Seek Companies With Quarterly Profit Growth Of 25% Or Better Juan Carlos Arancibia Fri Jan 13, 7:00 PM ET
Earnings growth is the primary force that drives stock prices. So how much growth is good growth?
The answer: at least 25% quarterly earnings gains, measured on a year-over-year basis.
That's not an arbitrary figure. Studies of the most successful stocks of the past half-century show most had at least a 25% EPS increase in the most recent quarter before they broke out to a big price advance.
In fact, 25% should be considered a floor. For a lot of winning stocks, their pre-breakout quarterly EPS was 50% or higher, with some boasting triple-digit gains.
Three out of four of the best-performing stocks in IBD's market research showed EPS jumps of 70% or more in the quarter before they started their big price advances.
True, earnings expectations are largely "priced into" stocks. But the research's findings show that prior quarters' results have a much larger bearing on a stock's performance.
A company's earnings history is a factual, accountant-certified record of performance, while expectations are, well, expectations.
Why couldn't 10% or 15% growth be acceptable?
According to Zacks Equity Research, total earnings for the S&P 500 should end up about 10.6% higher for 2005 and 13.4% in 2006.
If you want an outstanding growth stock, you need a company that can outperform the general market.
The table above shows stocks that have achieved 25% or greater gains in each of the past five quarters. That should give you a good snapshot of the market's earnings leaders. It also shows there's no shortage of companies producing solid profits.
Bear in mind that outstanding earnings growth is not the only factor that makes a winning stock.
Sales growth, return on equity and profit margins also are important.
And don't forget that some hugely profitable stocks have already extended themselves past proper buy points, or may be lacking in terms of their price and volume action.
In the Jan. 3 issue of IBD, we listed the best stocks of 2005. Many of those had outstanding profit growth. Energy drink maker Hansen Natural (NasdaqSC:HANS - News), for example, soared more than fivefold in 2005.
After a strong first half of the year, a July-to-October base set the stock up for another big advance in the fall. While it formed its base, Hansen's EPS the prior four quarters ranged from 140% to 417%.
Earnings figures aren't difficult to find. Many financial Web sites provide them for publicly traded companies. The SEC's site (sec.gov/edgar.shtml) also has them.
IBD's Company Earnings Reports section publishes each day's profit announcements. Daily Graphs and Daily Graphs Online, sister products of IBD, include EPS numbers for recent quarters.
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