C: Current Earnings Growth
Research shows that earnings growth is the single most important indicator of a stock’s potential to make a big price move. The stocks you select should show a major percentage increase in current quarterly earnings per share (the most recently reported quarter) when compared to the prior year’s same quarter.
Large increases in current quarterly earnings per share. Look for these increases to be at least 25%. (Three out of four of the best-performing stocks in our research showed earnings increases of 70% or more in the quarter right before they started to make their huge price moves!)
Preferably, look for accelerating earnings in at least the three most recent quarters.
Check earnings consensus estimates to make sure the company is projected to be on a positive track.
Investing Tip: The best stocks often have high – some would say ridiculous – P/E ratios when they start their big climbs. If you weren’t willing to pay the higher P/Es, you eliminated most of the best stocks of all time.
How to Identify Companies with Superior Earnings Growth
Investor’s Business Daily and investors.com make it easy to identify companies with superior earnings growth:
An Earnings Per Share (EPS) Rating is provided for all stocks in our database. This proprietary rating measures a company’s earnings performance by looking at its: 1) latest two quarters’ earnings per share growth, 2) 3-year annual earnings growth rate, and 3) stability of annual earnings growth. These factors are then weighted and compared to the same measures for all other public companies.
EPS Ratings are on a 1-99 scale, with 99 being highest. An 80 EPS Rating, for example, indicates that a stock is outperforming 80% of all other companies based on earnings performance. In other words, a stock with an EPS Rating of 80 is in the top 20% of all companies in terms of recent quarterly and annual earnings growth. Research shows that the stocks that make the most powerful gains usually have an EPS Rating of 80 to 85 or higher.
Where Can I Find Earnings Per Share (EPS) Ratings? EPS Ratings can be found in IBD’s main stock tables and the IBD Stock Checkup® and IBD Charts on investors.com.
Domestic companies generally report their earnings four times a year. Investor’s Business Daily’s “Earnings News” section provides comprehensive earnings reports. To make finding earnings leaders easier, IBD separates these reports between companies posting earnings gains and those reporting lower results. The list is arranged by order of highest percentage gains in earnings to save you time. IBD also provides a “Best Ups” section to help you zoom in on the absolute best earnings reports. The number of companies in each of these categories gives you an overall idea of whether corporate earnings are healthy or not.
Where Can I Find Earnings Reports? Quarterly earnings reports are provided in the “Earnings News” section of Investor’s Business Daily. Earnings information is also available in IBD Stock Checkup®.
Another source for identifying companies with superior earnings is IBD’s “Your Weekly Review,” produced each Friday. This feature lists stocks that rank in the top 15% of all companies in earnings performance. In addition, these stocks must pass rigid performance criteria in order to make the list (85 in both EPS and RS Ratings) and must be within 15% of their 12-month price high. Make sure you view this prospect list for potential new investment ideas.
Black-bar highlighted stocks in IBD’s main stock tables identify stocks you may want to research further. In addition to having strong earnings, these companies possess top growth fundamentals, including sound profit margins and ROE figures.
A: Annual Earnings Growth
As we’ve seen, strong current quarterly earnings are critical to picking the market’s biggest winners. However, three out of four of the biggest winners in our research also showed at least some positive annual growth rate over the five years preceding the stock’s big run-up. We’ll also look at other key fundamentals you’ll want to consider.
The annual earnings per share should show consistent growth over the past three to five years. Look for average annual EPS growth of at least 20% to 25%.
Between 1980 and 2000, the median annual growth rate of all outstanding stocks in IBD’s study of the greatest stock market winners, prior to big price moves, was 36%.
Look for stocks where each of the last three years shows an increase in annual earnings, with no one single-year being down.
It is also helpful to see either the annual pre-tax profit margin and/or the annual return on equity expanding.
Return on Equity (ROE) should be 17% or higher.
The last three quarters’ sales should either show acceleration in the rate of increase and/or the latest quarter should be up at least 25%.
Investing Tip: In a few cases you may accept one down year in the last five as long as the following year’s earnings quickly recover and move back to new high ground.
How to Identify Companies with Superior Annual Earnings Growth and Other Strong Fundamentals
Investor’s Business Daily and investors.com make it easy to identify companies with superior earnings growth and strong fundamentals.
An Earnings Per Share (EPS) Rating is provided for all stocks. This proprietary rating measures a company’s earnings performance by looking at its: 1) latest two quarters’ earnings per share growth, 2) 3-year annual earnings growth rate, and 3) stability of annual earnings growth. These factors are then weighted and compared to the same measures for all other public companies.
