“I like to invest in companies that I know.”
“I like to invest in businesses that I understand.”
“I want to buy Apple because they’re introducing a new iPhone.”
I know that people like to invest in companies that give them a feeling of comfort, an illusion of control. I’m not going to argue with that approach. There’s a lot to be said for owning stocks that you can relax with, as opposed to owning stocks that confuse or worry you.
Instead, I’d like to tell you how I selected six successful stocks:
A big winner in my Growth & Income Portfolio was Blackstone Group (BX), rising 111% in 35 months. A big winner in my Growth Stock Portfolio was PulteGroup (PHM), rising 51% in 9 months. A big winner in my Buy Low Opportunities Portfolio was Vertex Pharmaceuticals (VRTX), rising 74% in 18 months. And for shorter-term traders, three of my winners included PBF Energy (PBF), up 54% in 3 months; Delek U.S. Holdings (DK), up 76% in 4 months; and Direxion Daily S&P Bear 3X Shares ETF (SPXS), up 35% in one week.
I continually screen about 1,100 stocks to identify undervalued growth stocks. I use Wall Street analysts’ consensus EPS estimates to find stocks that are expected to attain strong EPS growth over the next two years. Next, I screen the stocks for comparatively low price/earnings ratios (P/Es) and debt ratios. Finally, I make my buy recommendations based upon technical analysis, a.ka. price chart activity.
Please note that I did not say that I review companies’ past EPS growth. A company’s earnings history does not necessarily bear any correlation to its future prospects. However, Wall Street analysts’ consensus EPS estimates give investors a relatively accurate view of how companies are expected to perform financially for the next couple of years. Why would anybody guess at the future by looking at the past, when they can easily see the future by reviewing consensus earnings estimates?
I stopped looking at corporate earnings history long ago. Those numbers are somewhat useful in determining annual price/earnings (P/E) ranges, but they’re not remotely useful in identifying companies that are about to have aggressive earnings growth.
After I identify companies with strong future earnings growth, I then review their stocks for moderate or low P/E ratios, and moderate or low long-term debt-to-capitalization ratios.
The P/E is important because it measures valuation. Undervalued stocks generally carry much less price risk than do overvalued stocks. My investment strategy is all about lowering risk while seeking capital gains. Therefore, I concentrate on stocks that are fairly valued or undervalued.
There are several reasons that low debt ratios help the stock price. When companies have a lot of debt, much of their cash flow is allocated to debt and interest payments. That restricts companies’ abilities to hire workers, build facilities and invest in R&D.
But low debt ratios do the opposite. A low debt burden frees up cash flow for business investment. It also allows for dividend increases and share repurchases. And every now and then, a cash-rich balance sheet will spark a corporate buyout, which is usually quite profitable for the shareholders.
That’s it. Future earnings growth, P/Es and debt. After 32 years of stock investing, I’ve figured out that those are the three numbers I need to focus on, in order to beat the S&P 500 and the Dow Jones Industrials.
I go through this stock-screening exercise with blinders on, paying no attention whatsoever to company size, location or industry. If the stock passes those three numerical screens and has a bullish technical chart, it lands on my buy list.
Most growth stock investors would ignore railroad company Union Pacific, because they have a preconceived idea that Union Pacific is too large, and its industry too boring, for the stock to “do anything.” But I’ve learned that my screening process shows me exactly which stocks will most likely outperform the Dow and the S&P 500. If Union Pacific lands on my buy list, I don’t second-guess that decision. I welcome the stock into my portfolio!
Lots of investors also ignore companies that they don’t understand, and those that don’t present quick name recognition.
“Pressure-sensitive materials, engineered components, communication infrastructure, therapeutic application of cell therapies … what the heck are these things?! Can’t we just invest in cell phones, soda pop and sneakers?”
No. Not if you really want to outperform the stock markets. You need to be willing to step outside your comfort zone, and own stocks that require a little extra brain work. Because if you’re going to ignore all the different kinds of companies that don’t make you feel warm and fuzzy, you’re shutting yourself out of a multitude of capital gain opportunities.