There are plenty of criteria that investors use to identify potential stock winners. Technical strength (good price and volume action on the stock's chart) is one of the indicators to watch. However, fundamental strength attracts professional investors to a stock, and is frequently the driver behind a stock's price growth.
Spotting a stock with good fundamentals isn't hard, if you know the right items to look for. If you want to find out how to identify these possible winners before they make big price moves, read on for three easy steps toward achieving that.
The all-important initial step is to check the company's profit growth. The best growth stocks have strong earnings increases, ideally a minimum of 18%-20% in each of the recent quarters. You also want to see good profit growth estimates for the coming years and quarters.
You want to do this because strong earnings attract institutional investors, and that's who buys the stock in bulk, sending the price higher. The bigger mutual funds, hedge funds and pension funds seek stable, well-managed companies that show regular profits. It's going to be very important to avoid speculative, unprofitable names. While they may look attractive on their charts sometimes, they can be extremely volatile, and prone to sharp sell-offs.
Your second step will be to check the company's sales growth. Stocks with explosive price growth generally have a hot new product that's in high demand. Remember how Apple had been a languishing computer maker before the iPod hit it big in 2004? That new product was the first of many big sales engines at the company in the next few years. Items to avoid here are companies with slowing sales growth or, even worse, several quarters of declining sales.
Your third and last step will be to check the return on equity for company you are watching. This is very important because ROE shows you the return that investors get for the money the put into the company. You'd ideally like to see a company with ROE of at least 15%, as an indicator of operational efficiency. What will be important to avoid is a company with a low return on equity, or one that's been falling on a year-over-year basis. That shows that the company is delivering less to investors, and may indicate a problem with management. .
Carefully follow each of these three easy steps, for the reasons given. Lots of people like to invest in flawed companies, thinking they are getting a bargain, or finding a diamond in the rough. But the stocks that have the best potential for price gains typically have a track record of excellent fundamentals.