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Of all the metrics used by investors to understand the trajectory a company might be on, growth in both sales and earnings-per-share are among the most important.
These measures are a natural starting point when it comes to studying company growth. But they’re also useful in other areas, such as stock valuation. For that reason, you find them in strategies across a whole spectrum of investing styles, including value, momentum, yield and growth.
While most of us take an interest in company income, it’s growth investors that really prioritise positive changes in sales and earnings. That’s because comparing growth over different timeframes (including what might be expected in the future) can help track down some of the most exciting and fastest growing companies in the market.
In this article we’re going to look at why sales and earnings are important and how you can use them to find fast growing companies.
On a company income statement, sales are the top line and earnings are the bottom line. Most of what sits in between are expenses, taxes and accounting adjustments.
Sales is a term that’s interchangeable with revenue and turnover - and without it there can usually be no earnings.
Part of the reason why sales are taken seriously in growth strategies is that it’s a measure that is hard to manipulate. All things being equal (and legal), sales figures are metrics that management can’t easily dress up. So any investor looking for strong and accelerating earnings over time will want to see that sales are growing too.
In some cases - where a company is yet to generate earnings - sales might be the only obvious clue to growth. In the dotcom boom in the late 1990s, the price-to-sales ratio became a popular way of valuing companies with no earnings (and in many cases no chance of generating any). Understandably, the P/S ratio fell out of favour after that, but today sales and the P/S ratio are still very important measures.
Ultimately, however, most investors want to see sales lead to a positive bottom line - and that means positive earnings. Earnings is essentially a byword for profits. It captures what the company makes in sales minus all the associated costs that come later on. What’s left is attributable to common shareholders, and companies will retain or reinvest those profits or pay them out in dividends.
On its own, earnings gives you a snapshot of a company’s profitability. But to compare earnings over time or between different companies, a more useful measure is earnings-per-share (EPS). EPS takes a company’s earnings figure and divides it by the number of shares it has in issue.
Like many financial metrics, EPS isn’t perfect. It doesn’t really tell you about the ‘efficiency’ of a company’s profitability, and it can also be ‘gamed’ or distorted by events like share buybacks. But nonetheless, it is ubiquitous in stock analysis. It provides a picture of growth (or contraction) over time and is also an important component in valuation.
The price-to-earnings ratio, for example (which compares the price per share with the earnings per share), tells you how many years of earnings it will take to repay your investment at the current price. Generally speaking, the higher the number, the more expensive the stock.
Another measure, the price to earnings growth ratio (PEG ratio) is used by growth investors who have one eye on value. The PEG measures the trade-off between a company’s share price, its earnings, and its expected EPS growth rate. Generally, a lower PEG (below 1) indicates better value, because it means paying less for each unit of earnings growth.
According to some of the most influential growth investors, earnings are a crucial early consideration, especially when growth rates are compared over time. These measures are found in many strategies but a couple of the best known are those used by well known figures like Mark Minervini and William O’Neil.
In his book, How to Make Money in Stocks, O’Neil described the percentage change in EPS as “the single most important element in stock selection today. The greater the percentage increase, the better.”
In O’Neil’s CAN-SLIM checklist, the C and A stand for Current and Annual earnings and sales growth. Similarly, Minervini initially filters the market based on fundamentals including fast and accelerating earnings growth in recent quarters.
Generally, these strategies look for double-digit growth in recent years and then for signs of acceleration. That means looking at how the most recent quarter EPS compares against the same quarter last year, and then whether the EPS is growing quarter-on-quarter.
In essence, this approach looks for earnings that are snowballing. Often there will be other variables to take into account. Some strategies look at catalysts, institutional demand for shares and growing trading volumes. Likewise, tome growth investors will be wary of overpaying and will take valuation seriously - but others (like O’Neil and Minervini) are less concerned about price and more interested in chart setups.
To apply some of these ideas with the Stockopedia Screener, go to Screens and click to create a new screen:
Clicking “Add Rule” will launch the ratio picker. From there, you can select Growth > EPS Growth and then select the timeframe you want to use. In this case, the TTM timeframe will measure growth over the previous four financial quarters (including interims).
After adding that rule, you’ll be able to specify how you want to use it (in this case “greater than”) and by what measure (in this case ‘10%’). So this rule will filter the market for companies with EPS growth over the previous four reported financial quarters of more than 10%.
Returning to the ratio picker, this screen uses additional EPS Growth rules over different time frames, including the 1-year Forecast, to look for consistent and accelerating earnings growth.
To avoid companies that might be manipulating their earnings somehow, it also uses some sales growth rules. These take a similar approach to the earnings growth rule, and should give some added confidence that stocks with fast growing earnings have strong sales growth backing them up.
The results produce a screen list that looks like this (these are just the top results):
Growth means different things to different investors of course, but sales and earnings are fundamental components of many strategies. By just using these measures, it's possible to get quickly find companies that are genuinely growing quickly - and make the rules very demanding. These types of screening criteria can be a useful check in any strategy, but they are a foundation in some of the most popular growth strategies. You can find this Fast EPS and Sales Growth screen here
It’s worth noting that fast growing companies can quickly capture the imagination of the market and their valuations can soar. Some growth investors are more concerned about this than others - but either way, it’s worth being cautious. There are rarely any guarantees that an accelerating growth record will continue, but in the hunt for ideas, studying sales and EPS growth over time can be an effective way of tracking down the fastest moving companies.
