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Time to Consider Growth Stocks

With the economy no longer looking like it’s falling off a cliff, and the stock market showing signs of life, this may be a good time to consider edging back into the market.

If you agree, here’s a search you can run on Morningstar’s user-friendly stock screener to find interesting growth stock candidates.

If you’re not familiar with the terms, screeners are programs available on some financial sites that enable you to search the entire market for stocks meeting your particular selection criteria. Growth stocks are those expected to increase earnings at least 15% annually.

I used Morningstar because it’s free and using it is a snap. Find it from Morningstar’s home page (www.morningstar.com) by selecting stocks and then Stock Screener in the Tools section. I’ll give you the details as I describe my growth stock screen.

Get Aggressive
Start by selecting “Aggressive Growth” from the Stock Type dropdown menu. Morningstar classifies stocks into one of eight categories, such as high-yield or classic growth depending on its assessment of each stock’s fundamentals. Aggressive growth stocks, consistently profitable and rapid growers, usually make the best growth candidates.

Strong Financials
You can select stocks based on Morningstar’s grades in three categories: growth, profitability, and financial health. The grades range from A to F, where A is best. Morningstar bases the grades on how each stock compares to other stocks in its business sector.

Since, in these times, financial strength is priority number one, I required A or B grades in that category.

Real Growth
By definition, a company can’t grow without growing sales. I confined my list to stocks with a solid track record in that department by requiring at least 20 percent three-year average annual revenue (sales) growth. Out of 5,000 or so U.S. stocks, only 156 met the three requirements that I’ve applied so far.

Most Profitable
The more profitable the company, the better your results. Return on equity, which compares net income to shareholders equity (book value) is a widely used profitability measure. For ROE, higher is better, and most companies fall into the 10 to 20 percent ROE range. Specify at least 20 percent ROE, limiting the field to the most profitable firms. Adding that requirement cut the list of eligible candidates down to only 57 stocks.

Got Growth?
Stock analysts forecast the next five year’s average annual earnings growth for stocks that they cover. Yes, I know that analysts get it wrong a lot. Still, forecasting earnings growth is their day job, and they do the best they can in that department. Require a minimum 20 percent expected five-year average annual earnings growth. Try increasing your minimum to 30 percent if you only want to see the hottest stocks. As it was, my 20 percent growth requirement cut the list of passing candidates down to 18 stocks.

Go With Winners
Contrary to the buy low, sell high mantra, stocks that have already outperformed the market are your best prospects. Underperforming stocks will probably continue to disappoint shareholders. Pinpoint outperforming stocks by requiring returns equal or greater than the S&P 500 Index for the year-to-date, one-month, and three-month timeframes.

Adding those performance requirements cut my list to only six finalists: China Fire & Security (CFSG), Green Mountain Coffee (GMCR), Health Grades (HGRD), Starent Networks (STAR), True Religion Apparel (TRLG), and VistaPrint (VPRT).

As is the case for any stock screen, consider the results to be candidates worthy of further research, not a buy list. The more you know about your stocks, the better your results.

published 6/7/09

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