Do You Need Growth for Successful Stock Picking?


Investor-UpdateA new stock screen I created omits one characteristic that may surprise some (or perhaps many) of you: growth. Nothing in the screen requires a passing company to be growing revenues or profits. It is an admitted deviation from how I’ve previously looked for stocks.

I’m not alone in omitting growth. The four AAII Stock Screens with the best long-term performance all do not seek growth: Estimate Revisions Up 5%, Piotroski High-F Score, Estimate Revisions Top 30 Up and O’Shaughnessy Tiny Titans. Add in Price-to-Free-Cash-Flow, and five of the seven screens with the best performance since the start of 1998 (when we started tracking the returns for our screens) do not specifically require growth. Even our Model Shadow Stock Portfolio—a real-world portfolio—has a long-term annualized return of 15.5% since its inception in 1993. This compares to the Vanguard Small Cap Index fund’s (NAESXreturn of 9.9% over the same period.

There’s no argument about whether growth is a positive trait. Rising revenues can drive profits, cash flow and retained earnings higher. It can also increase the denominator in the price-earnings, price-to-cash-flow and price-to-book ratios (and will obviously increase the denominator in the price-to-sales ratio). When the denominator in a valuation ratio grows, either the stock’s price has to rise or its valuation will become cheaper. Growth in cash flow also allows a company to raise its dividend and buy back more shares, all positive things. The problems with growth are what one pays for it and the ability to forecast it.

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The Week Ahead

Dow Jones industrial component Nike (NKE) will report earnings on Tuesday.

August new home sales will be the first economic report of note, released on Monday. Tuesday will feature the July S&P Case-Shiller home price index (HPI) and the Conference Board’s September consumer confidence survey. August durable goods orders will be released on Wednesday. Thursday will feature August international trade, August pending home sales and the second revision to second-quarter 2016 gross domestic product (GDP). August personal income and spending, the September Chicago purchasing managers index (PMI), and the University of Michigan’s final September consumer sentiment survey will be released on Friday.

Federal Reserve Chair Janet Yellen will speak on Thursday. Several other Federal Reserve officials will also make public appearances: Minneapolis president Neel Kashkari on Monday and Wednesday; Dallas president Robert Kaplan on Monday; St. Louis president James Bullard, Chicago president Charles Evans and Cleveland president Loretta Mester on Wednesday; Kansas City president Esther George on Wednesday and Thursday; and Philadelphia president Patrick Harker, Atlanta president Dennis Lockhart and board governor Jerome Powell on Thursday.

The Treasury Department will auction $26 billion of two-year notes on Monday, $34 billion of five-year notes on Tuesday, and $13 billion of two-year floating-rate notes and $28 billion of seven-year notes on Wednesday.

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