T. Rowe Price | Identify companies at early growth stage

Price is considered to be "the father of growth investing." He founded T. Rowe Price Associates, Inc. in 1937. At that time, he defied convention by charging fees based on investments that clients had with the firm, not commissions, and always "putting the client's interests first." Price believed that as his clients prospered, the firm would too.  The firm has survived several bear markets and today manages assets of over $315 billion!

He was also the first to depart from conventional wisdom (prevalent at that time) that all stocks were cyclical. He was of the opinion that earnings of most companies pass through a life-cycle - much like humans - growth, maturity and decline. He sought to identify quality companies at their early growth stages and hold on.

Price and his firm became extremely successful employing the growth stock approach to buying stocks. By 1965, he had spent almost thirty years as a growth advocate. At that time, many of his favorite stocks became known in the market as "T. Rowe Price stocks." Merck, the pharmaceuticals firm which grew at an average rate of 18.6% per annum over 32 years, not including dividends, was one of his early finds. As was IBM, Black & Decker among others.

Check out ValuePickr's T. Rowe Price Growth stock screen selections for the Indian stock market, here.

T. Rowe Price Growth Investing Approach

T. Rowe Price died in 1983. He did not write any book or document his thoughts much on investing strategies for us to directly benefit from.  Assorted articles and references by stock market experts appearing in the media is the basis and source for this article, and stock screen.

Stock Picking strategy: identify companies at early growth stage, and hold

As mentioned earlier in the 50-60s the name T. Rowe Price became synonymous with growth stocks. 

This quote from him alongside, outlines his investment strategy best.

He looked at following characteristics in Growth stocks:

• Superior growth of earnings per share

• Growth greater than inflation

• Strong Management

• Strong Finances - ability to fund growth through retained earnings, leveraging the Balance Sheet

• Absence of cut-throat competition - favourable profit margins

• High and expanding Return on Invested Capital

• Low labour costs, but well-paid employees

 T. Rowe Price Growth Stock Screen Design

Objective

To locate stocks of companies with long-term earnings growth prospects in their early growth stages of their life cycle before they become "glamour" stocks.

Primary Criteria

Criteria to locate stocks that match our screening objective

1. T. Rowe Price specified that earnings per share should be increasing faster than inflation. Historical inflation rate in India is about 5-6 percent. That would be a very unrestrictive filter for the Indian market. Instead  we use Median 5 year EPS growth rate for the entire stocks database.

2. Superior earnings growth but at a reasonable price. He looked for stocks quoting at a price-to-earnings ratio lower than its historical average - a potential sign that a stock is undervalued

Secondary Criteria

Criteria that ensure that the companies passing the primary screen do not meet our objectives just by coincidence, but because they are deserving candidates and truly meet our objective. Usually these are useful to eliminate the duds from creeping in.

1. Eliminate companies with extreme price-earnings ratios. Our screen excludes companies with price-earnings ratio over 40 for any of last 5 years

2. Ability to increase retained earnings and ability to obtain further financing by leveraging the balance sheet. Our screen looks for comfortable levels of debt and positive cash flows

3. High and expanding Return on Invested Capital (RoIC). Our screen looked for RoIC higher than Industry Medians

4. Favourable profit margins. Our screen looked for GPM and NPM above industry medians