How to select growth stocks

By Vikash Agarwal

When choosing growth stocks, you should consider investing in a company only if it makes profit and if you understand how it makes that profit and from where it generates sales. Usually, you compare the growth of a company with growth from other companies in the same industry or with the stock market in general. If a company has earnings growth of 15 percent per year over three years or more, and the industry’s average growth rate over the same time frame is 10 percent, then this stock qualifies as a growth stock.

A growth stock is called that not only because the company is growing but also because the company is performing well with some consistency. Having a single year where your earnings do well versus the Nifty/ Sensex average doesn’t cut it. Growth must be consistently accomplished.

When you hear the word fundamentals in the world of stock investing, it refers to the company’s financial condition and related data. When investors especially value investors do fundamental analysis, they look at the company’s fundamentals — its balance sheet, income statement, cash flow, and other operational data, along with external factors such as company’s market position, industry, and economic prospects. Essentially, the fundamentals indicate the company’s financial condition.

Are the company’s sales this year more than last year? As a decent benchmark, you want to see sales at least 10 percent higher than last year. Although it may differ depending on the industry, 10 percent is a reasonable, general “yardstick.” Are earnings at least 10 percent higher than last year? Earnings should grow at the same rate as sales (or, hopefully, better). Is the company’s total debt equal to or lower than the prior years? The death knell of many a company has been excessive debt.

A company’s financial condition has more factors than I mention here, but these numbers are the most important. I also realise that using the 10 percent figure may seem like an oversimplification, but you don’t need to complicate matters unnecessarily.  You can invest in a great company and still see its stock go nowhere. Why? Because what makes the stock go up is demand — having more buyers than sellers of the stock. If you pick a stock for all the right reasons, and the market notices the stock as well, that attention causes the stock price to climb. The things to watch for include the following:

Are mutual funds and Insurance or other financial institutions buying up the stock you’re looking at? If so, this type of buying power can exert tremendous upward pressure on the stock’s price. Some resources and publications track institutional buying and how that affects any particular stock. Frequently, when a mutual fund buys a stock, others soon follow. In spite of all the talk about independent research, a herd mentality still exists.

Are analysts talking about the stock on the financial shows? As much as you should be skeptical about an analyst’s recommendation, it offers some positive reinforcement for your stock. Don’t ever buy a stock solely on the basis of an analyst’s recommendation. Just know that if you buy a stock based on your own research, and analysts subsequently rave about it, your stock price is likely to go up. A single recommendation by an influential analyst can be enough to send a stock skyward.

Independent researchers usually publish newsletters. If influential newsletters are touting your choice, that praise is also good for your stock. They offer information that’s as good or better than the research departments of some brokerage firms, don’t use a single tip to base your investment decision on. But it should make you feel good if the newsletters tout a stock that you’ve already chosen.

Pick a company that has strong fundamentals, including signs such as rising sales and earnings and low debt. Make sure that the company is in a growing industry. Be fully invested in stocks during a bull market, when prices are rising in the stock market and in the general economy. During a bear market, switch more of your money out of growth stocks (such as technology) and into defensive stocks (such as utilities). Monitor your stocks. Hold on to stocks that continue to grow, and sell those stocks that are declining.

(The writer is an investment consultant based in Rourkela)