We hear so much about earnings growth these days, you’d think we’d have it down pat by now, right? After all, it’s pretty straightforward-a company that’s showing an increase in profits from one year to the next is growing. And if those increases happen to be 10% or more, then you’ve quite possibly got a winner on your hands.
Think again, says Michael Manns, a portfolio manager for American Express’ asset management division in Minneapolis. In his eyes, too much attention is paid to growth and not enough light shone on just how a company beefs up its earnings. That distinction, Manns says, is crucial when you consider the fact that over the past 10 to 15 years, corporate America has accomplished a lot of its earnings increases by cost-cutting. While that certainly helps, he likes to see companies grow the old-fashioned way: by conquering markets, expanding their product lines and winning over customers. "It’s then you know that whatever is going on is sustainable, and more likely to benefit shareholders over the long haul," he says.
As a professional stock picker, Manns should know. Over the past three years, a large-cap growth portfolio he runs for institutional investors has averaged a yearly total return of 27.7% to 28.2%. Last year, a new aggressive growth portfolio gained 38.2% vs. 28.8% for the Standard & Poor’s 500.
Just how does he determine what’s real growth? Manns looks for unit volume growth, a fancy way of saying a company is expanding the number of products it sells. That’s an important sign, Manns points out, if only because inflation has been low and companies simply can’t boost prices to increase their profits. In fact, show him a company with good volume growth that exceeds its rivals, and he’s almost certain a company is gaining market share, operating efficiently and definitely growing earnings.
His other criteria: a decent earnings growth rate, roughly 13% annually; price-to-earnings multiples that are 1.5 to 2 times a company’s growth rate in a booming industry; and whether a company’s key executives receive options or cash payments based on the performance of their company’s stock. "That way I know management’s interests are linked with mine," he says.
The companies that excite Manns include Pfizer (NYSE: PFE), Citigroup (NYSE: C), General Electric (NYSE: GE), Safeway (NYSE: SWY) and Cisco Systems (NYSE: CSCO).