Harry Domash's Winning Investing


 New Growth Stock Finder

Although everything still looks in disarray, within a few weeks, the government will probably have succeeded in getting the credit markets functioning again. If that happens, the stock market will begin looking beyond current conditions to the eventual recovery.

With that in mind, I’m going to describe a new tool that you can use to find promising growth stock candidates. By “growth stocks,’ I mean stocks that are expected to grow sales and earnings at least 15 percent annually, Since, long-term, share prices usually track earnings, these are usually the best stock price appreciation prospects.

I’ll use Zacks Investment Research’s Custom Stock Screener to find the growth candidates. Stock screeners are web-based tools that allow you to search the entire market for stocks meeting your particular selection requirements. Zacks’ Custom Stock Screener, which is one of the most powerful free screeners around, is not new. But until recently, the screener was so difficult to use that I never mentioned it.

Now, Zacks has redesigned its screener to make it user-friendly, and they’ve mostly succeeded. Zack’s screener is, say, 10 percent more difficult to use than Google’s extremely simple Stock Screener (www.google.com/finance), but offers more, and even better, more powerful selection choices.

Select “Screening” from Zacks homepage (www.zacks.com) and then Custom Stock Screener (Screening Tools) to get to the screener. Once there, click on a Category to see the search parameter choices available for that group.

Smaller Is Better
We’ll start with Market-Cap, which is listed in the Company Descriptors category. Market capitalization, which is how much you’d have to shell out to buy all of a company’s shares, is the way most analysts measure company size. Stocks with market-caps below $2 billion are small-caps, those with market-caps above $10 billion are large-caps, and those in-between are mid-caps.

Usually, larger companies are safer investments than smaller firms. But, considering what’s happened to the likes of Bank of America and General Electric, that hasn’t been the case in this market. Thus, there’s no point to confining our selections to larger companies. That said, the very smallest firms are less able to withstand this economy’s ups and downs, and thus, are risky bets.

Specify a  $250 million market-cap (>= 250). Click “Add “ to add that selection to your screen (parameters without an ‘Add” button are not available on the free screener). Zacks displays your selected search criteria near the top and indicates how many stocks meet your screen’s requirements.

Follow the Money
Institutions are mutual funds, pension plans, and other big investors. By virtue of the huge trading commissions that they generate, institutional investors have access to inside information that we’ll ever see. Thus, if they don’t own a stock, you shouldn’t either. Institutional ownership is the percentage of a firm’s stock held by those big players. It runs from 40 percent to 95 percent for in-favor growth stocks. Specify 40 percent minimum (>=) institutional ownership (Ownership category).

Analyze the Analysts
Stock analysts publish buy/sell recommendations on the stocks that they follow. Zacks compiles the analysts’ advice into strong buy (1), buy (2), hold (3), sell (4), and strong sell (5) categories. It assigns the value shown in parenthesis to each category. For instance, if all analysts were at strong sell, the consensus rating would be 5. Since, if anything, analysts tend to be overoptimistic, it pays to avoid stocks that they are advising selling. Specify 3 (hold) for the maximum (<=) Current Average Broker Recommendation (Broker Rating category).

Analysts also publish estimates for long-term (three to five years) average annual earnings growth. Since we’re looking for growth stocks, specify 15 for minimum (>=) Long-Term Growth Consensus Estimate (EPS Growth).

Profitable, But No Debt
In any market, you’ll always do best by sticking with profitable companies. Return on equity (income vs. book value) is the most widely used profitability measure. For profitable companies, values typically range from five percent to 25 percent, where higher is better. Most money managers that I know require at least 15 percent ROE, so specify a minimum (>=) 15 Current ROE (Return on Investment).

Considering current conditions, the last thing we need is a high-debt stock. The debt/equity ratio, which compares long-term debt to book value, is a good debt measure. A zero D/E signals no debt, and the higher the ratio the higher the debt. Specify a maximum (<=) 0.1 Debt/Equity Ratio (Liquidity & Coverage).

Magic Sauce
Research done by Zacks and many others has found that changes in analyst earnings estimates move share prices. Stocks tend to move up after estimates increase, and vice versa. Further, once earnings estimates have moved, they tend to move further in the same direction. Thus, stocks with recent positive earnings estimate changes have better price appreciation potential than those that don’t. Zacks’ “% Change F1 Estimate (4 weeks)” parameter tracks the last four-weeks percentage change in current year consensus earnings forecasts. Specify a minimum (>=) 5 percent change (EPS Estimate Revisions).

Five Stocks Found
My screen turned up five stocks: restaurant operator Buffalo Wild Wings (ticker BWLD), online post-secondary educator Capella Education (CPLA), gold miner Randgold Resources (GOLD), wireless technology developer InterDigital (IDCC), and online trading transaction provider Mercadolibre (MELI).

Caution: growth stock candidates perform best in an uptrending market. So, don’t buy them if the market is heading down. Further, consider stocks turned up by any screen to be research candidates, not a buy list. The more you know about your stocks, the better your results.

published 3/15/09


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