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Screening for Stocks With Strong Secular Growth

by John Bajkowski

Screening For Stocks With Strong Secular Growth Splash image

Many growth stocks have performed strongly during the recent uncertain economic times. Investors have been attracted to companies that have been able to improve net income while other firms struggle.

However, the allure of buying into a stock with the potential for a tenfold increase in price must be balanced with the potential for substantial price declines if the company fails to meet the market’s growth expectations. As long as a firm maintains its earnings per share momentum and exceeds the market’s growth expectations, its stock price can be expected to outpace the market. When expectations are high, a small deviation from market expectations in a quarterly earnings announcement can send the price flying in either direction. Over the long run, stock prices are driven by proven company earnings and cash flow, while in the short term, changes in expectation can move stock prices sharply. If you seek out high return potential, then you must be willing to take on additional risk.

Two Types of Growth

Investors seeking out growth stocks like to separate secular growth from cyclical growth. Companies expanding on a secular basis are growing without regard to the overall business economic cycle. In contrast, the fortunes of a cyclical company depend upon the business cycle. Positive cyclical growth occurs as the economy moves from a recession to expansion. Cyclical auto manufacturers such as Ford Motor Co. (F) have shown strong growth in earnings over the last three years as the economy has come out of its deep recession. True growth companies expand throughout the economic cycle.

Growth companies expand at a rate above that of the overall economy. Practically speaking, however, the minimum benchmark for being classified as a growth stock is at least a 10% annual growth rate in earnings per share, with many investors requiring a 20% annual growth rate. To maintain growth rates this high over any extended period, capital spending is required; for this reason, growth stocks tend to retain most of their earnings, paying little or no cash dividends.

Screening for Growth

Screening can be used as the first step in indentifying growth stock prospects. Screening is the process of applying a set of criteria to a universe of stocks to filter out those securities that merit a closer look. AAII’s Stock Investor Pro fundamental stock screening and research database program was used to perform the screening for this article.

While there are many ways to measure company growth, most investors focus on earnings growth, with an emphasis on a high and expanding growth rate. A common first screen is to specify a high absolute minimum growth rate. Unfortunately, most studies indicate that portfolios constructed using just high levels of historical or expected earnings growth tend to underperform the market. An analysis of the successful stock strategies tracked on AAII.com shows greater success with growth strategies that seek out consistent year-after-year growth. Requiring consistently rising earnings each year can help identify more stable growth companies.

Increasing Earnings

The primary growth filter constructed for this article focuses on year-to-year changes in earnings per share from continuing operations, looking for steady and increasing earnings annually. A screen requiring increased earnings for each of the last five fiscal years was specified. Only 207 stocks out of a universe of over 10,015 companies passed this filter. If you want to be more stringent in your screening, you might require an increase in the year-to-year growth rate for the past few years. The acceleration of the growth rate is referred to as momentum. In our case, simply looking for companies that were able to keep increasing earnings while the world went through a severe recession seemed stringent enough.

In selecting a time period for historical analysis, the economic environment should be kept in mind. Earnings growth should be examined over longer time periods that cover at least one economic cycle to make sure you are focusing on true secular growth companies, not cyclical firms during an economic upswing.

We also established a filter that required that the trailing 12-month earnings be equal to or greater than earnings for the last fiscal year. Note that for one quarter of the year these two figures will be the same. As a firm starts to report quarterly results during the course of the year, the trailing 12-month earnings number will encompass a time frame different from the prior year’s annual figure.

Trend in Earnings Growth

Investors examining growth stocks look toward any signs that a trend in growth may be broken. Quarterly earnings are closely examined and deviations from expected results are quickly rewarded or severely punished. The seasonality of sales and earnings for most firms, however, does not allow investors to compare one quarter to the preceding quarter in a meaningful way. To deal with seasonality, it is best to compare one quarterly figure to the figure for the same quarter one year prior. A decrease from the same quarter one year ago is a warning flag that merits investigation. In our screening process, higher quarterly earnings than that for the same quarter one year ago (quarter over quarter) was required for each of the last four quarters.

Industry Comparison

Beyond examining overall growth, or momentum, many investors examine how a company compares to its industry peers.
The ability to grow faster than the industry group may point to a firm that has a competitive edge. Even a firm in a cyclical industry may have a period of secular growth as it expands its market share.
Therefore, we established a filter that required the five-year annual growth in earnings for the company to be above that of its industry median (midpoint).

In-Depth Analysis of Earnings

Screening based upon earnings requires careful analysis of a firm’s reports, which can highlight how the growth was achieved.
Was the growth due to acquisition or internal expansion? Most growth companies report on their “organic” growth rates during quarterly earnings reviews. Did currency translation impact earnings? How are same-store sales for retail stocks?

