Smart Growth

Last modified 09:59, 5 Nov 2012

Smart Growth

The Smart Growth model employs a variety of strategies that individual investors can use. These strategies divide attractive stocks into different categories, each characterized by different criteria. Then the stocks in each criteria are subjected to further analysis.

There are three broad categories:

Fast Growers

These companies have little debt, are growing Earnings at 20% to 50% a year, and have a stock Price-to-Earnings ratio below the company's Earnings Growth Rate.

Investing in these types of stocks makes sense for investors who want to find solidly financed, fast-growing companies at reasonable prices.

Slow Growers

Here the Smart Growth model is looking for companies with high Dividend Payouts, since dividends are the main reason for investing in slow-growth companies.

Among other things, these companies are also required to have Sales in excess of $1 billion, sales that generally are growing faster than Inventories, a low yield-adjusted Price/Earnings to EPS Growth ratio, and a reasonable Debt-to-Equity ratio. In other words, slow growing, but fundamentally healthy.

Investing in these types of stocks makes sense for income-oriented investors.

Stalwarts

Stalwarts have only moderate earnings growth but hold the potential for 30%-to-50% stock price gains over a two-year period if they can be purchased at attractive prices.

Characteristics include positive Earnings; a Debt-to-Equity Ratio of .33 or less; Sales rates that generally are increasing in line with, or ahead of, Inventories; and a low yield-adjusted Price/Earnings to EPS Growth ratio.

Investing in these types of stocks makes sense for investors who are not willing to pay up for high-growth companies but still want the chance to enjoy significant capital gains.

Analysis

After classification into categories, the results in each category are subjected to two further levels of analysis.

The first level of analysis looks at fundamental data and ratio results that are specific to companies that are in that category. For instance the Price Earnings Growth Ratio (PEG) result is one of the figures scrutinized for Fast Growers, whereas large Sales volume are an important consideration for companies in the Stalwarts group.

The second level of analysis is not classification specific, rather the same criteria is applied to all results, regardless of which classification they fall into. These criteria is designed to confirm that the companies are well managed and fundamentally healthy.

Analysis / Calculation

As mentioned previously, the general process for the Smart Growth analysis involves three stages of categorization and analysis:

Click on one of the links above to go to that stage's description below.

General Classification

Smart Growth has a company type classification system based on 5-Year Earnings-per-Share Growth rate.

Fast Growers are companies where the EPS Growth Rate over the past 5 years is at least 20%.

Slow Growers are companies where the EPS Growth Rate over the past 5 years is less than 10%.

Stalwarts are companies where the EPS Growth Rate over the past 5 years is less than 20% but at least 10%.

Category Specific Analysis

Once classified into one of the three types, the groups of companies in each category are analyzed using criteria and parameters most appropriate for analyzing companies in that category.

Fast Growers

Three analyses are applied to companies in the Fast Growers category:

P/E Growth (PEG) Ratio

The PEG ratio looks at how the P/E Ratio relates to Earnings Growth.

It is calculated by dividing the P/E Ratio by Earnings Growth.

A PEG of 1, where P/E equals Earnings Growth, is theoretically considered fair value, whereas a value greater than 1 is expensive and below 1 is considered cheap.

Smart Growth considers PEG ratios up to 1.8 to be acceptable.

A PASS reflects a stock with a PEG of 1.8 or less.

A FAIL is a stock with a PEG more than 1.8

Sales Volume & P/E Ratio

Price/Earnings (P/E) ratio is calculated by dividing the stock price by Earnings-per-Share (EPS).

Smart Growth considers a company with a P/E ratio less than 40 reasonably priced and sales of more than $1 billion makes it the right size.

A PASS indicates a company has annual sales of more than $1 billion and a PE Ratio of less than 40.

A fail indicates the company does not satisfy Smart Growth's requirements in this regard.

Moderate EPS Growth

EPS Growth indicates that the company is growing over time. Smart Growth prefers stocks with EPS Growth between 20-50%.

Once EPS Growth gets above 50%, the model's view is that it may not be sustainable from year to year.

A PASS rating reflects Earnings-per-Share Growth between 20-50% over the past 5 years.

A FAIL rating reflects that EPS Growth is either too high and possibly difficult to sustain, or too low and not growing fast enough.

Slow Growers

Three analyses are applied to companies in the Slow Growers category:

Sales

Sales can be a measure of size of the company. The larger the company, the greater the sales should be.

For Slow Growers, Smart Growth aims for sales around $2 billion or more.

A PASS reflects annual sales of $1 billion or more and hence the company is considered big enough.

A FAIL reflects sales less than $1 billion and hence too small to be a Slow Grower.

Yield-adjusted PEG Ratio

The Yield Adjusted PEG is the Price-to-Earnings Growth ratio which has been adjusted for dividends.

