results. Start with stocks that are going up and you won’t go far wrong.
Editor’s Note: This method works. I know it works because that’s what I and the editors of Cabot’s other growth advisories–Cabot Market Letter, Cabot Top Ten Report and Cabot China & Emerging Markets Report–actually do every day. We are constantly combing the markets to isolate the strongest stocks with the best growth credentials. And we start with price appreciation.
I will just point out that if you don’t have the time or the temperament to do the kind of screening I’ve described above, you can still have access to the results by subscribing to one of our growth publications. For those who have a taste for life in the fast lane of the growth highway, I’d recommend Cabot China & Emerging Markets Report, the newsletter that I write. The emerging markets are blowing the doors off their developed market counterparts right now, and prospects are excellent.
Cabot China & emerging Markets Report was recently named the top-performing newsletter for the past five years on a risk-adjusted basis by Hulbert Financial Digest. The Report gained 12.2% for the five years ending March 31, 2009, trumping the -27% return for the Dow during that time. Click here to get started today.