Growth in Sales

Looking at sales growth will also provide a confirmation of how earnings were achieved. Growing sales create growing earnings as long as profit margins are not severely sacrificed. A truly attractive growth stock must be able to demonstrate top-line sales growth. A screen requiring increased sales for each of the last five fiscal years was specified. We also established a filter that requires trailing 12-month sales to be equal to or greater than sales for the last fiscal year. And as with earnings, higher quarterly sales than that of the same quarter one year ago (quarter over quarter) was required for each of the last four quarters.

Passing Companies

The final screen we applied simply required that stocks be listed on an exchange. Around 50 stocks passed all of these criteria. To highlight a cross-section of companies, the firms passing the screen were divided up into groups based upon size as measured by market capitalization. The largest number of passing stocks fell into the large-cap range, so the 20 large-cap stocks with the highest five-year annual historical growth rate are presented in Table 1 along the 10 fastest-growing mid-cap stocks and the 10 fastest-growing small-cap stocks. Medians for the companies in the S&P 500 index, MidCap 400 index, and SmallCap 600 index are provided for comparison.

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Table 1. Companies Passing the Consistent and High Earnings Growth Screen

  Annual EPS
Growth Rate
Ann’l
Sales
Grth
Rate
5 Yr
(%)
Qtr-Over-Qtr
EPS Grth
P/E
Ratio
Share
Price
(4/13)
($)
Market
Cap
($ Mil)
 
 
 
Hist
5 Yr
(%)
I/B/E/S
Est
(%)
Q1 vs
Q5
(%)
Q2 vs
Q6
(%)
 
TTM
(X)
Est
(X)
 
Industry
Large Cap (above $4.5 billion)
Digital Realty Trust (DLR) 103.6 17.9 31.3 25.9 190.9 55.1 45.3 72.79 7,809 Real Estate Opers
Baidu.com, Inc. ADR (BIDU) 84.7 44.8 76.9 75.5 77.1 50.3 32.7 151.38 52,853 Computer Services
Green Mountain Coffee (GMCR) 74.9 32.9 63.7 3250.0 145.0 22.5 16.3 43.59 6,750 Food Processing
Priceline.com Inc (PCLN) 65.1 22.6 31.1 64.1 105.4 35.6 23.6 735.18 36,611 Business Services
Apple Inc. (AAPL) 64.9 20.1 41.2 114.9 51.4 17.2 13.7 605.23 564,298 Computer Hardware
Chipotle Mexican Grill (CMG) 39.5 21.7 22.5 22.7 24.5 65.1 50.3 440.40 13,953 Restaurants
Cognizant Technology (CTSH) 29.9 18.9 33.9 16.2 10.3 25.9 21.4 73.80 22,389 Software & Prog
Ross Stores, Inc. (ROST) 27.5 13.3 9.1 22.9 23.1 20.7 17.6 59.06 13,380 Retail (Apparel)
Dollar Tree, Inc. (DLTR) 26.8 17.9 10.8 23.8 19.2 23.7 19.5 96.02 11,105 Retail (Dept & Disc)
Google Inc (GOOG) 24.5 17.7 29.0 58.9 4.9 18.9 14.7 624.60 203,080 Computer Services
Novo Nordisk ADR (NVO) 24.5 16.0 11.4 22.3 20.2 27.6 23.7 145.73 68,480 Biotech & Drugs
IntercontinentalExchange (ICE) 23.5 13.9 33.4 29.6 38.2 19.3 16.7 133.05 9,678 Investment Services
NetEase.com Inc ADR (NTES) 23.2 16.3 27.5 25.3 40.8 14.5 12.7 56.98 7,462 Casinos & Gaming
Tractor Supply Company (TSCO) 21.2 17.1 12.3 43.5 46.3 32.6 27.9 98.38 7,066 Retail (Home Improve)
Oracle Corporation (ORCL) 21.1 11.8 19.9 19.0 16.2 15.0 11.8 28.50 141,791 Software & Prog
AutoZone, Inc. (AZO) 21.0 15.6 6.3 24.6 24.4 17.9 16.4 380.97 14,847 Retail (Spec Non-Appar)
Red Hat, Inc. (RHT) 20.9 19.2 23.1 11.8 42.9 80.3 50.7 60.20 11,601 Software & Prog
Family Dollar Stores (FDO) 19.9 14.7 6.0 17.2 17.2 18.9 17.6 64.26 7,502 Retail (Spec Non-Appar)
AmerisourceBergen (ABC) 19.3 13.1 5.7 8.6 7.8 14.5 13.3 37.53 9,677 Biotech & Drugs
Check Point Software (CHKP) 16.8 11.1 16.7 18.2 18.2 24.6 19.7 62.48 12,895 Software & Prog
S&P 500 Stocks 7.4 11.1 5.7 7.1 10.9 17.1 14.2 12,104 (Range: 1,360–564,298)
 