EPS Ratings are on a 1-99 scale, with 99 being highest. An 80 EPS Rating, for example, indicates that a stock is outperforming 80% of all other companies based on earnings performance. Seen another way, a stock with an EPS Rating of 80 is in the top 20% of all companies in terms of recent quarterly and annual earnings growth. Research shows that the stocks that make the most powerful gains usually have an EPS Rating of 80 to 85 or higher.
The Annual Earnings Growth Rate is provided for every stock in our database in the Vital Statistics section of IBD Stock Checkup®.
“Stocks In The News” charts in Investor’s Business Daily profile stocks showing current strength – either making new price highs, near new highs, or showing price strength on unusually high trading volume. Annual earnings growth can be found on these charts also.
Another source for identifying companies with superior earnings is IBD’s “Your Weekly Review,” produced each Friday. This feature lists stocks that rank in the top 15% of all companies in earnings performance. In addition, these stocks must have strong price performance in order to make the list. Make sure you view this prospect list for potential new investment ideas.
Black-bar highlighted stocks in IBD’s main stock tables identify companies you may want to research further. These are top fundamental stocks.
An SMR Rating™ (Sales + Profit Margins+ Return on Equity) is provided for every stock listed in Investor’s Business Daily. This rating combines four fundamental factors that research shows can influence a stock’s price: sales growth rate over the last three quarters, pre-and after-tax margins,and return on equity (ROE). The SMR Rating™ uses a simple A to E scale:
A = Top 20% (Outperforming 80% of all other stocks in these key fundamentals)
B = Next 20%
C = Next 20%
D = Next 20%
E = Bottom 20% (Under performing 80% of all other stocks in these key fundamentals).
Where Can I Find the SMR Rating™? The SMR Rating™ can be found in IBD’s main stock tables and the IBD Stock Checkup®.
The Fundamental Rating found on the IBD Stock Checkup®, provides a single assessment of a company’s earnings and key fundamentals. This rating measures annual and quarterly sales and earnings growth, sales and earnings acceleration, earnings stability, and profit margins and return on equity. Like other IBD ratings, the Fundamental Rating uses a simple 1-99 scale, with 99 being highest.
N: New Products, New Services, New Management, New Price Highs
Explosive stock growth doesn’t happen in a vacuum. Usually, new products, new services, new management or new industry conditions propel stocks to new heights. In its study of the greatest stock market winners, IBD discovered that more than 95% of the successes in American industry met at least one of the above criteria. And, contrary to the beliefs of many investors, stocks that make the biggest price advances start their moves when they are already at or near new price highs. By following the old adage, “buy low, sell high” investors would have missed out on most of the biggest stock successes in market history.
A stock that makes big gains often results from new products or services. But be wary of unproven products, especially if the company management doesn’t have a solid track record.
Superior management is essential to a company’s success. That’s why often a shakeup at the top pushes a stock’s price higher.
Quality stocks making new price highs just as they emerge from sound chart bases on higher volume are often likely to continue climbing, while stocks making new lows are probably headed even lower. Therefore, focus on the new price highs list for the best potential opportunities.
You can think of a stock’s price as a measure of its quality and, consequently, its potential. Typically, stocks higher in price reflect higher quality.
Always be on the lookout for new products, new services, new management, or major improvements in industry condition.
Investing Tip: An IBD survey indicated that 98% of investors do not buy stocks making a new high price. An analysis was made of the IBD’s new-high and new-low stock lists during several good, as well as poor, market periods. The findings were clear: stocks on the new-highs list tended to head higher, and those on the new-lows list often continued lower.
How to Identify Companies with Positive New Conditions
“The New America,” found daily in IBD, features companies with enterprising products or services and good fundamentals, often before they are widely known. These are companies that exhibit the characteristics found among the market’s biggest leaders of the past.
IBD publishes a daily list of stocks making 52-Week Highs. These new highs are categorized by sector to more easily identify potential market leadership.
IBD’s main stock tables show each stock’s 52-week high. And stocks making new highs or up at least $1 for the day are boldfaced to help quickly identify strength.
The “Internet & Technology” pages in IBD regularly profile high-tech companies developing innovative products. A team of Investor’s Business Daily reporters and editors in the heart of Silicon Valley covers this field. The section includes interviews with top executives of leading technology companies.
