How to Screen for Stocks With Strong Profit Growth

by Jeff Reeves | April 2, 2012 12:11 am

[1]In a previous article, I explained how to do exhaustive revenue research[2] to guarantee growing sales. That’s the “top line” for balance sheets. However the use of the phrase “bottom line” shows that no matter what sales are, it’s really profits that matter most.

Think of revenue as the gross amount of cash a company brings in. Obviously growth there is good … but if a company’s expenses grow faster than sales, there’s a problem.

Also called “net income” or “earnings” in Wall Street vernacular, these numbers are hugely important to investors. The money left over after the cost of paying salaries, buying materials and running operations is a company’s earnings.

You want can easily find the “net income” for any stock in Google Finance to provide important insights.

Just input the ticker you want — same as for revenue — then click on “Financials,” “Income Statement” and “Annual Data” in the same sequence. Consult the instructions previous section if you get hung up on this.

If you scroll down, after a host of charges, you’ll find ta line that says simply “net income” (underneath “extraordinary items” here).

As with revenue, what matters is growth year-over-year. A good stock will see its profits go up in each successive annual report.

And as with revenue, if you want to get even more information, you should look at how the company is performing in a few quarterly reports. Ideally, year-over-year profits will be on the rise in each quarterly filing — not just each fiscal year. That shows growth isn’t coming in spurts, but steadily and reliably.

Quality Can Matter as Much as Quantity

Here’s the catch, though: Those numbers above the “Net income” figure are not insubstantial. Sometimes companies face one-time charges that skew numbers either way.

The sale of a subsidiary, for instance, could produce hundreds of millions in revenue. But obviously you can’t replicate those gains every quarter. Similarly, a restructuring charge to lay off workers or close a plant could add short-term expenses but might result in long-term cost savings.

So don’t ignore those fields above. Of particular note is the “Net Income Before Extra Items,” which will show if any “extraordinary” charges resulted in a one-time change. Also of note is the “Unusual Expense (Income)” field. When banks write off bad debts, they put the cost of those losses in these fields.

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Are unusual or extraordinary charges uniformly bad? Not necessarily. But they always warrant further investigation. After you identify a substantial charge like this, start hunting around the Internet based on the year or quarter of the charge to find more details. A simple Google search for your company and “one time charges” or “extraordinary expense” will yield good results most of the time.

Look at Profit and Revenues Together

You might be wondering why we bothered to look at revenue first if profits are broken out separately. Isn’t profit more important?

In a way, yes. Obviously a company spending more than it takes in is bad. But profits also can be faked by squeezing out bigger margins or cutting costs. Many companies did more with less during the recession to boost profits, when boosting sales wasn’t an option.

Similarly, a company that is facing tough competition might slash prices and sacrifice margins. Imagine if Kellogg started selling its cereals for half price. It would sell millions more boxes of Rice Krispies … but it would sacrifice profits big-time.

There is a necessary balancing act between both profits and earnings, and you must look at them together. Ideally a company will see both profits and revenue on the rise, proving the company is not just selling more, but also raking in more dough.

Think critically about your research on both of these metrics, because they overlap.

The good news, however, is that the numbers often appear in the same reports, so you won’t have to do too much more work to find the numbers and compare them side-by-side

Check out a complete list of Investing 101 articles by Jeff Reeves for more on learning how to invest and pick stocks[3].

Don’t want to keep clicking? Then download the complete series of Jeff’s educational articles for just 99 cents via his e-book “The Frugal Investor’s Guide to Finding Great Stocks: 11 Free Resources to Help Beginners Identify Fantastic Investments.”[4]

You can also buy a printed copy of “The Frugal Investor’s Guide” [5]for $15.10 via online publisher Lulu.

  1. [Image]:
  2. how to do exhaustive revenue research:
  3. learning how to invest and pick stocks:
  4. “The Frugal Investor’s Guide to Finding Great Stocks: 11 Free Resources to Help Beginners Identify Fantastic Investments.”:
  5. buy a printed copy of “The Frugal Investor’s Guide” :

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