How To Evaluate Growth Stocks?

  • Oct 23, 2018 AEDT
  • Team Kalkine
How To Evaluate Growth Stocks?

When investors start looking for growth stocks, many factors take a front foot and a number of equities get scanned for key financial and quality indicators. A guide to scan through the stocks thus entail few features that are to be kept in mind:

  •  Aggressive companies are generally expected to post strong earnings: Growth stocks are those companies that are aggressive and are estimated to be posting strong earnings, especially when viewed over the next couple of years. These companies grow at a faster rate than the average companies in terms of profit. These companies thus give strong returns to equity. Like Bapcor Ltd, which is projecting profit growth of at least 30% in FY18 and has recently launched its first stores in Thailand. CSL Limited has highlighted for a profit growth of about 20% or above this financial year at the back of investments in existing and new market leading healthcare products. Syrah Resources Limited’s bottom-line is projected to grow by 47% on the back of the underlying strong triple-digit sales growth rate over the next few years. Then you have a small-cap biotech company, Mesoblast Limited that posted healthy revenue growth to USD 14.9 million from USD 0.6 million noted in the previous corresponding period, and this has been at the back of earnings from two licenses that relate to marketing of Mesoblast products in Japan and Europe.
  • Unique Product Line or Offerings: Growth stocks are expected to grow due to unique product line or offerings, which is based on rise in demand. For instance, ASX listed Pioneer Credit Limited is into offering services to unsecured retail debt portfolios and the stock has seen growth in earnings and revenue since the company went public in 2014. Zip Co Ltd is a fintech stock that is into digital point-of-sale and fast growing payment solution space. Currently, there are a few players in this e-payments domain and competition is not very intense. Another stock, Syrah Resources does not have impressive financials but possesses high-quality asset that has the potential to supply the Chinese market. The company is becoming the only major supplier of graphite to battery market as China switches from an exporter to importer scenario.
  • Stocks with historical growth or strong free cash flows: The investors analyze the historical growth of the company to find out the managements’ focus and ways to deal things. Along with it shows the quality of the company to sustain growth. Moreover, the investors for analyzing growth stocks, analyze the free cash flow of the company. The companies with strong free cash flow may have capital for R&D, acquisitions, etc., that are required for the growth of the company. However, not all growing companies can build on cash stupendously.
  • Innovative Management: Henry Ford, Thomas Watson, Ray Kroc, Jack Welch, Walt Disney, Akio Morita, Sam Walton, Bill Gates, Larry Ellison, Steve Jobs, Meg Whitman, Jeff Bezos, Craig Venter and Dennis Kozlowski were and are all great managers who had led their companies to great heights by thinking differently. The key aspects to look for include stability and expertise when evaluating the companies from management standpoint. 
  • Strategize on Intellectual property (patents) or access to related technologies: Growth driven companies generally hold patents or have access to technologies, which keep them ahead of others in their industry. Intuitive Surgical (ISRG) was one-of-a-kind surgical robotic systems that remain untouched by competitors due to the firm’s great patent protection.
  • May not pay dividends: These companies are not necessarily into declaring dividends, as the companies usually want to reinvest their earnings for further acceleration of growth in the short term. Growth companies might pay just small part of their earnings as dividends and keep plenty of cash for further growth. Bapcor in FY 17 had paid out only 13 cents in dividends from an earnings of 23 cents. Flight Centre Travel Group Ltd in FY 17 had paid out $1.39 per share in dividends on earnings of $2.32. The company’s business continues to grow through a mix of global expansion and acquisitions around the world.
  • Significant market share in their industry: Growth Stocks are those that hold significant market share in their industry as they intend to stay resilient to competition and maintain market leading positions.
  • These stocks may be overvalued: Due to stocks performance and expectation of growth, the growth stocks are always in limelight. The investors rush for punting in growth stocks, so that they get excess gain compared to investments in other stocks. As a result, these stocks sometimes become overvalued very soon. The prices generally double within 2-5 years, which is easily possible for young companies in rapidly expanding industries. Thus, an eye on price dip with future catalysts borne in mind can be regarded well for some of these stocks.

While the above aspects can be looked upon for evaluating stocks in terms of growth based investment themes, investors need to critically understand the growth rate, PE multiples, EV/EBITDA ratios, EPS projections along with revenue and profit forecast, product launches and partnerships that can be key drivers for the future.


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