Sometimes, a company may not show very high profits, but their sales would top the charts. A classic example of this is Eicher Motors. Look out for such companies as they show great promise to perform once they take off.
Upward Trend in Earnings Growth
The Earnings Per Share or EPS of a company indicates how profitable a company is. The ratio is the retained earnings to the number of shares a company holds. One would like to invest in a company with an upward trend in its EPS as they are perfectly capable of paying its shareholders a high return for their investment.
Return on Equity
Return on equity comes topmost on Warren Buffet’s list of criteria for evaluating companies. Return on Equity or ROE measures how well the money invested by the shareholders in the company by dividing the net income by shareholders equity. If a company is aiming for growth, it efficiently allocates its capital through equity. A growth stock company retaining its capital for expansion should be able to show that they are able to generate high returns for their shareholders through equity, else there’s no point for such retention.
A strong balance sheet is one with low debt over a good cash position. Liquidity is an important factor for growth. Many companies expand quickly only to realize that they do not possess liquid cash enough to settle the debt and borrowed capital used for such growth. A company that has a high debt and borrowing may focus mainly on repayment rather than growth. They are also under the constant fear of winding up due to insolvency.
Strong Cash Flow
Strong inflow of cash indicates high sales turnover or the sale of a company’s own subsidiaries, overseas branches or even heavy machinery. A company with a lot of free cash flow is target for high dividend seekers, since they expect payment out of such free cash. On the other hand, growth stock companies are low on free cash because it is converted into capital expenditure or Capex for business growth. A good way to inspect a growth stock is to check its operating cash flow rather than the free cash flow. Consistent and increasing operating cash flow is a good indicator that a company is getting new money from capital expenditure.
Dividend Payout Ratio and Retained Earnings
A growth stock company preferably has a dividend payout ratio of 50% or lower. The dividend pay-out ratio is the return paid to shareholders based on the company’s net income by means of dividend. The amount that is held back for growth and reinvestment by the company is called retained earnings. A growing company usually keeps all the profits to expand and diversify its business. A matured one that has established itself in the sector prefers to share its profits with its members.
Every company leaves a trail of its progress and success behind. A growth stock company should have a trail of tangible growth in the past 3-5 years. Evaluate the company’s records for concrete evidence of cash flow, profits, rising revenues and sales. You may come across several companies selling the investors only dreams that soon turn to dust once trapped in the scam. It is important that investors do not fall for charismatic words of growth, expansion and high returns before they check for stable growth over a period of time.