My third rule for investing in the stock market is all about choosing companies with positive earnings growth. No negatively here thank you very much; it’s all positive thoughts and patchouli. The patchouli is of course entirely optional.
So where was I? Oh Yes …
Like Return on Equity, it’s another extremely important factor when it comes to finding winners to invest in the stock market. Which is why it’s one of my rules of course.
Throughout history the recurring theme is that earnings growth and stock price have a strong relationship. As earnings growth increases, so does the stock price, as it falls (or turns negative) then the share price plummets.
So get your Zen on and focus on only those companies who exhibit positive earnings growth figures. It doesn’t really matter if it’s only a 1% growth or 100% growth, anything positive is good. It’s not about the size as my ex would say. Or at least I think he was talking about stocks? Hmm.
Like all of my simple rules, it’s relatively easy to find out the earnings of a company simply by looking at its key statistics page. Here is DuPont’s Earnings Growth showing a very healthy 26.7%.
And here is its stock price over the past twelve months.
Nice increase isn’t it. Oh yeah.
But does it work the other way? Does a negative earnings growth figure show a decreasing price? Generally yes. And so that’s why I generally avoid companies that have negative growth.
I know what you are saying. Yes it’s still important to look at the overall picture. Some companies are cyclical and have their strongest months during certain seasons, like for example a hotel resort during summer, or a department store during the holiday season. So it’s quite possible that they could show negative earnings growth for the quarter following a particularly strong period as sales slow down again and return to normal.
Many investors will look at earnings growth and nothing else when deciding which stocks to buy. If they find a large cap or mid cap stock with increasing earnings every quarter they’ll buy without batting an eyelid. These growth investors can sometimes do quite well (which is why many people specifically seek out ‘growth’ stocks), however I feel that JUST looking at earnings is missing part of the puzzle. You still do need to look at all the other factors such as ROE and debt before you jump in and buy.
You want to buy the very best companies that you can and being strict on choosing those companies is one step closer to making real money through stocks.
Thankfully I’ve found it doesn’t need to be difficult; just a few key statistics are all you need to find great companies to invest in.
And earnings growth is one of them. I’m sure you’ll agree.
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