Often I get questions from prospects, clients at Faith-Based Investor, or from subscribers at Wall St. Renegade, and sometimes they are such important questions that I think my whole audience can benefit from such a response.
This past week, Brandy had a question about investing. She wants to know:
“Jay, what factors do you consider when investing, and how do you balance out all of the short-term and long-term information coming out about the markets and individual stocks?”
Whenever I consider investing, I view my investments as companies rather than just stocks. I look to “invest” in great businesses rather than just put together winning trades. Don’t get me wrong, for a portion of my investments, I do trade. I find lots of short-term windows of opportunity and buy and sell based on those opportunities; but for the bulk of my serious money I look for great companies that I can hold for a long time!
My “proud to own” process involves three areas of focus:
- I look to avoid companies that violate my faith and values. Some of the types of companies I avoid include those involved in the abortion industry, those producing explicit entertainment and pornography, those conducting embryonic stem cell and fetal tissue research, companies funding and lobbying for homosexuality, those involved in vices like alcohol, tobacco, and gambling, and companies that are abusing the environment.
- I seek out companies that complement my faith and values. This involves finding companies: helping the poor and defenseless; protecting the sanctity of human life; producing morally sound entertainment; finding cures for life threatening diseases; and improving the society in which we live.
- I seek companies with strong profit potential. This involves finding companies in solid financial condition that have strong profit potential and/or provide strong cash flows via dividends. My goal is to find quality companies that stay true to my values AND are profitable! This is not an either /or scenario but rather a winning combination.
Now, once I make a list of potential companies I am considering for my portfolio, I specifically look for “great companies”. Not companies that are just the “stock du jour”, I want companies that have lasting power! Just like Jim Collins spends his time looking for companies that have gone from “Good to Great”, I specifically target companies that are making a difference in our world and growing by leaps and bounds.
Here is how I find great growth companies:
Growth investors are concerned with a company’s future growth potential, and there are many formulas and methods to find such companies. Let’s look at five of the things I look at when searching for growth opportunities.
1. Strong historical earnings growth
I start by looking at a company’s past. Though past results are no guarantee of future results, it is still a great place to start. As a growth investor, I start by looking to see if the company’s annual revenues have been growing in the past. I specifically look for companies with strong Earnings Per Share (EPS) growth over the last five years. Ideally, I like to see strong 10-year EPS growth as well. If a company has displayed good growth over the last five- or 10-year period, there is a strong possibility that this trend is likely to continue.
2. Strong forward earnings growth
My minimum projected five-year growth rate is at least 10-12%, but I prefer companies that show a growth rate in excess of 15%. Though forward estimates are only expectations, it still helps to see how analysts view the company’s future prospects.
3. Strong management team that is controlling costs and growing revenues
I tend to look very closely at profit margins. This is an assessment of a firm’s income as a percentage of its revenue. If a company has margins at 25% that means it is earning 25 cents for every dollar’s worth of products or services it sells.
Margins will vary by industry with retailers often having thin margins due to tight competition. Technology and health-related companies tend to have wider margins with more price flexibility. I look for firms with the best profit-to-sales ratios in its industry with expanding margins quarter-by-quarter and year-by-year.
I find that those with the highest margins tend to have stronger pricing power for their products or better control inputs to produce their products at a lower cost than the competition.
By comparing a company’s present profit margins to its past margins and its competition’s profit margins, it helps gauge whether or not management is controlling costs and revenues and improving or lowering margins. To make things easier, I look to pretax margins (simply divide the firm’s income from operations before taxes by its net sales). If a company exceeds its previous five-year average of pre-tax profit margins and also is above the industry average, it certainly makes a good growth stock candidate.
4. Strong, efficient business operations
Here I look at return on equity (ROE). If a company is efficiently using its assets, you will see stable or rising ROE. To get a good pulse on a company, I compare a company’s present ROE with its five-year average ROE and with that of the industry. If it beats both criteria, again it’s a good growth stock candidate.
5. Stocks with a strong chance of doubling in price over the next five years
If a stock cannot realistically double within the next five years, it’s not really a growth stock. So that is why I focus so heavily on a 15% annual growth rate, which would enable the stock to double within the next five years.
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