IBD’s Industry Groups page features Groups With Highest % Of Stocks Making New Highs to help identify market leadership, as represented by new highs.
A good way to keep up with changes in corporate boardrooms is Investor’s Business Daily’s “To The Point” section. This is a one-page news summary, packed with dozens of developments at U.S. companies, including reports on leadership changes at major businesses.
S: Supply and Demand
Our study of the greatest stock market winners validates what most investors understand.when demand for a stock outpaces supply, the price usually heads north. The best way to measure a stock’s supply and demand is by watching its daily trading volume. When a stock rallies up in price, you want to see volume rise at the same time, which may represent institutional buying that can really power a stock’s move. When a stock pulls back in price, you want to see volume dry up indicating no significant selling pressure.
Watch the demand for shares by looking at the Volume % Change for each of your stocks. It will show you immediately how much a stock traded vs. its average daily volume over the last 50 trading days. For example, a stock that trades 100,000 shares on average will have a 50% Volume % Change if it trades 150,000 shares on the day.
Stocks closing at their highs for the day or gapping up in price can indicate strong demand.
Companies buying back their stock in the open market and companies showing stock ownership by management can be positive indications.
When a stock breaks out of a price consolidation area, trading volume should be at least 50% above its average daily volume, indicating strong demand.
In many cases, a strong stock breakout will see volume up 100% or more for the day, indicating solid buying and the possibility for further price increases.
Investing Tip: A stock moving up in price on lower than normal volume could be a sign of weakness. Look for strong demand supporting price increases.
How to Track Demand for a Stock
Volume % Change is computed for all stocks in IBD’s main stock tables. This helps you easily identify stocks with higher than average demand.
In the quotes area on investors.com, Volume % Change is updated continuously throughout the day, looking at volume at that point in the trading session.
Investor’s Business Daily can help you track the level of supply and demand among large institutional investors. The Accumulation/Distribution Rating (ACC/DIS Rating™) , provided for every stock in our database, analyzes price and volume changes over the past 13 weeks. An A or B Rating is bullish, because it indicates big investors are, on net, loading up on the stock. Such accumulation is one sign that the stock could turn out to be a winner.
Where Can I find the Accumulation/Distribution Rating (ACC/DIS Rating™)? This key rating can be found in IBD’s main stock tables as well as on IBD Stock Checkup® at investors.com.
“Stocks On The Move” lists higher quality stocks that are moving up in price on unusually high demand. Investors.com provides a continuously updated version of the Stocks On The Move list as well.
For a broader look at the moves of institutional investors, there are two key charts to check out on IBD’s Industry Groups page. One is “Big-Cap Growth Funds Vs. Small-Cap Growth Funds”. When the line on this chart is moving up, it tells you big-cap stocks are outperforming small-cap stocks. This indicates there are probably more investment opportunities in large-cap stocks than in small-cap stocks, based on current institutional demand. “Value Funds vs.Growth Funds” is the other screen that can help you zoom in on where current demand is focused.
L: Leader or Laggard
Our studies show that, on average, 37% of a stock’s move is directly tied to the performance of the industry the stock is in, and another 12% is due to strength in its overall sector. That’s why it’s so important to track the performance of both industry and sector groups. Leadership also refers to an individual stock’s performance in the market. Once you’ve identified the most powerful industry groups, the next step is to identify the strongest stocks in those industries.
Look closely at the top 20% of industry groups (Investor’s Business Daily tracks 197). Our study of the greatest stock market winners show the best stocks generally come from the top 22% of industry groups. Also, you want to avoid the bottom 20% of groups. Historical analysis also shows stocks within the top half of all industry groups greatly outperform those in the bottom.
The best-performing stocks are generally No. 1 in their industry based on key fundamentals, including return on equity, annual earnings growth, pretax and after-tax profit margins and its relative price strength.
Look for confirmation of strength from at least one other company in the same industry group.
Look for leading stocks: Our study of the greatest stock market winners found that all-star stocks had, on average, outperformed 87% of the market before they began their most dramatic price advances. In a manner of speaking, if you want to find next year’s winning stocks, look at the better-performing stocks today.
Once a general-market decline is definitely over, the first stocks to bounce back to new price highs are almost always your authentic leaders.
Investing Tip: Stay away from “sympathy plays,” meaning a stock in the same industry group as a leading company bought in hopes that the leader’s luster will rub off on to it. The performance of such sympathy plays usually pale in comparison to the true leaders. Eventually they will try to move up “in sympathy” but they rarely, if ever, do as well.
