Navigate the Stock Selection Processes

Physician's Money Digest, May 15 2003, Volume 10, Issue 9

There are key criteria to considerwhen identifying andevaluating companies withoutstanding growth prospects. Ittakes a time investment to visit corporateWeb sites, review annualreports and financial statements,and even listen to replays of conferencecalls between company executivesand Wall Street analysts. Butmore often than not, this will betime well spent.

SALES/EARNINGS GROWTH

BusinessWeek

For starters, look for companiesthat have strong, sustainable salesgrowth. According to an article in, a good indicator of agrowth company is that its revenuesgrow at a pace greater than that ofthe overall economy. For example,considering that the gross domesticproduct is expected to increase atan annual rate of 3% over the next3 years, sales growth above that ratewould be attractive.

However, it's also important tocheck if sales and inventories aregrowing at similar rates—informationyou can find in annual or quarterlyfinancial statements. If youfind that company inventories grewat 12% in a given year while salesgrew at only 9%, it's possible thecompany might have misread demandfor its products.

Another word of caution:

Companieswhose revenues are primarilygrowing through acquisitionsrarely tend to reward their investorsover the long haul.

A company's earnings growth isalso an important consideration.Since sales drive earnings, both categoriesshould rise at approximatelythe same pace each year. If yourresearch of a company reveals thatits sales rose 10% in 2001 but earningsincreased 20%, something elseis going on. It could be that thecompany has gone overboard withcost cutting or selling assets. Inaddition, liberal employee stockoptions can make earnings look betterthan they actually are.

CASH FLOW AND DEBT

Another factor to consider is acompany's cash flow (ie, what acompany earns before accountantsbegin subtracting intangible costsof depreciation and amortization).For example, if you owned a neighborhoodpizza shop, your mainconcern would be how many dollarswere in the register at day'send, minus what was owed forexpenses. Those remaining dollarsare your cash flow.

To evaluate, you should knowthat net income and cash flowshould rise by about the same percentageeach year. This informationwill appear in the company'squarterly financial statement. Ifearnings are higher than cash flow,it could be a sign that future earningsare at risk of being draggeddown by bad debt.

Corporate debt is a big concernwhen selecting a stock. Borrowing isfine, but excessive borrowing is aproblem. A good rule of thumb is tolook at a company's capital, which islong-term debt plus shareholderequity. The debt should be less than50%. But remember to compareapples to apples and look at companiesagainst their peers in the sameindustry.