Wednesday, 21 April 2010

****How to identify Growth Stocks? You should not try to identify a growth stock using financial ratios alone.

Wal-Mart has been a great growth stock, giving an 80,000 percent return over a 38-year period since 1970, when shares first became publicly available, or an incredible 35% per year.

How to identify Growth Stocks?

The success of a business, and hence its growth, depends primarily on its customers.  To find a great growth business, you need to evaluate it from a customer's point of view.  Once you are satisfied that the company's sales and earnings will continue to grow and that you can buy the stock at a reasonable price, buy and hold it for a long time.

Here is an important lesson:  How NOT to identify Growth Stocks?

Let's start with how NOT to identify a growth stock because it is especially important if you have been considering value investing.

You should not examine the financial fundamentals immediately after you have discovered a company that may grow in leaps and bounds for many years.  Do not emphasize the fundamentals much.

  • In other words, when you start thinking about a growth stock, do not start thinking about the historical P/E ratio or, for that matter, any other quantitative measure that you might have learned in business school.  
  • If you start thinking about traditional financial ratios, you will start thinking of value stocks, and you will probably never pick a great growth stock.  You would never have picked shares in Microsoft, Wal-Mart, or Home Depot if you had looked at the fundamentals soon after the companies went public.  
  • Even if you knew these were incredible companies, you would have missed their tremendous potential.

We are not suggesting that traditional financial ratios are not important; we are simply suggesting that you should not try to identify a growth stock using financial ratios alone. 

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