Identifying Growth Stocks

Indian markets have witnessed a sideways long-term trend for a long time now. No one knows when a long-term bull market will start; but one thing is certain, its going to happen sometime or the other. In the current scenario, the market will signal the start of a long  term bull market when it emphatically makes a new high and surges ahead (hopefully after the a decisive 2014 elections). Start of Bull Markets are a good time to hunt for long-term winners. But, when a new bull market starts, how do you ensure that you have a list of stocks that can be multi-baggers?

One way to do it is to build a list of stocks that have sound fundamentals with a lot of growth potential. The fundamental parameters that are important to identify growth potential are:

1. PEG – This ratio indicates if the stock is growing at a rate much faster than its PE. You can find more details  about it  in this post.
2. P/S – This ratio indicates the ratio of Price to Sales for a company. The lower it is the better it is. It needs to be used in conjuction with Sales Growth%. You can find more details  about it in this post.
3. EPS Growth % – This ratio is an indication on how fast the company’s earnings are growing. It is calculated on a month-over-prior year month basis or TTM (trailing twelve months) basis.
4. Sales Growth % – Sometimes a company may not have any earnings to show but has a very impressive Sales Growth %. A classic example of this was Amazon.com that went IPO on NASDAQ in the late 90s. It was not profitable for a long time but grew sales at a phenomenal rate. It is calculated on a month-over-prior year month basis or TTM (trailing twelve months) basis.

A growth stock can exhibit several characteristics and one needs to use different criteria depending on whether or not it is profitable. Here are examples of criteria to use under different conditions:

If a stock is profitable:

1. A low PEG ratio of < 1
2. EPS Growth (TTM)%  > 30
3. [optional] Sales Growth (TTM)% > 40

If a stock is not profitable:

1. Sales Growth (TTM)% > 40  – This number can be even > 100 ( e.g. US Internet stocks of late 90s like Amazon.com fall into this criteria). The nearest example in Indian market would be a company like Flipkart if it were to go public now. It is also not profitable yet, but growing sales at an exponential rate.
2. P/S –  A relatively low P/S is a bonus as this means that the stock is selling relatively cheap compared to its Sales. However, just because the P/S ratio is high, it does not mean you should ignore it. Stocks that are growing their sales very fast tend to have high P/S ratios. In such cases, it helps to compare the P/S ratios with others in the industry and then decide.

In Investar, there are several fundamental scans to help you identify growth stocks, and they are shown in the picture below (Hint: Click on the Manage Scans toolbar button to get to this window).