5 Strategic Ways To Identify US Stocks For Growth

Introduction: Performance of businesses are reflected in their stock prices –Investors tend to invest in certain stocks based on the anticipation of future earnings from these companies. There are several categories of businesses where investors put their money in anticipation of future gains. Based on the operating performances, companies can be categorized into four types, namely matured companies, growth companies, turn-around companies, slow-growers.

(Source: Google)

Categories of Businesses: Companies which have a strong business model and the products of which are required in the daily lives of the consumers can be classified under ‘Matured Companies’. (only made it bold) Since the inception, these companies tend to follow the same business model and irrespective of the economic conditions, the demand of the products remains intact. Investors do buy these companies for steady growth and dividend yields. However, as per the valuation, these stocks always remain high because of the higher margin of safety. Companies whose earnings growth rate are the more than the current industry median are known as ‘Growth-stocks’ while those with earnings growth lower than the industry median and equivalent to the GDP growth rate of the country can be termed as ‘Slow-Growers’. ‘Turn around’ stocks can be categorized as the companies which are running at losses and suddenly due to some macro and micro factors like- change in the outlook or the scenario, government legislation, change in management or parentage, geopolitical reasons, these companies foresee earnings growth.

Reasons to choose ‘Growth-stock’: As per ace Investor Mr. Peter Lynch, companies with a decent earnings growth over the years along with steady dividend payout ratio can be termed as ‘Growth-stocks’. Investors have a tendency to buy at a lower price and sell at a higher price. The difference between the buying and selling price is considered as the profit for the Investor. In case of growth stocks, the difference becomes higher and so the return on investment. Due to positive earnings growth, the price also appreciates quickly compare to the Index. The risk to reward ratio continues to be high for these stocks.

Let’s have a look at the strategic ways to identify US stocks for growth.

1. Product of the Company: One of the major traits of these growth stocks is that these companies have managed to grow by more than 25% for the last one decade and more. These businesses participate on the upcoming trends in the market, and hence they are able to generate higher pricing power resulting in earnings growth. For example – we can take a look at the business model of Netflix. The business offers content related to drama, movies, tele series etc. on a subscription basis and its services are widely accepted across the world. Due to digitization, the products offered by the company are globally transmitted and the company offers contents as per the regional preferences of the consumers. Earlier, the company use to offer contents limited to the viewers of United States only; later with rising mobile phone penetration across Asia, Africa etc. the company started offering contents applicable to viewers outside United States. The strategy became successful and the subscription base increased many folds generating strong bottom-line growth for the business. Investors do look up to the business model and its ability to derive profits from changing circumstances.
2. Scalability of the Business: There are many instances where investors have observed, that due to lack of scalability and funds, a small business with huge potential failed to cater to the wide customer base. The products offered by a small company is appealing to the small section of people because of its smaller market presence. The products might have a higher margin as compared to its competitors. But due to its restricted scale of operations, the business fails to capture a higher market share. Thus, news of amalgamation, takeovers or capital infusion excites investors and they tend to favor smaller business. So, during any takeovers or mergers or capital infusion, analysts try to gauge the utilization of the funds. If they get a hint of scalability of the business operations, then it a positive indication for the Investors and Analysts alike.

• Valuation: Investors looks at the long-term viability of the business and invests in the stock when available at an attractive price. Investors are keen to invest when they feel that valuation-wise, the stock is undervalued or due to price correction, the stock is available at an attractive price. As per ace investor Peter Lynch, the price to earnings multiples should reflect the recent growth rate of the company. During the initial stages of the company, the company does not have reserves like matured companies, nor their market shares comes close to them. Thus, Investors might take 3 -year CAGR or 5-year CAGR to determine the Price to earnings multiple. During bear market scenario, when the stocks get beaten down, stock prices become attractive enough to invest.

1. Performance during tepid times: Historic growth rate does not guarantee future profits and there must be some unique qualities which distinguishes the business from the rest. Investors do search for a ‘Moat’ of the business, which could sail the boat during tepid times. For example, if we talk about the business of The Coca Cola Company, we would see that the nature of product remained the same during ages together. The taste and quality remained almost same and the product offtake was due to habit of customers such as a kid of 5 years age or an adult would continue to consume carbonated drink till the end of his life. The performance of these companies does not get hampered during tepid times. Thus, companies with good earnings growth during challenging times can be looked at favorably. The fundamental reason behind the performance can be evaluated. Based on that, investors might take a call.
2. Management and diversification of funds: The management plays an important role of every business and is regarded as the captain of the ship. The outlook of the management plays important role in building of any business enterprise. In many cases, a prospective business has failed due to some disastrous activities by the Management. For example, the utilization of the funds has to be in the right direction, followed up by several business activities. When a company receives any assistance, the investors and the analysts must keep an eye on it. In many cases, the funds are diversified in other business activities which might have a low return of investment compared to that of the existing model. So, analysts pay attention to the revenue and profitability generation form the existing product lines. The primary product should derive the major revenue. While, in some cases, the word diversification is applicable as there might be evolution of new products by the businesses, which may lead to a lower return. Investors should be aware of a major launch of new product lines. They must question to the management regarding the scope, availability, capex planning, target customers and expected margins of the new products. The analysts must emphasize on the margins as lower margin than that of the principal products might hinder the overall group performance. However, in the reverse case, if the company is able to deliver better margins on a new product than on its principal product on a sustainable basis, then there is the time to cherish! Investors can enter into the stock when there is the launch of an excellent product which has better margins along with increasing growth of overall revenues.

Conclusion: Growth stocks carry higher return to risk ratio compared to slow-growers, matured stocks etc. In case there happens to be any adversity in terms of business performance due to government regulations or competition, the stock tumbles creating capital erosion to the investors. The company might have invested a lot in a new product line with average margins which could hinder its overall ROE.

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