ver time, you want your stocks to increase in value. If the market
values stocks relative to operating statistics such as sales and earnings,
what will it take to drive up the price? Higher sales and earnings. Can stocks
appreciate in price without generating growth? For a while, yes. But without
growth, eventually those gains will dry up—and sometimes “eventually”
means “just about now.” You can never be sure when the market will lose
patience with a company that no longer grows. For this reason, investors
tend to prefer companies that know how to grow.
For example, suppose Acme Widget generated $6 billion in revenue and
$1 billion in profit last year. If the stock trades at 2.5 times last year’s sales
and 15 times earnings, it has a market capitalization of $15 billion. With 1
billion shares outstanding, the shares cost $15 apiece. If Acme posts the
same revenue and profit this year and the valuation ratios remain the same,
how much will the stock appreciate in value by the end of this year? 0%.
On the other hand, what if Acme invests its cash wisely—in new
equipment to broaden its product line, and markets the new goods to its
existing customers—boosting sales and profits 20%? Once again, assuming
the P/E and P/S ratios don’t change, the company’s share price will rise to
$18, a tidy 20% gain. Of course, these numbers represent an ideal situation.
Sales and profits rarely grow at the same rate, and valuation ratios rarely
remain steady for long periods of time.
As discussed earlier, companies report operating results on a quarterly
basis, and disclose their performance via the media in an earnings release.
Investors should read the earnings releases of every stock they own, as well
as those of stocks they’re considering for purchase. While some companies
pack their releases with information and others keep the document sparse,
they all present the basics: sales, profits, and share counts.
To view these releases, visit the company’s website and seek out the
investor relations (IR) section. Some companies make it tough to find their
corporate information, but once you locate the IR page, you shouldn’t have
any trouble downloading the earnings releases and filings with the
Securities and Exchange Commission (SEC).
Why mention earnings releases now? Because to assess a company’s
growth in detail, you’ll need to gather some numbers from those releases
and SEC filings. Not all growth statistics tell the same story. As a
conscientious investor, insist on learning as much of the tale as you can up
front. Taken in combination, the following six growth numbers will reveal
much about a company:
Trailing 12-month growth.
Four-year annualized growth.
Estimated current-year growth.
Estimated next-year growth.
Estimated five-year annualized growth.
Table 5.1 presents the data you’ll need to create your company’s growth
profile. As with valuation, try to compare the stock’s growth to the same
numbers for similar companies in the same industry. Remember that stocks
with faster growth tend to command higher prices as measured by such
valuation ratios as P/E. Start by picking a company, preferably a large,
strong one that’s been around for a long time. Next step? Read the growth