How to Identify Growth Stocks?
If you are looking to invest your money in stock markets, there are several
things that you should know before you take the leap to purchase. Of the many stock market investment strategies,
we are going
to discuss in this blog what growth stocks are and how to identify them.
What is a growth stock -
Stock is a share in the company which is expected to increase its earnings at a
rate above the average market numbers.
stock company usually pays no dividend and chooses to reinvest the retained
earnings (NOPAT- Net Operating Profit After Tax) as capital for potentially
profitable projects. It can be one of those technically advanced companies that
who own growth stocks are interested because there is a potential for huge
capital gains. At the same time it is a risky business as great upside
potential goes hand in hand with great downside potential. Some examples of
Indian growth stocks are Suntec Realty, Edelweiss Financial, Ajanta Pharma,
etc. Let us delve deeper to know seven ways to identify a growth stock.
How to Pick
the Best Growth Stocks
Sometimes, a company may not show very high profits, but their sales
would top the charts. A classic example of this is Eicher Motors. Look out for
such companies as they show great promise to perform once they take off.
2. Upward Trend
in Earnings Growth:
The Earnings Per Share or EPS of a company indicates how profitable a
company is. The ratio is the retained earnings to the number of shares a
company holds. One would like to invest in a company with an upward trend in
its EPS as they are perfectly capable of paying its shareholders a high return
for their investment.
3. Return on
Return on equity comes topmost on Warren Buffet’s list of criteria for
Return on Equity or ROE measures how well the money invested by the
shareholders in the company by dividing the net income by shareholders equity.
If a company is aiming for growth, it efficiently allocates its capital through
equity. A growth stock company retaining its capital for expansion should be
able to show that they are able to generate high returns for their shareholders
through equity, else there’s no point for such retention.
A strong balance sheet is one with low debt over a good cash position.
Liquidity is an important factor for growth. Many companies expand quickly only
to realize that they do not possess liquid cash enough to settle the debt and
borrowed capital used for such growth.
A company that has a high debt and borrowing may focus mainly on
repayment rather than growth. They are also under the constant fear of winding
up due to insolvency.
5. Strong Cash
Strong inflow of cash indicates high sales turnover or the sale of a
company’s own subsidiaries, overseas branches or even heavy machinery. A
company with a lot of free cash flow is target for high dividend seekers, since
they expect payment out of such free cash. On the other hand, growth stock
companies are low on free cash because it is converted into capital expenditure
or Cap Ex for business growth.
A good way to inspect a growth stock is to check its operating cash flow
rather than the free cash flow. Consistent and increasing operating cash flow
is a good indicator that a company is getting new money from capital
6. Dividend Payout
Ratio and Retained Earnings:
A growth stock company preferably has a dividend payout ratio of 50% or
lower. The dividend payout ratio is the
return paid to shareholders based on the company’s net income by means of
dividend. The amount that is held back for growth and reinvestment by the
company is called retained earnings.
A growing company usually keeps all the profits to expand and diversify
its business. A matured one that has established itself in the sector prefers
to share its profits with its members.
Every company leaves a trail of its progress and success behind. A
growth stock company should have a trail of tangible growth in the past 3-5
years. Evaluate the company’s records for concrete evidence of cash flow, profits,
rising revenues and sales. You may come across several companies selling the
investors only dreams that soon turn to dust once trapped in the scam. It is
important that investors do not fall for charismatic words of growth, expansion
and high returns before they check for stable growth over a period of time.
Bonus Tip: Look for
small and mid- sized companies, as they have prospects for higher growth. These
companies are not very high on liquidity and hence give retail investors the
opportunity to own the shares of the company before it grows. A Matured
company’s focal point is usually giving back to its investors and hence is more
often than not a dividend centric investment.
Finding growth stocks can be a fun
part of your research. India is the fastest growing economy in the world, which
results in highly profitable companies. Growth stocks can come in all forms, be
it mature companies or wee start-ups that are just on the verge of a break
through. Many a times it is difficult to recognize one apart from a financial
Several companies are well hidden
under the radar in extremely technical or strategic industries; they may seem
modest, but the future trends may be in their favour. If you are
trying to stay safe in the stock market, monitor the current
stock market trends since
risk is ancillary to this adventure. Huge stakes means so much to win, but also
too much to lose.