Avoid overpaying for growth in stocks
Currently, some investors are apparently willing to pay any price for stocks with decent growth prospects. But, eventually, fundamentals will apply. Here are six rules to help you avoid overpaying for stocks.
You can find all of the needed information on Yahoo Finance (finance. yahoo.com). Start by entering a ticker symbol to get a price quote.
Avoid cheap stocks
Cheap stocks get that way because most investors are shunning them because they see problems ahead. Buying them adds unnecessary risks. What’s too cheap? Given current market conditions, avoid all stocks trading under $10.
Trend is your friend
Stock prices tend to move in trends. That is, despite short-term wiggles, in favor stocks move up over time and viceversa.
You can tell whether a stock is in a long-term uptrend by comparing its recent price to its 200day moving average (average close dor the previous 200 market days). Uptrending stocks are trading higher than their moving averages and downtrending stocks are trading at less than their morning averages.
From Yahoo’s quote page, click on Statistics and then scroll down to the Stock Price History section to see the current “200 Day Moving Average.” Stick with stocks trading higher than their moving averages, but only to a point. Avoid stocks trading at double their moving averages or higher. They’ve probably gone up too far, too fast.
Profitability drives earnings
Suppose that you’re comparing two stocks that both reported $10 million in earnings last year. But Company A’s shareholders had to invest $100 million to generate that profit while Company B only had to spend $50 million. Obviously, you’ll enjoy higher returns holding Company B.
Find profitability ratio “return on equity,” which compares net income to shareholders’ equity (assets minus liabilities), in the Management Effectiveness section of Yahoo’s Statistics report. Require at least 15% return on equity and higher is better.
Don’t overpay
Stocks racking up strong growth numbers attract attention. Eventually, everybody piles on and the shares get too expensive.
The price/earnings
(P/E) ratio, which is the recent share price divided by the last 12 months earnings, is the most widely followed valuation gauge. But earnings often vary substantially from quarter to quarter. However, revenues (sales), although hopefully growing, are a steadier gauge. Thus, the price to sales ratio, which is the recent share price divided by 12 months’ revenues, is a more reliable valuation gauge.
Yahoo lists the Price/ Sales ratio under Valuation Measures. Look for ratios less than 8 for firms with up to 10% expected annual revenue growth, and up to 15 for faster growers.
Revenues power earnings
In theory, investors price stocks based on earnings growth, but revenue growth is what usually drives earnings higher. Focus on stocks that have already recorded strong revenue growth and are expected to maintain, or even exceed, historical numbers in coming quarters. Require 8% annual revenue growth and higher is better. Yahoo lists the most recent quarter’s revenue growth vs. year-ago in the Income Statement section.
Continued revenue growth
Click on Analysis (top menu) to see analysts’ quarterly and annual earnings and revenue forecasts. Focus on the annual numbers and look for forecast growth rates at least even with historical figures and higher is better.
Passing these quick checks doesn’t mean you should buy a stock. Do your due diligence. The more you know about your stocks, the better your results.
Harry Domash of Aptos publishes the Winning Investing and the Dividend Detective websites. Contact him at www.winninginvesting.com or Santa Cruz Sentinel, 324 Encinal St., Santa Cruz, CA 95060. To see previous Domash columns, visit santacruzsentinel.com/ topic/Harry_ Domash.