In this week’s filter created for The Globe and Mail, we screened for established growth stocks poised for further gains.
In the late stage of the business cycle, such as many argue we are in now, it is important for growth investors to improve their downside protection without sacrificing potential upside returns.
Today we look for growth stocks supported by favourable fundamentals that should allow them to capture further gains in a rising market.
We screened Inovestor’s U.S. universe of stocks by focusing on the following criteria:
- Market capitalization greater than US$10-billion;
- 12-month change in the economic value-added (EVA) metric greater than 10 per cent – a positive figure shows us that the company’s profits are increasing at a faster and greater pace than the costs of capital. The EVA is the economic profit generated by the company and is calculated as the net operating profit after tax (NOPAT) minus capital expenses;
- One-year return of at least 10 per cent;
- Average annual earnings-per-share (EPS) growth over five years of at least 15 per cent;
- Annual sales change one year ago or two years ago of at least 10 per cent;
- Current economic performance index (EPI) greater than one. This is the ratio of return on capital to cost of capital, representing the wealth-creating ability of the company. A ratio above one is key for sustainable investment opportunities;
- Free-cash-flow-to-capital ratio. This ratio gives us an idea of how efficiently the company converts its invested capital to free cash flow, which is the amount left after all capital expenditures have been accounted for. It is an important measure because it gives us the company’s financial capacity to pay dividends, reduce debt and pursue growth opportunities. We are looking for a positive ratio.
- Future-growth-value-to-market-value ratio (FGV/MV). This ratio represents the proportion of the market value of the company that is made up of future growth expectations rather than the actual profit generated. The higher the percentage, the higher the baked-in premium for expected growth and the higher the risk.