The dividend yield is important for Slow Growers, therefore the PEG is adjusted for dividends.

Where a normal PEG is calculated by dividing the P/E ratio by the Earnings Growth rate, the Yield Adjusted PEG is calculated by dividing the P/E ratio by both the earnings growth rate plus the dividend yield.

A PASS indicates that the Yield Adjusted PEG is 1.0 or less.

A FAIL indicates that the Yield Adjusted PEG is more than 1.

Elevated Dividend Yield

When looking for a slower growing stock, a higher dividend yield becomes important. The Dividend Yield is the full year dividend divided by the stock price and then multiplied by 100 to express the result as a percentage. It reflects the income that the company distributes to stockholders. Smart Growth requires that a company's Dividend Yield is at least 3%.

A PASS reflects a stock which has a dividend yield of at least 3%.

A FAIL is a stock that has a dividend yield below 3%.

Stalwarts

Three analyses are applied to companies in the Stalwarts category:

Sales

Sales can be a measure of size of the company. The larger the company, the greater the sales should be.

For Stalwarts, Smart Growth aims for sales around $2 billion or more.

A PASS reflects annual sales of $1.9 billion or more and hence the company is considered big enough.

A FAIL reflects sales less than $1.9 billion and hence too small to be a Stalwarts.

Yield-adjusted PEG Ratio

The Yield Adjusted PEG is the Price-to-Earnings Growth ratio which has been adjusted for dividends.

The dividend yield is important for Stalwarts, therefore the PEG is adjusted for dividends.

Where a normal PEG is calculated by dividing the P/E ratio by the Earnings Growth rate, the Yield Adjusted PEG is calculated by dividing the P/E ratio by both the earnings growth rate plus the dividend yield.

A PASS indicates that the Yield Adjusted PEG is 1.0 or less.

A FAIL indicates that the Yield Adjusted PEG is more than 1.

Positive EPS

A positive EPS reflects that the company is profitable.

Smart Growth excludes companies from the Stalwarts group which make no money or lose money.

A PASS is a profitable stock with positive EPS.

A FAIL is given to companies losing money or making no money.

Five General Analyses Applied to All

After companies have been categorized and analyzed using criteria specific to each of those categories, ValueGain's Smart Growth model applies the following analyses to each company, regardless of which category they have been assigned to.

The criteria employed by these analyses is designed to confirm that the companies are generally well managed and fundamentally healthy.

Decrease (or minimum growth in) in Inventory to Sales

An increase in inventory compared to sales is negative because it means that there is more stock not moving. A decrease in inventory to sales is positive because it reflects more efficiency and a faster turnover of stock. The best case scenario is that sales is increasing but inventory to sales is negative. Smart Growth does not like it when inventories increase faster than sales.

A PASS rating reflects a company in which inventories are not increasing faster than sales, or if inventory is increasing, it is increasing no more than 5% of sales.

A FAIL is a company where inventory levels are increasing 5% more than sales

Total Debt to Equity

Successful companies are usually net borrowers of money. The Debt-to-Equity ratio measures how much debt the company has, compared to shareholders equity.

The Debt-to-Equity ratio is important in gauging a company's financial stability. If Debt-to-Equity is too high then the company may run into financial difficulty. If it is too low, it may indicate that the company is foregoing positive business opportunities in order to merely create more return to shareholders.

The ratio is calculated by taking Total Debt and dividing it by Shareholders Equity.

A PASS reflects a company with a Debt-to-Equity ratio less than 80%.

A FAIL rating is given if the company has a Debt-to-Equity ratio of 80% or more.

Equity to Assets (EA) Ratio and Return on Assets (ROA) Ratio

The best case is if Equity-to-Assets (AE) is greater than 13.5%, however Smart Growth accepts a EA ratio of 5% or more.

Return-on-Assets (ROA) must be at least 1%.

A PASS means that EA is 5% or more and ROA at least 1%.

A FAIL rating is given if EA is less than 5% and/or ROA is less than 1%.

Free Cash Flow per Share as a % of Current Price

Earnings can fluctuate because of variables such as a change in the accounting method or changes to spending levels on research and development . Hence, Cash Flow is used as a more accurate representation of how healthy the company is. After all, cash represents what the company has to spend.

Free Cash Flow per Share is how much cash the company has left over after it has paid all expenses.

Smart Growth requires that FCF/price is at least 35%.

A PASS indicates that FCF/share price is 35% or more.

A FAIL means that the stock's FCF/price is less than 35%

Net Cash per Share as a % of Current Price

Net Cash per Share is the cash and marketable securities minus long term debt divided by number of shares on issue.

Smart Growth likes to see lots of net cash with a minimum of 30%.

A PASS means that the stock's net cash to price is at least 30%.

A FAIL means the stock's net cash to price is less than 30%

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