Mid Cap ($1.6 billion to $4.5 billion)
Mercadolibre Inc (MELI) 180.6 28.5 41.8 36.1 39.5 55.5 42.6 96.60 4,264 Computer Services
Genpact Limited (G) 49.2 15.5 21.2 33.3 22.2 19.4 17.0 15.92 3,541 Business Services
Credit Acceptance Corp. (CACC) 33.5 na 19.1 11.6 28.0 12.9 11.4 92.01 2,343 Consumer Fin’l Servs
ITC Holdings Corp. (ITC) 29.2 17.5 27.6 13.7 13.2 23.0 18.8 75.99 3,903 Electric Utilities
LKQ Corporation (LKQX) 28.8 20.4 32.9 31.0 36.0 21.1 16.6 29.97 4,416 Auto & Truck Parts
Buckle, Inc., The (BKE) 20.9 11.5 14.9 12.3 9.3 13.9 13.0 44.43 2,129 Retail (Apparel)
Quality Systems, Inc. (QSII) 19.8 20.5 24.3 20.0 52.2 29.9 28.2 40.00 2,359 Software & Prog
FactSet Research Sys. (FDS) 17.1 12.9 13.4 6.1 12.2 26.1 24.0 98.78 4,437 Computer Services
Jack Henry & Assoc. (JKHY) 10.4 10.5 13.4 7.1 13.5 19.8 18.8 32.94 2,858 Computer Networks
Aqua America Inc (WTR) 8.2 7.5 5.9 19.0 12.9 20.5 19.9 21.52 2,992 Water Utilities
S&P MidCap 400 Stocks 4.7 12.0 6.4 9.6 9.1 18.3 15.2 2,668 (Range: 523–11,511)
 
Small Cap (below $1.6 billion)
Teavana Holdings, Inc. (TEA) 68.3 31.7 37.8 37.5 100.0 41.7 32.1 19.20 734 Retail (Grocery)
American Public Educat’n (APEI) 62.0 20.8 45.5 37.7 103.3 16.5 15.6 36.75 657 Schools
Echo Global Logistics (ECHO) 57.1 31.6 78.6 33.3 25.0 29.9 22.3 16.17 361 Trucking
Vitamin Shoppe, Inc. (VSI) 51.0 21.1 12.0 52.4 57.7 28.9 23.6 43.92 1,293 Retail (Grocery)
rue21, inc. (RUE) 33.9 18.4 27.5 17.8 24.1 18.8 16.4 29.21 715 Retail (Apparel)
EZCORP Inc (EZPW) 28.6 15.0 22.4 41.8 28.6 11.6 10.1 30.74 1,549 Consumer Fin’l Servs
Buffalo Wild Wings (BWLD) 24.3 20.3 23.0 32.1 29.8 31.4 26.1 85.62 1,575 Restaurants
World Acceptance Corp. (WRLD) 22.8 na 15.1 15.7 20.9 9.5 9.0 59.01 877 Consumer Fin’l Servs
MWI Veterinary Supply (MWIV) 22.2 16.2 20.9 20.7 12.7 24.2 21.8 86.62 1,102 Med Equip & Supplies
U.S. Physical Therapy (USPH) 20.1 18.3 11.9 94.4 3.0 12.9 15.0 22.72 267 Health Care Facilities
S&P SmallCap 600 Stocks 3.5 12.8 5.9 7.5 6.6 19.0 16.2 738 (Range: 27–3,146)
 

Definitions of Terms

Annual EPS Growth Rate—Hist 5 Yr (%): Annual growth in earnings per share from continuing operations over the last five fiscal years. A measure of how successful the company has been in generating and expanding its bottom line, net profit.

Annual EPS Growth Rate—I/B/E/S Est (%): The consensus annual estimate of earnings per share growth over the next three to five years that is forecasted by analysts polled by I/B/E/S. An indication of the market’s growth expectation for a company.

Ann’l Sales Growth Rate 5 Yr (%): Annual growth in sales (revenue) over the last five fiscal years. Used to provide a confirmation of the quality of the historical earnings per share growth rate.

