Firms With High Sustainable Growth
by John Bajkowski
Apple’s decision to initiate a dividend highlights the trade-off between distributing profits to shareholders and preserving excess cash to fund future growth. Dividends are normally paid by more mature companies that are generating free cash flow and no longer need as much money to fund expansion and growth. The sustainable growth rate is a common calculation that examines the profitability of a firm and how the dividend payment may impact its growth potential. If a firm does not make significant changes to its assets or financial structure, the sustainable growth can be calculated by multiplying the return on equity by the percentage of earnings retained by the firm.
The return on equity (ROE) is equal to earnings divided by shareholder equity (book value) of the firm. The higher the ROE, the more successful the firm has been in acquiring and managing assets that generate income and in financing assets through debt, common stock and retained earnings. ROE can be increased with higher profit margins, more efficient use of assets, or higher levels of debt relative to equity.
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The percentage of earnings a firm retains, while generating the same ROE, determines the future earnings growth and provides an indication of its sustainable growth rate. Called the retention ratio, it is equal to one minus the ratio of dividends to earnings per share (the payout ratio). When all earnings are retained, the ratio is 1.0, or 100%. If a quarter of the earnings are paid out, the retention ratio is 0.75, or 75%. The higher the ROE and the greater the retention ratio, the higher the sustainable growth rate.
Stocks that made this issue’s First Cut are domestic, exchange-listed stocks, with positive earnings, debt levels below the norm for their industry, positive projected earnings growth rates, and a current return on earnings above their five-year average. The 30 stocks with the highest sustainable growth rates are presented in the table. About one-third of the First Cut stocks pay a dividend, but the retention ratios tend to be high.
—John Bajkowski, President of AAII
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Discussion
Clicking on the table title will open it in Excel.
--Jean from AAII
posted 11 months ago by Jean from Illinois
Is it possible to also accompany a back test result (or historical performance) of the stock screen ?
posted 11 months ago by Vincent from California
I'm not meaning to embarrass anybody by what I am about to say, but merely mean to add value, if I can, to the discussion.
It is a policy of mine NEVER to buy ANY stock that has under-performd NASDAQ consistently over the trailing two years.
I put these 30-or-so stocks on a watch list and then, as I routinely do, i looked at a snapshot graph (in my Fidelity.com account) comparing each of the others to .ixic (the graph of NASDAQ's performance and, also, to DLTR AND TO AAPL. At least three of them may have "grown" their net worth, but their price has underperformed the NASDAQ over the trailing two years.
I found it, therefore, ironic that the next article below this onw speaks to the very point I wish to make.
When I screen stocks, I look at fundamentals and ALSO at the price graphs and I look with little more than idle curiosity at technical analysis. Maybe that helps day traders, but I'm not a day trader. The three friends I know who WERE day traders, lost their shirts in recent years.
Anyhow, let me encourage any investor who looks at the list of stocks of companies with strong evidence of sustainable growth to study them also in relation to how they would have done in your portfolio despite their historical growth over the past two years.
I like stocks that can stand up to scrutiny in respect to multiple parameters.
Oh, let me say, however, that I often will buy in my personal portfolio a stock or two of a company I've been studying that has not yet "broken out" into the black, but has something going -- such as a fantastic patent, or insider activity that suggests that a break out for that company is on the brink of occurring. (Over the years I've gotten some bad results from such choices and some good ones, and the good ones were so good that -- on average -- those kinds of bets have paid off well.
But the main thing I want to say is, "History is not the best indicator of future performance; BUT it's not a counter-indicator, either. Taken in perspective, along with other parameters, it is an indicator I never buy a stock without st least examining and weighing along with other parameters.
posted 11 months ago by Gil from Louisiana
For whatever it is worth, my practice is to always carefully review M*'s stock analysis, *rating and risk rating. I also look at M&A facts and fair value calculations, debt/equity ratios, and free cashflow. I absolutely do not attempt to time the market, not a day trader, always buy and hold until a price target is achieved. M* has proved highly informative. I look at technical analysis as "false science" in relation to investing, the same way some people look at chiropractic in relation to staying healthy. In either case, it may or may not work but it is best not to rely on it. IMHO.
posted 11 months ago by Steve from Georgia