How to Find the Leaders
IBD’s “Your Weekly Review,” found in Friday’s edition, lists earnings and performance leaders sorted by industry group strength. This is a great starting point for potential investment ideas.
Each day, Investor’s Business Daily’s Industry Rankings table, found on the Industry Groups page, ranks 197 different industry groups by the price performance of all stocks in that group over the latest six months.
An Industry Group Relative Strength Rating is provided for all stocks. The proprietary rating describes how well the industry to which the stock belongs is performing. Industry groups are rated on a scale of A+ to E, with A+ being best. B-rated stocks may also have potential. It’s also significant when the industry group has been moving up in ranking in the industry rankings table.
Where Can I Find The Industry Group Relative Strength (RS) Rating? This gauge of industry strength can be found in IBD’s main stock tables and IBD Stock Checkup® on investors.com.
The table of 52-Week Highs, which IBD sorts by sector, can also provide good insights to which industries are drawing interest among professional investors.
Look for stocks with a Relative Price Strength (RS) Rating of 80 or higher. This rating is on a scale of 1 to 99, with 99 being highest. An 80 rating indicates the stock is outperforming at least 80% of all other companies based on its price performance over the last 12 months.
Where Can I Find The Relative Price Strength Rating? RS Ratings, indicating the price strength of a stock relative to all other stocks, can be found in IBD’s main stock tables and IBD Stock Checkup® on investors.com.
The Relative Strength line, included in IBD Charts on investors.com, helps confirm a stock’s upward price movement. You also want to see the RS line moving in a strong up-trend.
IBD Stock Checkup® on investors.com provides a list of the top five stocks in each industry, based on the most relevant fundamental and technical factors.
: Institutional Sponsorship
Mutual funds and other professional investors represent the vast majority of trading activity in the market. As such, they wield tremendous influence over stock prices, capable of sending their favored stocks up significantly. Here, you’ll learn how to spot stocks benefiting from “institutional sponsorship.”
A stock should show an increasing number of institutional sponsors in recent quarters (accelerating sponsorship).
A stock should have at least several institutional owners. If there is no institutional sponsorship, it is likely the performance will be more run of the mill.
You want stocks owned by the most successful money managers, the ones who have a proven record for consistently selecting top-performing stocks at the right time.
Consider giving greater weight to those stocks being bought by top-performing mutual funds, either as new positions or add-on purchases.
Investing Tip: Many institutional investors avoid buying stocks selling for less than $15 a share.
How to Track Institutional Demand for a Stock
One of the most useful ways to spot current institutional trading is to study Volume % Change figures, that is the percentage up or down in trading volume of a stock compared to its average daily volume over the past 50 days. This is often the first sign that institutions are moving in or out of a stock in a major way.
Volume % Change is listed in the stock quotes at investors.com and provides an updated projection of the day’s volume as an early indication of any unusual trading activity. Investor’s Business Daily’s stock tables also include Volume % Change.
“Stocks On The Move,” provided on the home page of investors.com, is a continuously updated screen of stocks making notable price moves with the most unusual buying and selling activity. Such activity may be an early indicator of stocks heavily traded by institutions.
“Stocks On The Move,” also offered in the pages of Investor’s Business Daily, provides stocks making notable price movement and showing unusual trading activity the previous day compared to their average. A different list is provided for the NYSE, Nasdaq and American Stock Exchange.
“Your Weekly Review” shows positions taken by the best-performing mutual funds in the top-quality stocks chosen for their high EPS and RS Ratings. This powerful list identifies high-quality stocks that may be in high demand by institutional investors.
The Accumulation/Distribution Rating weighs the amount of buying volume vs. selling volume in a stock over a 13-week period. (The calculation uses a moving average of price and volume data.) The result is represented by IBD on a scale of A to E and enhanced by “+” and “-” symbols to show institutional buying and selling activity in finer detail. You should consider stocks with A or B ratings. C stocks are neutral and may be O.K. to buy. The Accumulation/Distribution Rating is a proprietary rating included in the IBD SmartSelect® Corporate Ratings.
Where Can I Find the Accumulation/Distribution (ACC/DIS) Rating™? This key rating can be found in IBD’s main stock tables as well as the IBD Stock Checkup® at investors.com.
