Growth Investor Tools and Tips
Growth Investing is the other major school of investment theory. While Value Investing looks for good news in a bad news situation, growth investors look for
good news that they think will only get better. They look for accelerating earnings which are ahead of the pack, and whose earnings are predicted to stay ahead
of the market over a long period of time. If those earnings do stay ahead of the market, so will the stock price - at least that's the way growth investors plan
on it working.
A growth investor might use a variety of tools to determine a stock’s potential. A high beta, for example, indicates a stock’s price will move at a higher percentage than the overall market if it starts to rise.
The book-to-bill ratio is a predictor of future sales based on current unfilled orders. Some of the best-known growth investors have had their own favorite tools. Let’s take a look at some of these growth investor metrics and how to take advantage of them.
Price/Earnings to Growth - PEG Ratio
PEG is a widely used indicator of a stock's potential value. It is considered by many to be a stock's potential value.
It is favored over the price/earnings ratio because it also accounts for growth.
A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows:
Keep in mind, the numbers used are projections, and so, can be less accurate. Also, there are many variations when using
earnings from different time periods (i.e., 1 year vs. 5 year). Be sure to know the exact definition your source is using.
Beta is a measure of a stock’s relative price volatility to the S&P 500. For example, a beta of 1 would indicate that
for every 1.0-point move in the S&P 500, your stock would move 1.0-point. A beta of 1.5 would indicate that a 1.0-point
move in the S&P 500 would move your stock 1.5-points.
This stock's Beta is 1.22 or about 22% greater volatility than the S&P 500 Index:
Book to Bill Ratio
Describes the technology industry's demand to supply ratio for orders on a "firm's book" to number of orders filled.
Calculate the three-month averages of orders booked and sales billed. Then you divide orders by sales. This quotient
reflects the relation of the potential revenue (orders) to actual revenue (sales).
This ratio measures whether the company has more orders than it can deliver (if greater than 1), equal amounts (equals 1),
or less (under 1). This monthly figure is used frequently for companies in the technology and chip (semiconductor) sector.
Price to Book Ratio
This is used to compare a stock's market value to its book value, calculated by dividing the current closing price of
the stock by the latest quarter's book value. (Book value is simply assets minus liabilities).
A lower Price-To-Book Ratio could mean that the stock is undervalued. But it could also mean that something is fundamentally
wrong with the company. As with most ratios be aware this varies much by industry.
This ratio also gives some idea of whether you are paying too much for what would be left if the company went bankrupt immediately.
Also known as the price/equity ratio.
Famous Growth Investors and Their Tools
“You get recessions, you have
stock market declines. If you don't understand that's going to happen, then
you're not ready, you won't do well in the markets.”
Peter Lynch was the investing guru of the 1980s, and the person who, arguably more than any other person in
the investing field, made putting money into mutual funds exciting for Main Street investors. He accomplished
that feat through a combination of legendary returns from his Fidelity Magellan Fund and a commonsense way of
explaining himself, which endeared him to most middle class investors. It was in 1977, when he became the head
of the $18 million Magellan Fund and after averaging returns of 29.2% the fund grew to $14 billion by 1990.
Lynch had several criteria of which he was fond. He wanted the company's Earnings Per Share (EPS) to grow
between 25-50 percent and higher than 50 percent was too strong to be sustained, in his opinion. He also liked to
examine the P/E very closely. He divided the rate of growth in the company's earnings into the current P/E. What
is an acceptable P/E ratio? These days the answer is much more complex, and depends greatly on the present condition
of the market in its cycle of ups and downs. When the market is strongly moving up, there tends to be high P/E ratios
because prices are higher, but afterwards when the market goes down, the numbers can be deceiving. P/E ratios will be
lower because they are calculated using the earnings that companies had 12 months ago. For example, if the current price
of a stock is $40, and 12 months ago they earned $2 per share, then the P/E ratio will be 20. However, they may only be
making 50 cents per share right now, which would give them an actual P/E ratio of 80. Perhaps, one can find an acceptable
P/E ratio by determining the average for the sector and researching the company’s recent performance history.
In addition, he generally wanted a company's inventories to stay abreast of sales. If inventory starts to increase
faster, that's a red flag. He also had some more folksy rules of thumb, such as whether he liked the store and whether
the company's annual reports had a minimum of pictures in it.
“In playing the market, remember you must deal with probabilities, employ sensible strategies to limit risk, and get
aggressive only when conditions warrant.”
Martin Zweig's most famous accomplishment was to call the Crash of 1987 on the Friday before the crash hit. Zweig is the
chairman of The Zweig Fund and the Zweig Total Return Fund, and publishes the Zweig forecast.
Zweig wants to see a company's earnings be relatively stable, and that it have a 20 percent increase in each of the
preceding three quarters. However, he doesn't like a company's having a lot of debt. He also wants a company's P/E
ratio to be higher than 5, but not more than three times the current P/E for the overall market. In addition, he does not
want earnings growth to be markedly higher than revenue growth, a rising sales growth in quarterly sales and an increase
in annual earnings for each of five years.
“Since the market tends to go in the opposite direction of what the majority of people think, I would say 95% of all
these people you hear on TV shows are giving you their personal opinion. And personal opinions are almost always worthless …
facts and markets are far more reliable.”
William O'Neil bought his own seat on the New York Stock Exchange (NYSE) at age 30 with his stock market profits, and
he founded the investment firm of William O'Neil and Co., Inc., whose clients include many of the world's largest institutional
investors. He also is the founder of Investor's Business Daily.
O'Neil's approach is known by the acronym CANSLIM®, which includes (C) current quarterly earnings per share - which should
be up at least 25 percent in the last quarter, an (A) annual increase of 25-50 percent in earnings per share over a period of
five years, a great (N) new product or service which is selling very well, a major shift of (S) supply and demand in the industry
conditions and less than 30 million shares of all shares outstanding. He looks for (L) leaders in the industry with (I) institutional
sponsorship. He also thinks investors should learn to analyze daily price and volume charts and learn to recognize when
the (M) market has topped or bottomed out.
New Products or Services
Supply & Demand
Leaders in Industry