Shooting Stocks

Follow the clues growth managers look for to pick stocks that are ready to soar

with an inflated market means one thing: finding an “edge,” or a way to spot good prospects before hordes of investors bid up their share prices. Securing a head start on the market for growth pickers boils down to finding growth candidates

early. Instead of searching for shares that are underappreciated and underpriced, which is the strategy value players pursue, growth managers are more interested in finding companies where earnings growth is about to take off or “accelerate.” Then, by getting in before the growth spurt, professionals like C. Kim Goodwin, portfolio manager with Kansas City, Missouri-based American Century Investment Management, are able to buy in at a reasonable price.

Goodwin says a recent example is Wal-Mart (NYSE: WMT), which for much of the ’90s has delivered steady earnings growth on the order of 13% to 15% a year, according to Zacks. Last year, though, thanks to a big international expansion and a move to set up a chain of superstores throughout the U.S., Wal-Mart’s earnings growth leapt up to 27%, boosting its stock price by 80%. “Our mantra in this business is simple,” says Goodwin. “Money follows earnings, period.”

Just as we did in the value installment of this series, we’ve listed some of the figures growth investors look for when they invest in stocks. They are: earnings growth, earnings acceleration, price-to-earnings growth, sales growth and return on equity.

Earnings growth: The foundation of growth investing, managers look for earnings-per- share (EPS) growth of 7.8% or more.Corporate earnings growth of late has been nothing short of phenomenal, peaking at 21% year-over-year in 1995. And while earnings growth for the S&P 500 has skipped along at a
10% rate for the past five years, Holland says things are bound to cool down soon to the 7% to 8% range. Therefore, a good growth screen should aim for stocks that can increase earnings faster than the broader market. In our eyes, 10% is a good target, one that should surpass the S&P 500’s projected earnings growth rate.

P/E-to-earnings growth or PEG: Growth managers seek to determine if a stock is overvalued and look for a PEG of 2 or less. As much as they’re im-pressed with earnings, we don’t mean to imply that growth managers aren’t somewhat value conscious. It goes without saying that if the stock market bids up a company’s share prices too high, there’s little to attract investors. So as a practice, while growth managers may not angle for companies with P/Es below the market average, they do put a cap on how high a multiple they’re willing to pay. To do so, typically, the growth camp weighs P/Es against earnings growth rates.

Some, like Michael T. Manns, a portfolio manager with American Express Asset Management Group in Minneapolis, go so far as to divide a company’s P/E by its projected earnings growth to get what’s called a PEG ratio. Manns says that while a PEG of 1 is the sign of a bargain growth stock, he’s willing to go a bit

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