Growth stock investors buy stocks they think will
grow sales and earnings faster than inflation. Here’s a scorecard
for comparing growth stock candidates.
I’ll demonstrate the process using MarketWatch (marketwatch.com)
and Zacks (zacks.com) to research two candidates: Monolithic Power
Systems (MPWR), and Lumentum Holdings (LITE). Both are tech stocks.
Monolithic makes power supplies for electronic devices and Lumentum
makes lasers, including those used in fast growing 3D sensing
1) How Much Growth?
All else equal (of course it never is), over time, share prices more
or less track per share earnings, and to a lesser extent, per share
revenues (sales). Thus, your best stocks will often be those
generating the fastest earnings and sales growth while you hold
How do you determine which stock’s have the best growth prospects?
Although far from perfect, unless you have better information, stock
analyst’s sales and earnings forecasts are a good place to start.
Zacks is a good resource for that information. It lists both EPS and
revenue forecasts for the current and next quarters and fiscal
years. Find that information by getting a price quote and then
selecting “Detailed Estimates.” Scroll down to the Sales Estimates
and Earnings Estimates sections and pay most attention to the
Current Year growth forecasts.
Score one point each for This Year’s EPS and This Year’s Sales
growth forecasts above 10%, and subtract point each for growth
values below 5%.
When I checked; for Monolithic, Zacks was forecasting 24%t sales
growth and 27% earnings growth for 2018. For Lumentum, analysts were
forecasting 29% sales growth and 16% higher EPS for its June 2019
Both stocks scored two points each for the Growth category.
2) Too Much Debt?
You’ll always do better by sticking with low-debt stocks. The
debt/equity (D/E) ratio, which compares a firm’s total debt to
shareholders equity (book value), is a widely used valuation gauge.
Values below 1.0 signal low-debt firms and lower is better.
Zacks lists D/E ratios in the Fundamental Ratios section of its Full
Company Report page. Score one point for D/E ratios below 1.0 and
subtract one point for values above 2.0.When I checked, Zacks showed
D/E’s of 0.0 (no debt) for Monolithic and 0.4 (very low debt) for
Score one point each for both Monolithic and Lumentum.
3) How Profitable?
For stocks, profitability means more than not losing money. Here’s
Consider two hypothetical companies, Company A and Company B. Both
earned $10 million last year. However Company A’s shareholders only
had to invest $30 million to turn that profit compared to $60
million for Company B. Thus, Company A’s investors realized twice
the return of Company B for each invested dollar.
Return on assets (ROA), the ratio of a company's month net income to
its total assets, is a popular profitability gauge. For best
results, require ROAs above 5%, and higher is better.
Use MarketWatch to check ROA. Start by entering your stock’s ticker
symbol into the search box at the top of MarketWatch’s home page.
MarketWatch lists ROA in the Profitability section below the Company
Description. Subtract one point for ROAs below 5.0% and add one
point for ROAs above 10.0%.
MarketWatch listed Monolithic’s ROA at 11.2%, and Lumentum at 17.6%,
so each earned one point for Profitability.
4. Too Late to the Party?
It’s easy to get carried away and overpay for a hot growth stock.
The price/earnings ratio (P/E), which is the recent share price
divided by the last 12-month’s EPS, is the most popular valuation
gauge. However, EPS often varies widely from quarter to quarter,
making P/E an unsteady measure. By contrast, the price/sales ratio,
which is the share price divided by 12-month’s per share revenues,
provides more consistent numbers. For growth stocks, P/S ratios
mostly range between 5 and 10, but sometimes much higher.
MarketWatch lists P/S ratios under Valuations, next to the
Profitability section. Add one point for P/S ratios below 5.0, and
subtract one point for P/S ratios above 10. MarketWatch listed
Monolithic’s P/S at 10.4, and Lumentum at 2.9.
Subtract one point for Monolithic and add one point for Lumentum.
5) Follow the Cash
Reported earnings are subject to a variety of arbitrary accounting
decisions and can be misleading. By contrast, operating cash flow,
which measures the cash that moved into, or out of, a firm's bank
accounts attributable to its business operations, is a more reliable
On MarketWatch, Select Financials from the main menu, and then
select Cash Flow Statement. Scroll down to the Net Operating Cash
Flow (OCF) line and check the most recent year’s cash flow number.
At a minimum, operating cash flow should be positive, but it’s best
to stick with stocks whose operating cash flow exceeds the net
income (top line of cash flow report) for the same period. Add one
point when OCF is positive and exceeds net income. Subtract one
point when OCF is negative. Score zero points when OCF is positive,
but is less than net income.
Monolithic’s operating cash flow totaled $134 million vs. $65 2
million net income for 2017. Lumentum recorded a -$103 million net
income loss in fiscal 2017, but it earned a hefty $85 million when
you counted the cash. So, both stocks scored one point in this
For the five checks, Lumentum scored six
points vs. four points for Monolithic, the difference being
Checking these five items will help you make better investing
decisions, but they are just a start. Do your due diligence. The
more you know about your stocks, the better your results.