Page 1070 - How to Make Money in Stocks Trilogy

56 HOW TO MAKE MONEY IN STOCKS—GETTING STARTED

That’s why you also want to make sure the company is delivering solid
annual EPS growth.
Here again, 25% annual growth over the last three years is the minimum.
The top stocks often post numbers that dwarf that. Going back to Google in
2004, its three-year annual EPS growth rate was 293% before it launched its
five-fold gain.

Sales Growth and Return on Equity
Does your stock have the key ingredients that drive earnings growth?
Since big, accelerating earnings growth is the #1 factor to look for, make
sure the company has the basic ingredients that generate that type of earnings
performance: Superior sales, a high return on equity, and industry-
leading profit margins.
Sales growth shows how much demand there is for the company’s prod-
ucts or services. Profit margins and return on equity gauge how efficiently
the company is generating that sales revenue. All three factors ultimately
impact a company’s earnings growth.

■ ✔ SMR Rating of A or B
SMR Rating: Sales, Profit Margins and Return on Equity

The quickest way to see if a stock has the ingredients that drive earnings
is to check the SMR Rating. It measures a company’s Sales growth, profit
Margins (both pre-tax and after-tax) and Return on equity. Then it com-
pares that to the performance of all other stocks and assigns a rating from A
(best) to E (worst).
An A rating means that, in terms of sales, margins and return on equity,
the company is in the top 20% of all stocks.
Keep in mind, too, that the SMR Rating is a more accurate gauge than if
you looked at these three factors in isolation. For example, a company could
have rising sales growth but shrinking profit margins—which could have a
negative impact on EPS growth down the road. By looking at the more com-
prehensive SMR Rating, you get the full picture.
If a stock has good earnings growth but weak sales, profit margins, and
ROE, beware! That EPS growth may be less impressive—and less sustain-
able—than it appears.
In general, you want to buy stocks with an A or B SMR Rating and avoid
those with a D or E. The next table shows why that’s important.