Markets are showing more strength than we’ve seen for many months, and that always brings questions to Cabot’s growth analysts. And aside from queries about individual stocks, the big question is always, “How do you find great growth stocks?”
The obvious answer is that you take advantage of what Cabot’s growth analysts spend all of our working hours doing. We look for growth stocks with great promise and we advise our subscribers about how to build them into a portfolio.
But I think the real question for many investors is: “How can I, an individual investor, find leading growth stocks?” These are the people who want to do the work themselves.
So here goes.
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. And even if a stock trades at 10 or higher, a 20% gain (or more) often signals a climax in price action.
It’s also difficult to find stocks with big growth potential by watching the parade of babbling fund managers on financial TV shows. In the first place, most big fund managers apply a valuation approach to select stocks, so their recommendations focus on cheap stocks, rather than those with a chance at rapid price appreciation.
Financial blogs and columnists on financial sites are fun and fascinating, but they’re too hit-or-miss to use as guidance in putting your hard-earned money to work.
And lastly, it’s probably a mistake to look at the stocks that lead the last big rally or those that dominate headlines on financial sites. For example, Apple (AAPL) was a great story, but one look at what the stock has done over the past year is a reality check. Even with a rally from 93 in late February to 103 today, this isn’t a stock that’s going to lead the way.
No, the best way for the individual investor to find great growth stocks 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 grew to a high of over 7,500 stocks in 1998, but has now shrunk to just under 3,700, but that’s still a lot of choices.
So your job is to pick out 50 candidate stocks from among those 3,700 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. 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 hatch and die like mayflies.
If the markets are in improving 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 quarterly and over the years), institutional sponsorship and after-tax profit margins.
Finally, you will want to begin researching the business propositions 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 stock 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.
If you need help finding the market’s leading growth stocks, consider taking a risk-free trial subscription to Cabot Top Ten Trader.
This Week’s Cookie
Paul’s comment: I’m going to take advantage of both Tim Lutts and Mike Cintolo being out of the office to hog the Fortune Cookie all to myself. I’ve always enjoyed reading the “Featherisms,” the musings of William Feather, a man who was once thought of as the Will Rogers of Wall Street. This particular quote was popular enough to be misattributed to lots of other people, but it has Feather’s trademark irony.
The fact is that lots of trades are mistakes by either the buyer or seller, but not always. If an astute growth investor buys a stock on the way up that’s being sold by a value investor, both can indeed win. It’s the growth investors who buy too high and too late (or sell too late, long after they should have) who really take a bath. Knowing the rules of your preferred style is a key to success.
Chief Analyst, Cabot Emerging Markets Report