Qtr-Over-Qtr EPS Growth (%): The change in earnings per share for the a quarter relative to the same quarter a year ago, expressed as a percentage. Helps to provide an indication of the recent trend in earnings per share growth and signals if growth is accelerating.

P/E Ratio—TTM: Share price divided by the most recent 12 months’ earnings per share from continuing operations. A measure of the market’s expectations regarding the company’s earning prospects and risk. Firms with very high price-earnings ratios are being valued by the market on basis of high growth potential.

P/E Ratio—Est: Share price divided by the average earnings per share from continuing operations expected by analysts for the current fiscal year. A measure of the market’s expectations regarding the company’s earning prospects and risk. Firms with very high forward price-earnings ratios are being valued by the market on basis of high growth potential.

Market Cap ($ Mil): Current share price multiplied by the number of shares outstanding, expressed in millions of dollars. A measure of company size.

Industry: Primary industry as classified by Thomson Reuters.

Our screen focuses on historical performance, but growth stock investors also focus on expected performance. Looking at market consensus forecast figures helps to provide an indication of the expectations built into the valuation. It is the company’s ability to meet and, more importantly, exceed these expectations that leads to strong returns. Digital Realty Trust (DLR), the firm with the highest historical earnings growth among large-cap stocks, is a real estate investment trust (REIT) that specializes in leasing data centers. The growth in computer server farms and cloud computing has helped earnings expand more than 100% annually over the last five years. This type of growth is not sustainable. Looking forward, the average long-term growth estimate is 17.9%, but the range of estimates varies from a low of 5.0% to high of 45.6%.


The price-earnings ratios for the passing stocks tended to be above the market average, as would be expected for companies with above-average prospects. To better judge price-earnings ratios, many analysts look at price compared to forecasted earnings. While this helps to lower the price-earnings ratio for these growth stocks, many of these firms still have very high forward price-earnings ratios. Promising growth stocks attract a great deal of attention, and therefore prices tend to be bid up with high anticipation. It is not uncommon to see highly touted growth stocks with price-earnings ratios two to four times that of the market.

What It Takes: High and Consistent Growth Screen Criteria

  • Listed on the New York, NASDAQ, or American stock exchange
  • The compounded, annualized growth rate in earnings per share from continuing operations over the last five years is greater than or equal to the median for the industry in which a firm competes
  • Earnings per share from continuing operations for the last trailing 12 months (last four fiscal quarters) is greater than or equal to earnings per share from continuing operations for the last reported fiscal year (Y1)
  • Earnings per share from continuing operations must have increased over each of the last five fiscal years
  • Positive growth in quarterly earnings per share from continuing operations for the latest fiscal quarter (Q1) over the same quarter one year prior (Q5)
  • Positive growth in quarterly earnings per share from continuing operations for the prior fiscal quarter (Q2) over the same quarter one year prior (Q6)
  • Positive growth in quarterly earnings per share from continuing operations two quarters ago (Q3) over the same quarter one year prior (Q7)
  • Positive growth in quarterly earnings per share from continuing operations three quarters ago (Q4) over the same quarter one year prior (Q8)
  • Sales for last trailing 12 months (last four fiscal quarters) is greater than or equal to sales for the last reported fiscal year (Y1)
  • Sales must have increased over each of the last five fiscal years
  • Positive growth in quarterly sales for the latest fiscal quarter (Q1) over the same quarter one year prior (Q5)
  • Positive growth in quarterly sales for the prior fiscal quarter (Q2) over the same quarter one year prior (Q6)
  • Positive growth in quarterly sales two quarters ago (Q3) over the same quarter one year prior (Q7)
  • Positive growth in quarterly sales three quarters ago (Q4) over the same quarter one year prior (Q8)
  Field: Operator: Factor: Compare to:
  Exchange Not Equal   Over the counter
And EPS-Diluted Continuing 12m >=   EPS-Diluted Continuing Y1
And EPS-Diluted Continuing Y1 >   EPS-Diluted Continuing Y2
And EPS-Diluted Continuing Y2 >   EPS-Diluted Continuing Y3
And EPS-Diluted Continuing Y3 >   EPS-Diluted Continuing Y4
And EPS-Diluted Continuing Y4 >   EPS-Diluted Continuing Y5
And EPS-Diluted Continuing Y5 >   EPS-Diluted Continuing Y6
And EPS-Diluted Continuing Q1 >   EPS-Continuing Q5
And EPS-Diluted Continuing Q2 >   EPS-Continuing Q6
And EPS-Diluted Continuing Q3 >   EPS-Continuing Q7
And EPS-Diluted Continuing Q4 >   EPS-Continuing Q8
And EPS Dil Cont-Growth 5yr >   Industry EPS Dil Cont-Growth 5yr
And Sales 12m >=   Sales Y1
And Sales Y1 >   Sales Y2
And Sales Y2 >   Sales Y3
And Sales Y3 >   Sales Y4
And Sales Y4 >   Sales Y5
And Sales Y5 >   Sales Y6
And Sales Q1 >   Sales Q5
And Sales Q2 >   Sales Q6
And Sales Q3 >   Sales Q7
And Sales Q4 >   Sales Q8

Conclusion

Investing in growth stocks can be an extremely rewarding experience. Success, however, requires careful analysis and constant monitoring of the portfolio.

