From today's IBD
Date :02/29/2000
Author :
Copyright :Investor?s Business Daily
Title :Superior Profits Fuel Long-Term Winners
Greatest Stocks Show Stellar Earnings Per Share Growth
By David Saito-Chung
Some people see the market as a den of speculation. But those who seek the best stocks don't need to gamble.
Consider the greatest winners over the past four decades. IBD found that these companies typically share a record of outstanding profit growth before their shares rocketed ahead in price. In other words, past financial performance greatly affects future stock price performance.
These firms also share other key traits, including leadership in a high-growth industry, top sales growth and margins, and support from institutional investors such as mutual funds. Investors who focus on these fast-growing companies increase their chances of success.
To measure growth, analysts calculate the percentage change in a company's earnings per share in the latest quarter with that of the same quarter a year earlier. This is a fairer way to compare growth than, say, looking at numbers in the current quarter vs. the previous quarter.
Consider retailers, whose business is highly seasonal. They tend to see earnings in the quarter ending in January surge from the previous period as holiday sales fatten their bottom lines. To analyze profit growth quarter-to-quarter would give a misleading, boom-and-bust picture.
Investing pros prefer earnings-per-share figures to net income. A firm that keeps issuing lots of shares to expand its business may see flatter earnings-per-share growth. Every additional share issued dilutes the ownership of existing stockholders. Be wary of companies whose financial reports focus only on sales and net income. They may have trouble sustaining growth on a per-share basis.
Among the stocks from 1953 to 1993 that at least doubled in price, IBD found that three of every four firms on average posted 70% earnings-per-share growth in the most recent quarter before their stocks took off in price. A company that earned $1 a share a year ago would have earned $1.70 in the most recent quarter.
The fourth firm had smaller numbers but then grew earnings by an even higher rate - 90% - the next quarter. In contrast, S&P 500 companies raised profit by an average 22.7% in the third quarter of 1999, their best growth since 1995.
Those companies that can sustain such high growth rates over time often see the biggest increases in stock prices. From 1986 to 1990, Microsoft grew its year-over-year earnings an average 61% as its operating system software became the industry standard for desktop PCs. Its stock climbed 1,030% over that period.
Keep a close eye on companies with growth in the most recent quarter that rises at a faster rate than the previous quarter. If this acceleration continues over several quarters, it may indicate the company is leading the charge in a hot industry.
On Oct. 14, PMC-Sierra said its third-quarter profit rose 92% from year-ago levels to 25 cents a share. That marked the third straight quarter of accelerating growth, as profit rose 13%, 20% and 57% in the previous three periods. A month later, the broadband chipmaker's stock broke out of an eight-week consolidation on heavy volume. The stock has since risen 265%.
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