Shooting Stocks

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

higher-say a PEG of 1.5 or even 2-for companies that have been dependable in the past. “For established companies, I tend to get a little queasy at 1.5,” he says. “And paying a P/E two times a company’s growth rate is merited only in the case of a General Electric (NYSE: GE), a company with exceptional management, high barriers to entry, leadership in its products and 15% or
better earnings growth five years back.”

Sales growth: Some companies can grow earnings over the short term by cutting costs. However, positive sales growth points the way to continued earnings gains over the long term.
Often over the past decade, renegade owners have blazed their way to the top of companies. They’ve sold factories, sent workers packing, created spin-off divisions, then saw fabulous results in the stock market.

Over the short term, those strategies are bound to lift earnings and share prices. But for the long haul, American Century’s Goodwin likes to see a company creating something substantive for the future. Her measure: positive sales growth.

“If you ask me, sales growth really confirms corporate earnings,” she says. “To my eye, sales growth shows all the positives we look for in a company: good products seizing market share or dominant products in a given sector.” And as a gauge, Goodwin points out, sales growth will often separate stocks on their way up from those headed south. “In this day and age it’s hard to find large companies that can augment sales growth, but when you do, it’s often a sign of bigger and better things to come.”

Return on equity (ROE): How’s management putting your investment to work? Return on equity judges just what the execs in the corner office are doing with your funds. Look for a return on equity above 20%.

In last month’s screening story, we showed how value managers love to use ROE to keep corporate management honest. The growth camp is equally enamored of it as a measure of how a corporation uses your investment to grow. Amex’s Manns says he’s happy with a 20% ROE. “We like to invest for the long term, and when you see a ROE above 20, you’ve got a pretty good idea that management knows how to put shareholders’ money to work.”

Debt to capital: The lower a company’s debt, the less strapped it is by payments to creditors. The pros say look for a clean balance sheet, or companies with a debt-to-capital ratio of 40% or less.

We learn early on that a string of credit card payments is likely to prevent anyone from saving much or even acquiring the finer things in life. The same goes for big corporations. A growth company that has the banks looking over its shoulder will have less money to put into research, new factories or even share buybacks. Many investment pros will tell you that 40% is a good cutoff point. Above that, and a company is likely to be gasping for air. Below, and things are manageable.

Growth investing, like value,

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