IBD’s Sponsorship Rating (SPON Rating™), which can be found Tuesdays in the main NYSE and Nasdaq tables, is designed to spot stocks being bought by funds, especially those with good performance records. The Sponsorship Rating is boosted for stocks owned by more funds each quarter. A higher rating is also placed on stocks more heavily owned by the top-performing mutual funds. Sponsorship is shown on a scale of A to E, with A representing the highest rating. Because it relies on reports from fund companies, this rating is best used to evaluate longer-term sponsorship trends.
In IBD’s mutual fund charts, check the “Top New Buys/Sells and Top 10 Holdings” for information on which stocks have been bought and sold by leading funds. A stock should show an increasing number of sponsors in recent quarters.
You can tell if the market is shifting to small- or big-cap stocks by watching the chart titled “Big-Cap Growth Funds Vs. Small-Cap Growth Funds,” found in IBD’s Mutual Funds pages.
Market direction is the most critical characteristic to consider when investing. Almost all the best stocks over the past five decades have made their upward moves when the overall market was strong. And historically, three out of four stocks have followed the general market trend – up as well as down. So it’s critical to understand exactly what the market is doing by watching it every day. Accurately gauging the market is not a matter of luck or “Monday morning quarterbacking.” There are clear telltale indicators that can help you identify market tops and bottoms.
Bear markets are normal and necessary and serve to clean up prior excesses. They also allow the market to create a whole new set of chart bases and leaders for the next bull market. It’s important to not get discouraged or lose confidence; otherwise, you’ll miss the next bull market.
Bear markets create fear, uncertainty and a loss of confidence. When stocks hit bottom and turn up to begin the next bull market – loaded with opportunities – most investors simply don’t believe it.
New big winners emerge during the first 10 to 15 weeks of a new bull market. It’s important to identify market turns early to capitalize on these great opportunities.
The market indexes signal a market bottom. Look for the first attempt at a rally. If the rally follows through anywhere from fourth to tenth day of a rally (preferably by the seventh day), it is an indication of a new uptrend. For a valid follow through to occur, look for an increase in total market volume from the previous trading day and substantial price advances for the day – at least 2% in either the Dow. S&P 500 or Nasdaq Composite.
At major market turns, you may see market indexes moving in different directions. The Dow, for instance, may be making new highs while the S&P 500 does not. It’s also important to note if an index is advancing or declining at a much greater rate than another. For example, if the Dow rises 3% one day as the S&P 500 (the broader index) rises only 1%, it indicates the rally is not as broad or strong as it may appear. This is why it’s helpful to study market indexes in tandem, to more easily spot confirmations or divergences at key turning points.
Historically, market tops occur after the major market averages move into new high ground and show several days of large and increased volume with either poor price progress or actual declines in the averages.
Few market predictions ever materialize. That’s why you shouldn’t listen to any personal opinions about the market. Instead study the day-to-day price and volume changes in the leading indices. The goal is not to predict the market into the distant future but rather understand its exact condition at the time. Is it in a confirmed uptrend or downtrend, and is it acting in a normal or abnormal manner?
It’s of no value to make a worthwhile gain during several years of a bull (up) cycle and then give it all back during the following bear (down) cycle. It’s better to get out of the elevator on one of the floors on the way up than to ride it all the way back down.
Investing Tip: Many of the biggest investing opportunities can be found right as the market begins a confirmed change in direction.
How to Determine the General Market Direction
The Big Picture provides a clear analysis of what the market is doing. Just as important, you’ll learn what the market isn’t doing. This daily column includes the “Market Pulse,” a table summarizing the major action in the indexes and leading stocks. IBD’s Big Picture pointed out distress signals in March 2000 when distribution heralded the end of a great bull phase.
IBD’s General Market & Sectors page should be checked every day to evaluate the market’s health. The three key indices (S&P 500, S&P 600 and Nasdaq Composite) are stacked, one on top of the other, to help you spot confirmation or divergences in action at key turning points. A brief column next to the charts analyzes significant action, using numbered bullets to help readers understand what the charts are showing.
The Markets, accessible from the homepage of investors.com, updates index prices and charts throughout the day.
During attempted rallies in a bear market, the advance/decline line (produced by taking all NYSE stocks that rise in price for the day and subtracting those that fall) can be telltale, particularly when this line shows no ability to rebound when the indices try to rally.
The General Market & Sectors page also shows several valuable psychological market indicators. The percentage of investment advisers who are bullish or bearish and the ratio of put volume to call volume have historically been solid indicators. These contrarian indicators can be valuable when examined in conjunction with the major market indexes.