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Earnings: The Most Important Element of Great Stocks
There have been many researches on price movement of stocks and it has proved that earnings growth is single most important indicator of potential towards a big price move in any stock. Now how do we find which are the companies who are showing earning growth. We will learn slowly…
Why Earnings Growth is so Important
Since you have interest in stock market and want to make money, I am sure each one of you must have seen a few good stocks over a period of years such as Reliance Industries or Pantaloons retail or Vinati Organics or even Dhanuka. There were very clear signals that these winners are going to make major moves before they became big and well-known names.
Various studies have been conducted by researchers to establish and understand the relations ship on price movement and why only a few stocks grow by 100%; 200% or even 300%. Canfina Homes, Caplin Labs; and Suven Life Sciences are a few such examples. The researches proved that though growth of a stock is dependent on several factors but the earnings is the single most important factor responsible for such a phenomenal growth. We will learning about other winning factors too over a period of time.
WHAT TO LOOK FOR A STOCK TO GROW AND BEGINNING OF RESEARCH
• Earning growth per Qtr must be 25% or more on same period of earlier year.
• Earning must be increasing substantially in preceding three QTRs by QTR.
• EPS or earning per share must be more than 25% over preceding three years.
A good management and leadership of the organization will ensure min earning growth of 25% ++ and we must look for the same.
HOW DO WE EVALUATE THE EARNINGS
OOOPS Friends!!! This is one of the most difficult task as one needs to sit for a long before system and compile data before doing any analysis and this takes lot of time.
Unless hard work is done it would be very difficult to reap the harvest and once compiled everything one needs to focus on companies announcing superior earnings and fish the better ones to narrow down the search.
HOW DO WE AVOID TRAP
People normally get trapped by various common myths about earnings and one of the myth is “ONE SHOULD ONLY HUNT FOR THE STOCKS WITH LOW PE RATIO. (PE=PRICE TO EANINGS)
Basically PE ratio is nothing but a way to look at stocks price in relation to earnings per share for the whole year. For example if a stock quoted at 100 a share with annual earnings of INR 10 per share, its PE would be 10, in other words stock is available at 10 times higher price than its earnings per year.
The common myth is higher PE ratio means over priced stocks but the fact is mostly best stocks do have higher PE ratios.
SALES MARGINS AND RETURN ON EQUITY
It’s important to look at other parameters too viz. sales growth, profit margins and return on equity as they are vital for a company’s health and performance. Again the key of earnings comes here to play the role, which is derived and is dependent of above factors.
The profit volumes shall be dependent on sales figures which is the strength of a company or vice versa. Infact the growth reflection of any company comes through understanding of its sales growth and sales numbers year after year, which also depicts the customer’s confidence in the product or services of the company. Any company can record incremental profits only through two means one by increasing sales and the other will be by reducing expenses, however one can reduces expenses to a certain limit only as to run business and company you need s affixed set of min resources.
The sales growth is like the foundation of a house, if its strong obviously house will last longer and will be robust and same applies to any company. If sales numbers are good and strong, growing consistently this means it’s a sound company where customers have been continuously expressing their faith and confidence and are happy with its product and or services. As and when sales increases this means that company is making conscious efforts to create demand and making a sound base for growth and increased profits.
The good top companies show a consistent and regular growth pattern and at times its double digit min. at initial stages a good company can register even a three digit growth due to vacuum in market or increasing demand or any other factor.
WATCH FOR TRAPS IN SALES FIGURES
Even if sales numbers are increasing but customer base is very limited it will always be a risky business as most of the eggs are in one basket and if it falls down, all eggs are gone. There are companies who have a very handful of customers and markets and on other hand companies are there having a vast customer base and many markets including overseas exports in couple of countries and continent. If a company is solely dependent on exports, any fluctuation in currency, foreign country policy on those products and service will have a positive and negative impact on its sales growth. The current example is for TCS and INFOSYS in US market where the policies of new president are not favorable to them, second strong INR also is impacting their earnings and sales growth.
Companies at time take those orders as sales which actually has not happened in terms of transactions and is a sort of data manipulations as there is always a gap between cup and lip.