John Bajkowski is president of AAII.


Discussion

James from AL posted over 2 years ago:

I have just finished reading Screening for stocks with Strong Secular Growth. I find it to be very informative and useful in my future investments.
Thanks,
James Parkman


Vernon from AR posted over 2 years ago:

This is my first Screening for stocks and I find several socks that with which I'm not familiar.I plan to run a tab on these for a period of time to see how good they perform.
Vernon from Arkansas


Jerry from AZ posted over 2 years ago:

Thanks, great instruction and information.


Leroy from CO posted over 2 years ago:

be careful.


Michael from CA posted over 2 years ago:

This is getting close in terms of results, to a screen I have used successfully for many years. Some mathematical differences are that I use multiyear averages (instead of year to year), least squares trendline, set a limit on R squared value, set a limit on return on equity, and have fewer limits on sales growth, and set an absolute limit on earnings growth averages, but also put a p/e limit on there too.

Many of the same stocks that show up on this screen also show up on my screen too.


Bob from TX posted over 2 years ago:

I am unable to replicate the screen from this article is Stock Investor Pro. Can someone help me with what I am doing wrong?


Larry from MI posted over 2 years ago:

I cannot find this screen in the Stock Screens section of AAII website. Should I be able to?


Jean from IL posted over 2 years ago:

Larry - No, this is not one of the screens that we track on an ongoing basis in AAII Stock Screens. The First Cut column is focused on simple, first-pass screens. -Jean from AAII


Nick` from NJ posted over 2 years ago:

After first cut can some one guide what are the next step before we buy and when to sell


John from KS posted over 2 years ago:

This is a great earnings and sales growth screen! Since so many stocks passed the screen, it can be improved by adding some some industry-relative value criteria (Price/sales, Price/book, Price/earnings, or Price/cash--or free cash--flow) and then further adding some balance sheet safety factors (like Altman's Z score or Piotroski's F score [a combo or both income and balance sheet factors] and looking for more safety than the median for a given company's industry). Then you have a value/growth company screen that is fabulous!


John from KS posted over 2 years ago:

I just programmed the screen for my own use and noted that in lines 8-11 you compare EPS-Diluted Continuing quarterly items with non-diluted EPS-Continuing quarterly of the prior year. This is not quite consistent comparisons---like comparing apples with applesauce. Close but not quite the same. Going from 4/13/12 to 5/18/12 seven dropped off the Bajkowski list (NVO,RHT, ITC, QSII, WTR, TEA, and RUE).

Also, following my post above, the trailing twelve month F scores from Piotroski were 7, 6, 6, 4, 7, 7, and 6, respectively. QSII had no computable Z score and the two utilities were characteristically very low for that industry: .67 and .81--predictive of bankruptcy in two years for non-utilities.


Peter from FL posted over 2 years ago:

Thank you, Mr. Bajkowski!
This fist-cut screen provoked a lot of further analysis because I have begun to see that Consistency of growth is a valuable attribute, as much or more than the rate of growth. I began trying to find a consitency or secular growth measure in any of the AAII stock screens with out success. Is your screen similar to any of the regularly published screens?
Thanks.
Pete C.


Mike from OH posted about 1 year ago:

I tried backtesting this at http://keelix.com/backtester2 and did NOT have good results. The lead-in to the article said something about "good times and bad". The companies might have had good earnings, but the stock prices tanked in 2008. I was looking for a screen that gives consistent returns, in good times and bad.

Does anybody know of a screen that gives consistent returns, in good times and bad? I looked at the monthly return spreadsheet for the AAII screens and they all have periods of SIGNIFICANT drops.


Jim B from WA posted about 1 year ago:

Another way to look at the results of the AAII screens is to calculate compound annual returns divided by standard deviation for each series of results from 1998 to 2012. (Download the results in Excel to make this easier.)

Higher values in this measure will highlight those screens with good compound returns and lower variability of returns.

When you do this, several of the screens that use positive earnings surprises and upward earnings revisions bubble to the top.


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