Page 280 - How to Make Money in Stocks Trilogy

158 A WINNING SYSTEM

the size of the increase that cause a big move. It’s also that the increase rep-
resents an improvement from the company’s prior rate of earnings growth.
If a company’s earnings have been up 15% a year and suddenly begin spurt-
ing 40% to 50% or more—what Wall Street usually calls “earnings sur-
prises”—this usually creates the conditions for important stock price
improvement.
Other valuable ways to track a stock’s earnings include determining how
many times in recent months analysts have raised their estimates for the
company plus the percentage by which several previous quarterly earnings
reports have actually beaten their consensus estimates.

Insist on Sales Growth as Well as Earnings Growth
Strong and improving quarterly earnings should always be supported by
sales growth of at least 25% for the latest quarter, or at least an acceleration
in the rate of sales percentage improvement over the last three quarters.
Certain superior newer issues (initial public offerings) may show sales
growth averaging 100% or more in each of the prior 8, 10, or 12 quarters.
Check all these stocks out.
Take particular note if the growth of both sales and earnings has acceler-
ated for the last three quarters. You don’t want to get impatient and sell your
stock if it shows this type of acceleration. Stick to your position.
Some professional investors bought Waste Management at $50 in early
1998 because earnings had jumped three quarters in a row from 24% to
75% and 268%. But sales were up only 5%. Several months later, the stock
collapsed to $15 a share.
This demonstrates that companies can inflate earnings for a few quarters
by reducing costs or spending less on advertising, research and develop-
ment, and other constructive activities. To be sustainable, however, earnings
growth must be supported by higher sales. Such was not the case with Waste
Management.
It will also improve your batting average if the latest quarter’s after-tax
profit margins for your stock selections are at or near a new high and among
the very best in the company’s industry. Yes, you have to do a little home-
work if you want to really improve your results. No pain, no gain.

Two Quarters of Major Earnings Deceleration
Can Be Trouble for Your Stock
Just as it’s important to recognize when quarterly earnings growth is accel-
erating, it’s also important to know when earnings begin to decelerate, or