Growth Stock Screen | Creating an effective screen for Growth Stocks

Objectives

With a growth screen you are looking to identify businesses with high-quality, sustainable growth. Firms that have been growing faster than the economy, have enjoyed above-average and increasing growth for a number of years. You are looking for companies genuinely in the growth-stage life cycle with rapidly increasing sales and profits and not say, cyclical companies that may show growth, but are just on the rebound from lows.

Benchmarks

For a growth screen you are probably interested only in companies growing Earnings per share (EPS) at greater than 25 percent annually. Usually companies growing at this rate will need high capital spending and will be retaining most of the earnings, and pay little or no dividends.

Growth Screens from the Gurus

T. Rowe Price, O'Shaughnessy, Graham with his Enterprising Growth, and William O'Neil with his CANSLIM stock picking approaches have provided us growth screening frameworks that have proved effective. You can use these or devise your own growth screen. It is useful to familiarise yourself first with the characteristics common to stocks growing rapidly.

Characteristics

The market is usually enamoured with growth stocks. They are well-followed and attract a lot of attention due to the high growth and favourable prospects. Supply demand equations drive up the price and sometimes PE ratios for this stocks may go as high as 4x the market. High Instituitional ownership (FI, FIIs) is common in such stocks. This is a double-edged sword though. Quarterly results are followed closely. Things are hunky dory as long as the stock maintains earnings momentum and meets/exceeds market expectations. However underperformance or falling below market expectations, even marginally, can send stock prices tumbling as all try to exit. Stocks growing rapidly therefore tend to be volatile.

Weaknesses

Apart from the volatility, stocks growing fast usually have another weakness. Especially those growing rapidly and spending heavily in business expansion usually cannot meet the capital requirements from internal cash flows. They either issue more shares to meet capital requirements leading to dilution of your equity and/or take on more debt which can lead to high financial leverage risks.

Volatility and Monitoring

Stocks growing fast rapidly increase sales and profits. Usually they are high-fliers with prices moving faster than the market. Small variations up or down from market expectations can send the stock flying in either direction. Therefore, Growth stocks require close monitoring.