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Friday, March 29, 2024

Winning Stocks Need More Than Earnings

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Running the numbers for a stock is crucial when considering whether to buy it.

We’ve discussed that strong earnings growth is the most important factor that sets apart winning stocks. But that’s not all you need to be concerned about.

You want a company’s total picture, and that includes analyzing its sales growth, profit margins and return on equity.

Superior sales gains are a key indication of continued growth.

You should look for sales growth of at least 25% for the latest quarter compared with year-ago figures.

With some strong new issues, you might even see sales growth of 100% or more for many quarters.

If sales growth isn’t quite 25%, look for accelerating growth over the past few quarters. For example, a company’s gains of 12%, 15% and 22% over consecutive quarters show significant improvement.

If sales growth figures start to fall off, be careful. It could mean a product is no longer as popular, which could affect earnings negatively. But it may also mean a company has cut a money-losing division, which is good.

Look at what’s driving sales growth. If a firm slashes prices to pump up sales, you could see a slowdown in profit. Acquisitions, too, can boost sales temporarily, but it’s always a question of whether they’ll have the same effect long-term.

Also, increased sales don’t always mean the stock’s a winner if, say, it has reduced pretax or after-tax margins. Robust margins are important. They tell you how much profit a company makes for each dollar of sales. The bigger the margins, the better.

Look for margins that are ramping up or hitting new peaks. You want to see margins that stand out among a company’s industry peers.

Keep in mind that margins vary from one industry to another. A consulting firm, for example, will have higher margins than a construction firm that has to spend on building materials. Dropping margins could indicate a problem, such as more costly materials or labor.

Return on equity is also a major part of a stock’s health picture. IBD studies show that the greatest winning stocks of the last half-century had ROEs of 17% or better.

How do you check if a stock has these vital financial traits?

The revamped IBD Stock Checkup at Investors.com gives you a quick rundown of the stock’s performance within its group.

You can see how a stock’s SMR (Sales + Margins + Return On Equity) Rating stacks up against its peers in the Performance Within Group section. Hover your mouse over that and other ratings, and to the right you’ll see the group’s leaders in that rating.

Use the IBD Stock Checklist, part of the new Checkup, to analyze the elements of the SMR Rating, each of which is broken down under the Sales, Margins, ROE section.

The green circles tell you a stock is rated superior against its peers in that category. A yellow circle is neutral, and red represents unsatisfactory performance.

Remember, you want stocks with lots of green ā€” both on the checklist and in your pocket.

The stock quotes at Investors.com now include the most recent quarter’s sales performance and the three-year sales growth rate.

Look for the total package: strong price and volume action, superior earnings and sales growth, and hearty profit margins and return on equity. Historically, leading stocks score well on most or all of these key factors.

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