About Ben Hobson
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Using the screen I have uncovered a potential gem Frenkel Topping,Frenkel Topping (LON:FEN), and it has just broken into new highs. I bought in just before market close. I'm now loving doing my own research instead of relying on tips.
A major point in my view is that this screen will tell me what not to sell. i.e Sdi (LON:SDI) and Jarvis Securities (LON:JIM) which I hold.
I do hold both Sdi (LON:SDI) and Jarvis Securities (LON:JIM) but I’m not so sure about that, I have sold some of those a while ago such as Ferrexpo (LON:FXPO) and Rio Tinto (LON:RIO) and they have fallen more, FXPO considerably. A few are below the 50MA which is a rule some of the growth screens such as CAN-SLIM use.
Hi m84s.
I suspect Silver Moon simply saw the names of the stocks on the list and simply saw that they met the screen criteria. However, if you want to, it is possible to use these rules as a checklist for another stock not on the list to see which, if any criteria, it meets.
To do this, you will need to:-
Click on the blue link in the article above to the screen of selected stocks.
Make a copy of the screen in your personal screens portfolio.
Pull up a stock you want to look at, for example, Boohoo (LON:BOO) .
Click on the <Tools> link in the menu and select “Run through a Checklist”.
Select the saved screen as the required checklist.
You will get an output like this showing which of the screen rules it meets or fails. If you then click on the ticks and crosses Stocko will give you more detail on how the selected stock compares to the particular rule and explain what the rule is designed to assess.
Hope that helps.
Gus.
That’s correct but actually you don’t need to make a copy, you can just use the screen as a checklist, see at the bottom under the listed shares.
I have a problem because on the old site l had many screens set up, around 100 but on the new site there is a 50 screen limit, so now I can’t copy any screens over to my screens, not without deleting about half of my screeens first.
For those new to screening a few things I have experienced. Screens may miss some stocks because the information is not available, it is quite common on EPS forecasts, I have found.
The information as reported is not always accurate.
There maybe a reason why a stock is selected, such as a takeover bid, it pays to check.
The chart view on the screen is a very useful tool I find.
Screening I think is just a starting point for further research.
You can add your own rules to any screens.
I'm starting to get the hang of using screens now. I find that having multiple screens which focus on different criteria works the best. That way, if any shares appear in two or more screens, you'll know to add them to your watchlist. I have the screens from the two recent articles here, but I've also created a few of my own which could do with some fine tuning but that will come with practice.
Initially the screen would not save then it did after about 10 attempts. Odd. Anyway that aside, here is my take on this. Good article, BUT BE CAREFUL. I just ran a few stocks against this screen in the Tools section, as Gus v helpfully exlplains below. I ran it against Rio Tinto (LON:RIO), which has been on a downhill slalom run for months. Guess what? £RIO passed all of them. You would not have wanted to be in £rio recently if you cared about capital appreciation.
This is why trading just on fundamentals alone is not a good idea. Screening at least sorts out the wheat from the chaff, and as there are so many high risk, low quality companies out there you will want to avoid your hard earned cash going down with many of them. Picking good companies using screens reduces your risk of loss, but clearly does not prevent it.
Technicals, aka charts, is how you get in at a good price, that is timing, so combine both fundamentals and technicals and you'll have a way to get in a good quality company at the right price, if at all. Charts can get complicated, but if you follow a few simple rules you should be ok. Most important is to follow the trend. Plus I like certain chart patterns such as the cup and handle pattern, as it tends to have a favourable chance of success. The charting tools here are good, but for viewing lots of charts there is currently too many clicks to wade through(big charts not the mini charts), which is why I have to use another website for my charting.
The third pillar is risk management. Get that wrong and the first two won't matter.
As for not saving, i've not had an issues and I have built quite a few screens by now. May be a bug, or possible connection issues?
I think the site was playing up a bit yesterday. As for the screen, that’s why I suggested adding momentum rule in, I find that helps, that should cut out stocks such as Rio Tinto (LON:RIO), say M score > 70. Or you can click on the Momentum column and check, Anglo American (LON:AAL) and Rio Tinto (LON:RIO) have low scores.
Also I would look at chart view on the screen, good way to see all the stocks and share price movement. Some I won’t invest in, if the share has gone up almost vertically recently, as they often come back down again. Marshall Motor Holdings (LON:MMH) a while ago would be one example. Also Alpha Fx (LON:AFX) in mid September.
The screen has already paid for itself. Nice strong move upward into new highs for Frenkel Topping (LON:FEN) .
Amazing job, thank you very much Mr Hobson. I really like these kind of strategies. they're powerful like ¨James O'Shaugnessy Cornerstone Growth¨ or the one you mentioned from O’Neil. Have been following O'Shaugnessy strategy and has been really impressive and i believe your strategy is going to be pretty close to their returns.
P.S: I never buy the Basic Materials or Utilities appearing in these strategies since i don't like investing in those sectors.
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Thanks for the article! Very clarifying.