Ariston Select: Relative Growth
(Formerly Reuters Select)
Growth is a popular investment theme. But how much growth should an investor seek? Should one consider only those companies that are growing 20 percent or more? Or is a 15 percent rate of growth sufficient? Perhaps 25 percent would be a more attractive target.
Rationale for this screen
When screening for growth stocks, it's tempting to seek the highest rate that will produce a list containing a reasonable number of stocks. But that's not always a good idea. Such lists are often tilted toward "hot" industries. That's fine if you want to use a top-down approach to stock selection that focuses primarily on sectors or industries and secondarily on individual companies.
Bottom-up investors look mainly at individual companies and are more willing to invest in firms whose industries aren't in vogue. The idea here is that shares of such companies are likely to fare well over longer periods of time despite the ebb and flow of market fads.
Growth rates can be used to locate companies like this. Instead of targeting specific growth numbers, seek growth rates that look good measured against some other test(s). The Accelerating EPS Growth screen seeks companies whose recent growth rates that exceeded the rates tallied over past periods. This screen, however, considers acceleration, but also introduces other comparisons. It compares EPS growth to Sales growth. And it looks for growth that exceeds industry averages.
Specific screen criteria
Here's how the screen was created:
We start by requiring that the company's tax rate be at or above 25 percent. Unusually low tax rates are often unsustainable over time. One example of this would be a company whose tax rate is being depressed by loss carry-forwards from prior years. When those carry-forwards expire, the tax rate will jump significantly, leading to a lower level of earnings per share, even if the basic business (i.e. its capacity to generate pretax income) continues to grow.
A company can boost its EPS by cutting costs, and occasionally, by divesting money-losing operations (the latter would cause Sales to fall and EPS to rise). But such strategies can go just so far. Over prolonged periods of time, strong rates of EPS growth start with strong rates of Sales growth. This screen requires that each company's Trailing Twelve Month (TTM) Sales growth be greater than the three-year cumulative average rate of Sales growth (the acceleration factor) and greater than the average rate of TTM Sales growth for its industry.
EPS vs. Sales
The screen requires that EPS growth exceed Sales growth over the past three yeas, and in the TTM period.
As suggested above, this screen is designed to find companies that may be of interest to long-term investors. But all else being equal, most investors would prefer to take new positions in stocks that seem likely to behave well sooner rather than later. So we analyze EPS by focusing on recent results, these being more likely to influence near-term share price performance. The screen requires that EPS growth in the latest quarter (compared with the equivalent year-earlier period) be greater than the industry average growth rate, and that it be better than the growth rate that prevailed over the TTM period. I'm willing to shorten the time horizon for the EPS analysis in this manner because the previous tests probably eliminated most, if not all, flash-in-the-pan companies.
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